Here comes the bust: Financial experts warn of massive global crisis

The global economy is still struggling to recover from the 2008 financial crisis that hit the world’s biggest economies the hardest. Now, financial experts are warning that developing economies are on the brink of similar economic pain– and it’s expected to trickle up.

That’s according to an annual report out from the Bank for International Settlements, which contends that the next financial crisis will be caused by a bust in emerging economies where economic upticks in recent years sparked increases in borrowing and inflationary spending.

From the report:

The main cause of the next recession will perhaps resemble more closely that of the latest one – a financial cycle bust …

In fact, the recessions in the early 1990s in a number of advanced economies, without approaching the depth and breadth of
the latest one, had already begun to exhibit similar features: they had been preceded by outsize increases in credit and property prices, which collapsed once monetary policy started to tighten, leading to financial and banking strains.

Emerging economies like China are expected to be hit hardest by the growing debt bubble, but BIS predicts that the ensuing ripple of defaults will have global implications.

BIS reported:

Leading indicators of financial distress signal risks from high private debt and house prices in several economies that were not at the epicentre of the [global financial collapse.]

High household debt might become a drag on demand in some countries, especially if rising interest rates were to boost debt service burdens.

In addition to increasing debt in developing economies, BIS points to economic policy shifts in the U.S. and Britain toward protectionism as one of many catalysts of coming global financial trouble.

From the report:

Financial markets were confronted by a changing political environment as the economic background brightened. Political events surprised market participants, who quickly needed to take views on the shifting policy direction and its economic implications. Attention shifted away from monetary policy, and political events took centre stage. A natural consequence of this reorientation was a change to longestablished patterns of correlation and risk. Instead of broad-based swings between “risk-on” and “risk-off” positions, investors began to differentiate more across sectors and countries. Bond yields diverged across the major economies, with knock-on effects on foreign exchange markets. At the same time, a gap opened up between surging measures of policy uncertainty and record-low financial market volatility, while a number of indicators pointed to increased tail risks. Pricing anomalies that emerged in the aftermath of the Great Financial Crisis (GFC) retreated but did not disappear, suggesting that such anomalies may have become a more permanent feature of markets.

BIS, it’s important to remember, is as Bloomberg puts it, “the central bank of central banks.” So when Claudio Borio, the BIS’s chief economist, says the global economy faces recession that will arrive “with a vengeance,” you can expect that economic policymakers at the highest levels of all governments are listening.

For observers in the U.S., this means the central bank will likely begin to push back more vigorously against Trump administration policies that would benefit the U.S. at the expense of the global financial community.

The European Central Bank is already calling the Trump administration a “threat” to the global economy. Just last week, it declared in its Economic Bulletin:

Since the U.S. election, pressures for more inward-looking policies have risen … In particular, there is significant policy uncertainty surrounding the intentions of the new U.S. administration regarding fiscal and, especially, trade policies, the latter entailing potentially significant negative effects on the global economy.

And while the Federal Reserve’s mandate is pretty straightforward– keeping employment and interest rates balanced within the U.S. economy– it’s no big secret that the nation’s central bank believes its monetary responsibility extends far beyond the real of federal. 

A big part of the reason is that some 70 percent of so-called dollar-bloc economies move in lockstep with Fed interest policies, despite having different domestic economic realities than the U.S.

Fed Chairman Janet Yellen put pretty plainly her belief in the global responsibility held by the U.S. central bank during a 2010 speech while she was still the president of the San Francisco Federal Reserve:

For all practical purposes, Hong Kong delegated the determination of its monetary policy to the Federal Reserve through its unilateral decision in 1983 to peg the Hong Kong dollar to the U.S. dollar in an arrangement known as a currency board. As the economist Robert Mundell showed, this delegation arises because it is impossible for any country to simultaneously have a fixed exchange rate, completely open capital markets, and an independent monetary policy. One of these must go. In Hong Kong, the choice was to forgo an independent monetary policy. Thus, interest rates have essentially moved in lockstep with those in the United States, with the exception of Hong Kong’s one-off 1 percentage point cut in October 2008 to narrow the spread of its discount window lending rate relative to the federal funds rate.

She went on to note that China’s financial policy is also, though to a lesser extent, tied closely to the decisions made by the U.S. Fed.

Per the BIS report, China is facing some of the most damaging consequences of the coming financial bust. Simultaneously, Trump administration trade policies designed to better serve American workers are likely to put increasing pressure on the Chinese economy.

It isn’t a stretch to believe that the U.S. central bank would work to offset the president’s policies in the interest of the global economy; even if that means setting aside some concerns about the economic well-being of Americans.
On the campaign trail, Trump was an outspoken critic of the Fed, going so far as to call for the passage of “audit” legislation long championed by American conservatives suspicious of the central bank’s true intentions. But the president has since tempered his rhetoric.

If Trump’s call for U.S. economic policy that benefits America first was sincere, his best bet is to prioritize the push for an audit while simultaneously cleaning house at the Fed. The president has the authority to fire any Fed governor for cause, of which he could likely find plenty– but even some conservative economists argue that could cause unnecessary trouble in the markets.

Still, there’s an easier way for Trump to begin the process of making sure the Fed’s policy has American well-being at its center. Yellen’s term is coming to an end in February, meaning the president has a good opportunity to begin reforming the Fed from the top.

Earlier this month, Treasury Secretary Steven Mnuchin told Bloomberg that there’s currently no consensus within the administration on whether Yellen will be replaced or asked to stay on for another term.

If that’s true, it should be troubling for anyone whose vote for Trump was primarily cast in hopes of an economic future centered on American interests. The next Fed chairman is going to set monetary policy which will either set the U.S. on course to weather any global uncertainty with strength at home or tie American economic outcomes to struggling foreign economies in the interest of protecting globalization and the international corporations it benefits the most. We know where Yellen stands.

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