The Next Global Financial Crisis

Posted: February 24, 2016 in Economics

There is a storm coming. The next financial crisis is looming around the corner. The sword of Damocles is hanging over all our heads. I say “our heads”, because we all live in a financially interdependent and intertwined world. Anyone who believes that they are truly financially independent must literally be living like Matt Damon in the Oscar nominated “The Martian”. The velocity and intimacy of the financial interdependence between all countries in the world has been increasing exponentially. Advances in communication and transportation technology, combined with free-market ideology, have given goods, services, and capital unprecedented mobility.

In 1965, Intel co-founder Gordon E. Moore observed the exponential increase of the number of transistors on integrated Circuits – Moore’s Law. Essentially, this means that processing capacity for computers is doubling yearly. This phenomenon has continued until today, with the number of internet users worldwide following similar trends. The explosion of technological progress over the last 25 years has helped facilitate a worldwide interconnection that continues to increase exponentially every day. The speed and ease of executing financial transactions privately or in the open market have also followed the aforementioned technological trends. The increased reaction speed of worldwide markets to information, true or false, makes it increasingly difficult to hedge against a worldwide crisis. The next crisis will come to fruition much more rapidly than in 2008. News travels like lightning across the globe – especially bad news.

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2016 has commenced with the worst start to the S&P index in its recorded history. After the 2008 Financial Crisis, The Dodd Frank Wall Street reform act implemented in 2010 has promised “sweeping overhaul of the United States financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression”.  This act has surely made the U.S. financial system more robust – but not unbreakable. Ever since the 2008 crisis, most of the world has been dependent on the Federal Reserve’s massive bond buying program (quantitative easing) to prop up equity prices and stimulate growth in emerging markets. Quantitative Easing is basically the Federal Reserve (not a government agency – a central bank), “buying” (with an IOU) “distressed” assets from other banks, in order to relieve the bank’s balance sheets so they can continue lending money, therefore increasing the money supply. In theory, this practice is supposed to assist the economy by ensuring liquidity and consumer/lender confidence.

In the other side of the pond, European banks have adopted “Negative Interest Rates”. Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. As crazy as it sounds, several of Europe’s central banks have cut key interest rates below zero and kept them there for more than a year. Now Japan is trying it, too. Negative Interest Rates work by by imposing penalties on excess reserves left on deposit with central banks, negative interest rates drive stimulus through the supply side of the credit equation – in effect, urging banks to make new loans regardless of the demand for such funds.

Quantitative Easing can be likened to a mail-in rebate after a retail purchase. You (Central Bank) make a purchase (buying distressed asset from financial institution) because you believe that you will be re-reimbursed (Central Bank buys distressed asset for discounted price, asset is assumed to go up in value after hectic period). Negative interest rates can be likened to a clearance sale. You (Central Bank) make a clearance sale (giving loan to a financial institution at rock bottom price) because you believe that having the clearance item in your inventory is costing you more money than it’s worth. The above scenarios are examples of monetary policies which are designed to manipulate inflation, the money supply, interest rates and overall economic activity.

A financial crisis has occurred in the U.S. about every five years, on average, since the end of WWII; and it has been seven years since the last one — we are overdue. The next crisis will be here in a few years, here is why:

China’s economy has slown down considerably. The Chinese stock bubble is deflating amidst new projections that the economy cannot sustain its booming growth in prior years. This spells trouble for the rest of the world, because most developed countries are financially vested in China and/or rely on them for raw materials. The Chinese economy is moving from puberty to adulthood, and is trying to shift slowly from primarily exporting goods, to relying on domestic production. Unfortunately, this changing of gears does not look good on paper because China is no longer slated to exceed its economic expectations. Additionally, there is confusion about the reality of the Chinese situation because of questionable accounting methodologies and absent financial regulations. The United States sells hundreds of thousands of cars (among other goods) to China every year. If Chinese consumers are unable to buy American vehicles because the economy in China is faltering, the United States suffers. Financial interdependence.

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Oil prices have been under $30/barrel for over a year now. The reason for cheap oil, is because of growing concerns over the Chinese economy, fears of a persistent surplus in oil supplies, and most recently the removal of sanctions on Iran. Iran has vowed to bring back 500,000 to 1 million barrels per day (mb/d) in oil within a year. This translates into cheaper gas at the pump because of excess supplies, but layoffs and eventual bankruptcies at many U.S. energy companies. Cheap oil is keeping inflation at bay, but if the oil investment bubble bursts in the next couple of years, it will send a shock wave throughout most developed economies.

The officially unemployment rate is currently at 5%. The problem with this “official” rate is that it does not count workers who are too discouraged to continue looking for a job. The real unemployment rate if you add back workers who have been discouraged less than a year is 10%. If you add back workers that have been discouraged for more than a year, the unemployment rate is 23%. If you calculate the number of workers over the age of 16 and divide that number by the U.S. population, the rate is about 40%. Aside from the fact that Baby Boomers are breaking the Social Security bank, the real unemployment rate has been rising because there are more discouraged workers every day – many of them Baby Boomers. Over the next few years, the real unemployment rate will continue to rise; it is a mathematical certainty. A rising unemployment rate “official” or otherwise, will deliver stress to the economy, incarnated by rapid media coverage.

The $1 Trillion dollar Student Loan Bubble. An ever growing number of American students are graduating from college staring down the barrel of a debt gun. Wages are not climbing along with the ballooning amount of student debt in the U.S. today. The average college graduate carries a load of about $35,000 today. The cost of education continues to rise, while baccalaureate salaries are barely keeping up with inflation. Unfortunately average student loan debt will continue to increase over the next couple of years.

Eurozone. The Eurozone recovery remains disappointingly weak after Greece fell back into recession and Italy has slowed into stagnation. Portugal only grew by 0.2% in the last quarter, down from 0.4% in the third quarter. That’s a blow to Lisbon’s new left-wing government, as it tried to unwind some of the austerity measures implemented by its predecessors. Finland, one of the most fervent supporters of austerity during the debt crisis, is also still shrinking. GDP fell by 0.1% in the last quarter. Germany grew only 0.3% in the third quarter because of exports falling faster than imports (cars to China). The European situation is getting more desperate every day and is compounded by negative interest rates and an influx of migrant workers into countries with unique, but mostly dismal Economic outlooks.

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The combination of the above factors will help facilitate another financial crisis in a few years. There is something that I haven’t mentioned, a Black Swan. A Black Swan is a rare and unforeseen event that is almost impossible to account for. The next crisis will be driven to a cliff by the aforementioned factors. The Black Swan will kick the global economy over the cliff. After that, we will build increasingly robust financial models that promise to account for all uncertainty – an uncertainty in itself.

 

 

 

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