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Prepare Now for the Next Financial Crisis

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The Asian financial crisis started 20 years ago and the global financial crisis and recession 9 years back. When a new global financial crisis strikes, the developing countries will be more damaged than in the last crisis as they have become less resilient and more vulnerable.  They thus need to prepare from being overwhelmed.

A debate is taking place as to whether the time is now ripe for a new crisis.  Most economists and commentators think not, as an economic recovery, admittedly weak, appears to be taking place in developed economies.

On the surface, the present situation seems quite good.  The US stock market continues to hit new highs, and the head of the Federal Reserve recently testified the US economy is robust and job growth is good.

There has been a rebound of foreign capital flows to emerging economies in the first half of 2017, after two years of outflows.

The G20 leaders focused on climate change, trade and disagreements with the United States in their Hamburg summit, and seemed complacent about the world’s economic condition; they didn’t worry about any looming crisis.

But below the surface calm, the waters are boiling and churning.  As Shakespeare wrote in his play Hamlet:  “Something is rotten in the state of Denmark.”

Whether the deep-seated problems boil over shortly into full-blown crisis, or continue to fester for some time more, is hard to predict.  But the world economy is in trouble.

Amidst a weak global economy recovery, many serious risks remain, wrote  Martin Wolf, the Financial Times’ chief economics commentator, on 5 July.

“The possibly greatest danger is a collapse in global cooperation, perhaps even an outbreak of conflict,” he said.  “That would destroy the stability of the world economy on which all depend…

“We in the high-income countries allowed the financial system to destabilise our economies.  We then refused to use fiscal and monetary stimulus strongly enough to emerge swiftly from the post-crisis economic malaise.

When a new global financial crisis strikes, the developing countries will be more damaged than in the last crisis as they have become less resilient and more vulnerable. They thus need to prepare from being overwhelmed, says Martin Khor

Martin Khor

“We failed to respond to the divergences in economic fortunes of the successful and less successful.  These were huge mistakes.  Now, as economies recover, we face new challenges: to avoid blowing up the world economy, while ensuring widely shared and sustainable growth.  Alas, we seem likely to fail this set of challenges.”

The Star (Malaysia) on 12 July reported that the possibility of the US Federal Reserve raising interest rates and reducing its balance sheet of US$4.5 trillion is causing regional stock markets and currencies to fall and funds to flow out of the region.

Is this another blip that will be corrected soon, or the start of a turn of the boom-bust cycle in capital flows to and from emerging markets?

A comprehensive and in-depth analysis of the global economic situation and how it affects developing countries is given in a recent paper by the South Centre’s chief economist Yilmaz Akyuz, assisted by Vicente Yu.

The US and Europe have wrongly managed the aftermath of the 2008 crisis by policies that will have very adverse effects on most developing countries, according to the paper, “The financial crisis and the global South:  impact and prospects.”   (South Centre Research Paper 76;)

The developing countries went through the 2008 crisis without much harm, because of certain conditions, which no longer exist.

Meanwhile, these countries have recently built  up new and dangerous vulnerabilities which expose them to serious damage when the next crisis strikes.

It is thus imperative that the developing countries review their precarious situation and act to protect their economies to the extent possible to reduce the effects of the new turmoil.

It is thus imperative that the developing countries review their precarious situation and act to protect their economies to the extent possible to reduce the effects of the new turmoil.

Akyuz says the post-2018 crisis has moved in a third wave to several emerging economies after having swept from the US to Europe. A central reason is the wrong crisis response policies of the US and Europe.

“There are two major shortcomings:  the reluctance to remove the debt overhang through orderly restructuring, and fiscal orthodoxy,” adds Akyuz.

“These resulted in excessive reliance on monetary policy, with central banks going into uncharted waters including zero and negative interest rates and rapid liquidity expansion through large bond acquisitions.

“These policies not only failed to secure a rapid recovery but also aggravated the global demand gap by widening inequality and global financial fragility by producing a massive build-up of debt and speculative bubbles.  They have also generated strong deflationary and destabilising spillovers for developing economies.”

When a new crisis comes, developing countries will be harder hit than in 2008.  Their resilience to external shocks is now weak, due to three factors.

First, many developing economies deepened their integration into the international financial system, resulting in new vulnerabilities and high exposure to external shocks.

Their corporations built up massive debt since the crisis, reaching US$25 trillion (95% of their GDP);  and dollar-denominated debt securities issued by emerging economies jumped from $500 billion in 2008  to $1.25 trillion in 2016, carrying interest rate and currency risks.

Moreover, foreign presence in local financial markets reached unprecedented levels, increasing their susceptibility to global financial boom-bust cycles.

Second, the current account balance and net foreign asset positions of many developing countries have significantly deteriorated since the crisis.  In most countries, foreign reserves built up recently came from capital inflows rather than trade surpluses.  They are inadequate to meet large and sustained capital outflows.

Third, the countries now have limited economic policy options to respond to adverse developments from abroad.  Their “fiscal space” for counter-cyclical policy response to deflationary shocks is much more limited than in 2009;  they have significantly lost monetary policy autonomy and lost control over interest  rates due to their deepened global financial integration; and flexibile exchange rate regimes are no panacea in the face of financial shocks.

“Most developing economies are in a tenuous position similar to the 1970s and 1980s when the booms in capital flows and commodity prices ended with a debt crisis as a result of a sharp turnaround in US monetary policy, costing them a decade in development,”  warns Akyuz.

It would be hard for some of them to avoid international liquidity or even debt crises and loss of growth in the event of severe financial and trade shocks.

Unfortunately, the South has not been effective in reflecting on these problems nor in taking collective action.

Global reforms are required to prevent the major countries from transmitting the effects of their wrong policies to developing countries; and global mechanisms are needed to prevent and manage financial crises.

There have been many proposals for reform in the past but hardly any action taken due to opposition from developed countries.

“Now the stakes are too high for developing countries to leave the organisation of the global economy to one or two major economic powers and the multilateral institutions they control,” concludes Akyuz.

If his wide-ranging analysis is correct, then the crisis that started in 2008 will enter more dangerous territory due to new factors fanning the flames.

The underlying  causes are known, but what is yet unknown is the specific event that will trigger and ignite a new phase of the crisis, and when that will happen.

When the new crisis takes place, developing countries will in a less fortunate position to ride through it compared to 2008, so there is ever less reason for complacency.

Each country should analyse its own strong and weak spots, its vulnerabilities to external shocks, and prepare actions now to mitigate the crisis in advance, rather than wait for it to happen and overwhelm its economy.

IPS



10 Comments on "Prepare Now for the Next Financial Crisis"

  1. Davy on Mon, 24th Jul 2017 6:19 am 

    The next shock will be global. The last shock was global but now with debt and asset markets so elevated everywhere the ability of Central banks to provide liquidity is greatly reduced. Dollar denominated debt is so huge the Fed does not have the ability to manage it this time around. Much of this debt has been created outside of the Fed’s control. It is not yet clear how a crisis will happen and this is because the system is now repressed. Central banks are deep into market making and have interest rates locked in a low range.

    What can’t be controlled is confidence and that will be reflected in economic activity. Central banks can’t control economic activity at a certain level. You can’t make people spend and invest. We are now in a world where it is human nature that is the real danger. Otherwise we are increasingly likened to a climax ecosystem with all niches filled. Such systems are robust but brittle. They cannot bend too far or they break. We are now late term civilization because of this.

    I was once a near term doomer. I saw forces that appeared to be converging that would cascade into a destructive decline. I am not sure now because of this late term climax civilization we are in. We are prevented from straying too far from the herd by forces of the herd. There is nowhere to go now for money and people as was once the case. Once we could ditch a country and find a new place to live or park money. Now all places are vulnerable from dispersed risk.

    In such a world talking about a US or Chinese crisis in isolation is not valid. We will crisis together. This is influencing socio-political sentiment. The world is becoming multi-polar and unable to be steered by any one power both politically and economically. This is the end of American domination but by no means the end of its influence. Those who claim empire in waiting will be disappointed. Europe and Asia have no place to go.

    The next financial crisis will likely be a big one and it could be the end game of civilization because of this. We will see crisis that don’t amount to much. Extend and pretend will work for a time. At some point a perfect mix of events will sink this global financial arrangement. We have laid the foundation for this. It is anyone’s guess when this will occur because normal price discovery and free markets are no more. Power is concentrating and wealth is being transferred to ever smaller circles and these circles will cooperate to maintain this arrangement. They understand very well what is going on at some levels but on other levels they are oblivious. This is process is self-organizing and beyond internal management. Yet, we can manage collapse and global suicide. Stay tuned for the next round of news but don’t get too concerned. The end will be a complete surprise.

  2. Shortend on Mon, 24th Jul 2017 8:11 am 

    My prediction…50 Trillion of acknowledged
    Federal debt ceiling and Dow Jones reaching 50,000….Its the 50/50 Law of Averages.
    But than again, I’ve been wrong before!
    One thing for sure, the next “crisis” will be ugly…any time a superpower faces such, the war option is taken, God Bless America!

  3. Makati1 on Mon, 24th Jul 2017 8:20 am 

    I wonder which pocket the U$ paid him out of, to write this bullshit?

    It is the developed countries that will suffer the most in the crash. But, tell the sheeple often enough that they are better off and they will eventually believe it. It’s called “propaganda”.

    The ‘developed’ countries are already in deep decline. All are 3rd world if the facts were known. DEBT is highest in those countries and their whole economy is dependent on it growing.

    “The (US) economy has been shrinking roughly 3% to 5% for the last sixteen years. Because of the magic of compounding interest, the economy is less than HALF what it once was when you factor in the REAL rate of inflation. More people, less than half the pie.

    Now, do you see why everything’s gone for shit? Now, do you see why so many people are out of work, or if they do have jobs, why they cannot make ends meet? Even good jobs pay half what they once did. Lousy jobs pay even less. Bullshit inflation statistics hide the real decline.”

    https://www.theburningplatform.com/2017/07/23/the-economic-collapse-began-long-ago/#more-155290

    LMAO

  4. Makati1 on Mon, 24th Jul 2017 8:21 am 

    If there is a god, she is laughing her ass off at America, not blessing it’s war mongering populace.

  5. Shortend on Mon, 24th Jul 2017 12:14 pm 

    Send Money, Guns and Lawyers…see there is a solution

  6. Makati1 on Mon, 24th Jul 2017 6:13 pm 

    Shortend, you just gave a perfect short description of the U$. It’s ALL about money, guns (selling them) and lawyers suing for more money.

    “Total Number of Lawyers in the U.S. According to the American Bar Association, grew to 1,143,358 by the end of 2007.” About one lawyer per 275 Americans. A sue crazy country.
    LMAO

  7. Apneaman on Mon, 24th Jul 2017 6:15 pm 

    Mak

    https://www.youtube.com/watch?v=lP5Xv7QqXiM

  8. Makati1 on Mon, 24th Jul 2017 6:21 pm 

    Thanks, Ap. I never heard that one. Very appropriate! ^_^

  9. Shortend on Mon, 24th Jul 2017 8:04 pm 

    Lawyers are to us here in the USA as High Priests were in the age of the Egyptian Pharaohs..basically myth makers to maintain “order”

  10. Makati1 on Mon, 24th Jul 2017 9:03 pm 

    For all you China (Asia) bashers…

    http://www.zerohedge.com/news/2017-07-24/lagarde-hints-imf-being-based-china-future

    “The People’s Bank of China official referenced how this trend was already underway. Just last year Standard Chartered bank began to maintain accounts in SDR’s. “In terms of the first and secondary markets they will develop fairly well.”

    The Great Leveling is well under way. LOL

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