Is the Next Global Financial Crisis Upon US?

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Financial markets are currently in a frenzy – and a global market crash could be just minutes away. Earlier last week, China allowed its currency to fall in value, prompting its highest one-day decline in over two decades. Today, data shows that China’s factories have contracted at their fastest pace since the most recent financial crisis. Market panic is quickly gaining pace as China’s economy shows clear signs of further deterioration.

The US stock market has experienced its largest decline in 18 months, European shares have experienced their biggest weekly fall this year, and the FTSE fell to its lowest point this year. John Ficenec of the Telegraph believes things are only going to get worse, and he gives us 8 convincing reasons why.

 

  1. China Slowdown

When the financial crisis struck in 2008, it was central banks that essentially stepped in and provided the finance to keep the world’s major economies afloat. Indeed, a significant stimulus package was put together for China.

(Here at Positive Money we have previously noted that China has progressively lowered its benchmark interest rates since 2011 and has lowered reserve ratios a number of times in the past years. Accordingly, Chinese private sector debt has quadrupled in the last 7 years, and we noted that soaring Chinese debt levels are one of three of the biggest threats to global financial stability.)

The Chinese stimulus prompted a housing and infrastructure bubble, absorbing many of the World’s commodities. Ficenec, therefore begins his article by suggesting that:

“China was the great saviour of the world economy in 2008. The launching of an unprecedented stimulus package sparked an infrastructure investment boom. The voracious demand for commodities to fuel its construction boom dragged along oil- and resource-rich emerging markets.”

However, Chinese demand has begun to slow:

“Economic growth has dipped below 7pc for the first time in a quarter of a century, according to official data. That probably means the real economy is far weaker… Data for exports showed an 8.9pc slump in July from the same period a year before. Analysts expected exports to fall only 0.3pc, so this was a huge miss. The Chinese housing market is also in a perilous state. House prices have fallen sharply after decades of steady growth. For the millions who stored their wealth in property, it makes for unsettling times.”

chart (3)

 

  1. Commodity Collapse

Prices of commodities are very good indicators of global economic activity. Thus, when demand for important raw materials (i.e. copper, iron ore, aluminium, zinc, nickel, lumber etc.) plummets and prices drop, we are given a good idea of what to expect from our economies.

It is thus no surprise, that Ficenec suggests as China’s economy activity continues to decline, demand for commodities will similarly continue to fall. Indeed, the massive slowdown in China’s economy has almost single handily prompted a collapse in the commodity markets:

“The Bloomberg Global Commodity index, which tracks the prices of 22 commodity prices, fell to levels last seen at the beginning of this century.”

 

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  1. Resource Sector Credit Crisis

Numerous loans worth billions of dollars were used to finance exploration and excavation of raw materials and oil. Thus, with the continued collapse in prices for these goods:

“Many of these projects are now loss-making. The loans raised to back the projects are now under water and investors may never see any returns… As more debt needs refinancing in future years, there is a risk the contagion will spread rapidly.”

 

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  1. Dominos Begin to Fall

Many of the emerging economies, with export-oriented economies are dependent on the returns from high commodity prices. Accordingly, they use the profits from their exports to purchase imports from Western economies. Thus, there is a clear domino effect from China, to emerging economies, to the West.

“The great props to the world economy are now beginning to fall. China is going into reverse. And the emerging markets that consumed so many of our products are crippled by currency devaluation. The famed Brics of Brazil, Russia, India, China and South Africa, to whom the West was supposed to pass on the torch of economic growth, are in varying states of disarray.”

According to Ficenec, there are three primary knock-on effects that this will have for the West. 1) The profits that many Western companies have been dependent on for the last 6-7 years will no longer be available. 2) The prices of the shares of these companies are presently over-valued based on their current earnings. 3) Thus, as the profits of these companies decline, their share price will decline even more abruptly.

The author consequently suggests that:

“The central banks are rapidly losing control. The Chinese stock market has already crashed and disaster was only averted by the government buying billions of shares. Stock markets in Greece are in turmoil as the economy grinds to a halt and the country flirts with ejection from the eurozone.

Earlier this year, investors flocked to the safe-haven currency of the Swiss franc but as a €1.1 trillion quantitative easing programme devalued the euro, the Swiss central bank was forced to abandon its four-year peg to the euro.”

 

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  1. Credit Markets Roll Over

Next, Ficenec suggests that:

“As central banks run out of silver bullets then, credit markets are desperately seeking to reprice risk. The London Interbank Offered Rate (Libor), a guide to how worried UK banks are about lending to each other, has been steadily rising during the past 12 months.”

The author makes a good point that this is actually quite a natural process and may in fact be a ‘healthy return to normal pricing’ after a number of years of unprecedented monetary stimulus by a various central banks. But more importantly, Ficenec points out that:

“As the essential transmission systems of lending between banks begin to take the strain, it is quite possible that six years of reliance on central banks for funds has left the credit system unable to cope.”

 

  1. Interest Rate Shock

Another reason to believe that things are going to worse from here is the potential for an interest rate shock.

“Interest rates have been held at emergency lows in the UK and US for around six years. The US is expected to move first, with rates starting to rise from today’s 0pc-0.25pc around the end of the year. Investors have already starting buying dollars in anticipation of a strengthening US currency. UK rate rises are expected to follow shortly after”.

This will be particularly problematic for many emerging economies which have in recent years taken out massive loans in U.S. dollars and U.K. sterling. As the dollar and pound begin to strengthen in value (appreciate), many of the emerging economies who depend on a devalued currency in order export more, will struggle to pay back their loans – as paying back those loans will require a lot more of their respective domestic currencies than originally intended.

 

  1. Bull Market Third Longest on Record

Ficenec then puts forward something that Positive Money has been stating for a long time, prices on the UK stock market have been increasing primarily due to Quantitative Easing programmes.

“The UK stock market is in its 77th month of a bull market, which began in March 2009. On only two other occasions in history has the market risen for longer. One is in the lead-up to the Great Crash in 1929 and the other before the bursting of the dotcom bubble in the early 2000s… UK markets have been a beneficiary of the huge balance-sheet expansion in the US. US monetary base, a measure of notes and coins in circulation plus reserves held at the central bank, has more than quadrupled from around $800m to more than $4 trillion since 2008. The stock market has been a direct beneficiary of this money and will struggle now that QE3 has ended.”

 

  1. Overvalued US Market

Low interest rates and Quantitative Easing programmes have most likely had the same effect on the US stock Market. Ficenic thus suggests:

“In the US, Professor Robert Shiller’s cyclically adjusted price earnings ratio – or Shiller CAPE – for the S&P 500 stands at 27.2, some 64pc above its historic average of 16.6. On only three occasions since 1882 has it been higher – in 1929, 2000 and 2007.”

 

 

 

 

 

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Frank Van Lerven

Frank is our Research and Policy Analyst, and is responsible for our research on current events. Frank also leads our research in Public Money Creation and Quantitative Easing. Prior to working on the availability of credit under a Sovereign Money system, Frank also researched issues related to the 1844 Bank Charter Act and its implications for contemporary monetary policy. With a Research Master’s in Advanced Political Economy (cum laude) and a BA in African Development Studies, Frank is especially interested in how Western financial systems (and models) influence developing economies.
  • adiosspain

    My SOVEREIGN money is on Japan falling over first. For 17 years they have been propping up the credit dream with sovereign money. Gradual devaluation of its sovereign money through years of QE for finacials, has left the country very weak. As a manufacturing export nation it will have to devalue again.

    • Barney Rubble

      If that Sovereign Money was used for the real economy, (to fund tax cuts – i.e. instead of increasing consumption tax in April 2014, or for a citizens dividend fund, infrastructure investment) inflation target would have been hit by now…

      • adiosspain

        Your absolutely correct. But this would have cut the banks out of a nice little earner. I also don’t think the wealthy elite are to happy about using QE directly in the economy as it devalues their £billions. Its a real stitch up. Banks create our money out of thin air then charge us interest on it. This is where the transfer of wealth originates. I hope you join positivemoney we need people like you who question the status quo .

        • RJ

          Charged us interest to cover their running costs and debt write offs. And to allow a small dividend payout.

          • adiosspain

            Running costs? They don’t have to pay savers for money they create. Debt write offs are in the main due to banks own fault for making risky loans and inflating asset bubbles. Expansion of money due to credit creation has caused untold damage to our people and the economy. There is no defence of credit banks that will convince me they are fit for purpose . 2008 crash was just the start of what is to come and soon judging by recent global developments.

          • RJ

            Staff salaries, rent, power, tax etc

          • adiosspain

            What just like any legitimate business? Credit bankers are criminal counterfeites. Legitimate businesses don’t destroy peoples lives. If you want to defend them then your no better than them. Enjoy the crash!

          • RJ

            Rubbish. Banks have expenses, are legitimate and have real competition just like many other businesses. and people like you not seeing this and blaming it all on banks are the real main problem we have today. The UK Govt have all the power RIGHT NOW but choose not to use it. The real danger is they could lose this sovereignty like Euro countries have. And might do with a reform of the banking system if people wrongly think just kicking the banks will change everything.

          • adiosspain

            Credit banks are not legitimate businesses, they are counterfeiters. Won’t be replying to any more of your idiotic comments. Stick with the daily mail.

    • RJ

      No it hasn’t re QE. QE is an asset swap no more.

      • adiosspain

        Yep central banks buying government bonds. Result gradual devaluation of currency.

        • RJ

          Why. They use reserves (an asset created by JEs) to buy back Govt bonds (another asset created by journal entries)?

          • adiosspain

            UK bank regulation forces banks to hold 3% liquidity to leverage. How they get sovereign money into bank liquidity is a bit complicated. It is explained better than I could on the boe web site ( money creation in the modern economy).

          • RJ

            Don’t both govt bonds and reserves count as liquidity. So it makes no difference

          • adiosspain

            Gov bonds are assets, liquidity is a type of electronic cash central banks use to move bank reserves.

          • Barney Rubble

            Government bonds are assets of the holders and a liabilities of the issuers, every asset is someone else’s liability. Liquidity is DEFINITELY not “a type of electronic cash central banks use to move bank reserves “. In non-technical terms, liquidity essentially refers the ability to provide central bank liabilities on demand (thus the ability convert assets into cash or reserves on demand). Government bonds are liquid assets, however, central bank reserves are considered the ‘most liquid’ assets – as they are de facto central bank liabilities- so yes they both have liquidity connotations attached to them. You also might want to look up how devaluation works…

          • adiosspain

            This explains it.http://positivemoney.org/how-money-works/advanced/how-quantitative-easing-works/ and I know how devaluation works. liquidity is cash or anything hat can be converted into cash quickly. UK bank reserves are held in electronic form at the BOE, this allows the BOE to move reserves from one bank to another to makeup balance of payments on credit transactions between banks. In Japan QE has been used to buy many different asset types not just gov bonds.the more QE that is created the more devalued the currency becomes.

          • RJ

            Re Japan. Why (devalue the currency) unless the assets are bought at an inflated value. But even if it was why?

          • adiosspain

            You are correct if assets are bought with QE at inflated prices this devalues the currency if the assets are sold at above purchase price then this would increase currency value. Personally I think of sovereign money as shares in an asset. The more shares created the less value each share has. The asset being the national wealth of the state. Others may think of it differently but this works for me.

          • RJ

            It doesn’t work for me. If one asset is swapped for another one then what is the issue. If deficit spending resulted in full employment and then the Govt just kept on spending more and more then maybe it would. but just an asset swap? It makes no sense why this would

          • Barney Rubble

            Then why does most of the devaluation of a currency actually happen before QE takes place, when investors for example expect QE to be implemented?

        • Wacfuk

          Not necessarily. What if it’s set against a back drop of decreasing money supply in the real economy and money used for buying the bond in the first place is not used in the real economy?

          • adiosspain

            That’s why we have 0 inflation in the uk. QE was not put into the real economy, and growth from people lending is being taken out by debt repayment and trade deficit. Japan is a bit different as this article explains.http://english.pravda.ru/world/asia/10-04-2015/130252-japan_default-0/

          • Wacfuk

            So in regards to Japan we have a shrinking Economy due to population decline in which a decreasing money supply is what naturally happens. This might not necessarily be a bad thing except for the stickily proplem of servicing soviergn debt which depends on growth and inflation. Do I have this correct? Are there any credible solutions to these problems?

  • keithfromashford

    This is the oncoming crisis.

    The same crisis as 1999 and 2008, but a bit worse this time:

    “Leveraged Financial Speculation in the US at a Familiar Peak, Once Again”

    http://www.zerohedge.com/news/2015-08-30/leveraged-financial-speculation-us-familiar-peak-once-again

  • keithfromashford

    Many years ago when Alan Greenspan first proposed using monetary policy to control economies, the critics said this was far too broad a brush.

    After the dot.com crash Alan Greenspan loosened monetary policy to get the economy going again. The broad brush effect stoked a housing boom.

    When he tightened interest rates, to cool down the economy, the broad brush effect burst the housing bubble. The teaser rate mortgages unfortunately introduced enough of a delay so that cause and effect were too far apart to see the consequences of interest rate rises as they were
    occurring.

    The end result 2008.

    With this total failure of monetary policy to control an economy and a clear demonstration of the broad brush effect behind us, everyone decided to use the same idea after 2008.

    Interest rates are at rock bottom around the globe, with trillions of QE pumped into the global economy. The broad brush effect has blown bubbles everywhere.

  • http://www.moneryreformsindia.org Sumal Raj

    when investors loose money when stock markets crash somebody should get that lost money.. who gets it??? or this money simply disappear from economy as when loans are repaid…????

    • sjonniedroid

      No one gets it. It is value that decreases. It’s like the value of your own house, if it drops then it drops. If you ever decide to sell it then you will get less money.

      The same with the stock market. When you have stocks, you don’t have money, you just have value. If the value decreases then the value just vanishes, unlike money.

      On the other hand, the value can increase. Unlike 1 dollar in your pocket, that 1 dollar will stay one dollar forever.

      • http://www.moneryreformsindia.org Sumal Raj

        but stock or house is also brought with currency or electronic money … when the value decreases the difference should be earned by the person who had sold it for a higher price in the first instant. how could that money ever disappear??? vice versa also..

        • sjonniedroid

          That money does not dissapear.

          I got 1,000 dollar stocks, I sell it to you for 1,000 dollars (so 1000 value for 1000 money).

          A year from this transaction your stocks value decreases to 500. The value is 500, I still got 1000 dollars. As you can see the money does not dissapear, but value can decrease (dissapear).

          • http://www.moneryreformsindia.org Sumal Raj

            so person who sold it earned the lost 500$ value….if the reverse happen say value increases 1500…where the extra 500 dollar will come to the economy?

          • sjonniedroid

            He does not earned the lost 500$ value… I think you are fundamentally confused about value and money.

            To shortly answer your question, the 500 dollar will come from the buyer who buys the now increased value of the stocks (1500).

            If I sell you a bike for 100 dollars (marketprice). And next week the wheels are damaged because you hit a car, your bike will decrease in value, this does not mean I earned the lost value of your bike. It just means that the bike decreases in value, that is it. So if you sell it will be worth less.

            If I sell you a bike for 100 dollars (marketprice). and you upgrade the bike with wheels made of gold, the value of the bike will increase. If you sell it, it will then be worth more.

          • http://www.moneryreformsindia.org Sumal Raj

            yes thanks for your reply …i am trying to understand may be i am asking another foolish question… I understood the increase and decrease in value of a product. it will change according to market condition and situations. I want to understand the link between value and money take this example there is only one product in the whole world that is 1 cycle and only 100$ in existence and only 2 persons the wheel is damaged due to some reason and its value decreases to 50$. then the person who holds the cycle lost 50$ and the person who hold the dollar has 50$ extra. likewise when we take the whole share market when the value decreases (crashes) the equivalent money should be the gain of money holder. and if the value increases extra money should be created to buy it. so my point is when the market crashes the value decreases for the people who hold the share but the money is still their it is not destroyed ..can it be considered as the profit of the person who holds the money???

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