The next financial crisis?
Published in the Geelong Advertiser, 28 September 2011, p. 22 as ‘Reconciling price, real vlaue is just trouble.’ Roy Hay
This column does not offer financial advice. Nor is it very good at predicting the future. Trained as an economic historian with twenty-twenty hindsight, I can tell you how we got into this mess, but I cannot pretend to know how we will get out of it. All I can do is outline some of the issues in play, in the hope that you find that useful.
We are still feeling the effects of the global financial crisis (GFC) of 2007–2009 and the excesses which led to it, and we have not learned all the lessons therefrom or applied the remedies we thought were appropriate. That crisis came about essentially because significant players in financial markets had cut the links between any conceivable value of assets they held and the price at which they were trading them. They were simply doing what always tends to happen in a boom, gambling that they could make money on the trade before the collapse in prices occurred.
Thought the cant phrase is ‘nothing is inevitable except death and taxes’ the reality is that speculative bubbles always end in tears and consequences which take much longer than you might expect to unravel. Governments tried with varying degrees of success to mitigate the effects of the GFC by strengthening prudential measures affecting the lending policies of banks and other institutions and by a variety of stimulus packages to prevent economies falling into recession. Australia came through this phase better than most, in part because the Howard government had used the previous boom period to pay down national debt to historically low levels, though private borrowing had grown significantly. The skyrocketing demand for Australian raw materials thanks to the growth of China and the fact that Australian banks were not committed to a large extent to some of the more outlandish complex financial transactions going on in the United States home loan market also helped. Many other countries were not so lucky and it was not just the banks but national treasuries which were now under pressure.
Sovereign debt was believed to be safe because governments could always use taxation to raise internal funds to meet their obligations. This was the case when national debts tended to be a small proportion of the gross domestic product of most countries. The ones that exceeded these ratios were usually small, peripheral nations whose dodgy practices hardly threatened the international system and when they defaulted the impact was limited. There were exceptions such as the first Baring crisis in the 1890s when the bank was brought to its knees by overextending itself in loans in Argentina.
However, in the 21st century some major countries have built up very substantial debts during the era of easy money that preceded the GFC. In the case of Greece, joining the European community and the Eurozone, the single currency now used by all members except the United Kingdom, was supposed to introduce some fiscal discipline but it did not curb Greece’s binge on debt to the point where no conceivable measure of austerity can enable it to meet its short-term obligations. So it looks as if a partial default on its debt is being considered with the banks that are holding the Greek debt being supported out of a general European fund, probably backed by the International Monetary Fund. Will this so called ‘orderly default’ calm the market jitters or simply transfer the focus of concern elsewhere, perhaps to Spain or Italy? That is a real risk.
But debt is not just a Greek problem or even a European one. The United States has an economy that is just on the brink of recession and it has less room for fiscal stimulus thanks to the level of debt it has incurred. Much of this is held by China and that has consequences for the rate of growth of the economy that has been underpinning Australian resource exports.
Though there is much gloom in the current economic outlook and a high level of risk that the world economy will grow more slowly in the next few years, there are some amazing opportunities in the development of new technologies to meet the challenge of global sustainability. Collectively these have the potential to institute a new era of economic and social development if people could lift their focus for a moment. So I remain a glass-half-full economic historian.