• The Return of the Economic and Financial Crisis – Nervous Financial Markets and the Slowdown of the Worldwide Boom(1)

  • Auteur Joachim Bischoff | 19 Apr 19
  • It is no longer possible to deny that the world economy is growing more slowly now. The global boom lost traction starting in the second half of 2018. As a whole, the global economy had grown in 2017 more strongly than it had in years. Worldwide growth in 2018 amounted to only 2.9 per cent. And the World Bank is forecasting further decline for 2019. The diminishing dynamic will affect entrepreneurial profits. China, whose importance has grown in recent years, is no longer seen as an accelerating factor for the decreasing traction of the locomotive of the global upswing – the USA. Even pro-system market observers and experts are not only worried about the slowdown of growth, which typically diminishes in late- cyclic phases. Exactly at a time in which the economy has gone beyond the peak of its boom cycle, the banks of issue want to ‘normalise’ their monetary and credit policy. Until recently, an expansive monetary policy was the guarantor of booming security markets and rising real-estate prices. More restrictive parameters are risky for debt-ridden companies, which have for some time now been finding it difficult to attract new funds.

    The basis for the upswing ten years after the outbreak of the Great Financial and Economic Crisis of 2008 was the policy of the banks of issue. They were the institutions that, when the crisis broke out, prevented collapse of the global financial system and stimulated recovery with extremely low interest rates. ‘Thanks to central banks’ concerted efforts and their accommodative stance, a repeat of the Great Depression was avoided. Since then, historically low, even negative, interest rates and unprecedentedly large central bank balance sheets have provided important support for the global economy […].’[2]

    For now, the US economy is still running smoothly. With his radical tax reform, Trump wants to drive growth up to at least 3%. Considering the favourable conditions in the labour market the shopping mood of Americans is hardly surprising. The tax reform provides for lower corporate tax rates and less taxes for the rich. The manifold punitive tariffs and trade disputes have not thrown much of a shadow on the value-added process. Corporate investment is already running out of steam. But it could be strengthened if the customs duty conflict escalates.
       The boom in most EU countries is continuing, and even the countries of East and Southeast Asia are showing good growth rates. But global economic growth in recent months is less synchronised. In China too, state expenditure programmes are supporting growth. By contrast, growth is faltering in the Eurozone,[3] Japan, and Great Britain. The less synchronised global upswing evidences clear weaknesses in subareas: While some countries are doing well, the emerging economies – above all Turkey – are showing clear symptoms of crisis. Moreover, risks have recently increased.
       There is a paradox: In the midst of an economic upswing broadly supported by investments and trade, the Trump administration is endangering the boom. Part of the paradox is that the voters and supporters of a renewal of US capitalism will have to foot the bill, for punitive tariffs and walls consolidate the deficient productivity. In the US there is no longer any talk of the project of US capitalism’s ascent by modernising the capital stock, as in the Lgeislative Outline for Rebuilding Infrastructure in America.
       Instead of focusing on modernising the US economy, it is being shifted by tax cuts and punitive tariffs into high speed. With his tax reform and fiscal

    policy, Trump has stimulated the economy and additionally consumption. His aggressive trade policy rounds off his intervention. But this sped-up economy lacks a foundation.
       The current expenditure boom is being followed by an expansion of debt, and the contrasting debt burdens for private households and firms is aggravating the income inequality – both are setting limits to growth. This ‘doping’ is making it difficult to return to an accumulation dynamic. And it is against the background of this masked weakness of US society that the increased risk of a cyclic crisis has to be seen. The ailing substance is expressed in a chronic downward movement of private capitalist investment (see graph).


       With a recession in the US resulting from politically induced instability of the global economy, larger sections of the population would be decoupled from the economic dynamic. The International Monetary Fund, largely in agreement with other institutions, stresses three risks:

    ·         Intensified protectionist measures and an endangerment of the open multilateral trade system could trigger a slowdown of the boom.

    ·         In addition, there is a dangerous potential in the turnaround in interest rates; that is, via a rise in the historically low revenues from the most important state bond markets and the ending of the central bank policy the upward motion could be stalled.

    ·         Despite measures to stabilise the financial system, the possibility of turbulence in the ‘overvalued’ financial markets cannot be excluded and could trigger a downturn.

    In 2018 global growth rates on the whole regained the long-term average levels shown before the Great Financial Crisis. Unemployment continued to fall. In fact, last year was the high point of a steady recovery of the global economy. For the coming two years the prognoses are pointing to a positive growth trend – within a general slowdown – making the current upswing one of the longest of the post-war era.[4] But this good level cannot hide the fact that there are risks and signs of the end of the ongoing economic cycle. Growth in the Eurozone weakened in the first quarter of 2018, and early indicators lead us to expect a slackening industrial dynamic. The flattening in the Eurozone and Japan is at the moment overshadowed by the boom in the US, where the forces of expansion predominate.

       A characteristic of capitalism is that in the course of time, with increases of productivity, the economy grows but that this growth is neither continuous nor even. Years of upswing are redeemed by periods of economic weakness. What happens is: If new investments grow more quickly, then capital accumulation also accelerates; the average length of such a consumption cycle in the OECD area lasts seven to twelve years (see graph); if, in the midst of a boom, demand for investments, which in any case constitute about a fourth of economic performance, suddenly collapses and demand for durable consumer goods simultaneously slackens this leads to great uncertainty, with the potential for a domino effect.
       Currently, the industrial cycle is moving towards a crest, and the risks are now considerable. The very loose monetary policy contributes somewhat to cover it up. A minor incident might be enough to make the latent problems come to the surface. In what follows we will glance at the most important axes of instability.

    Financial cycle

    The soaring global debt has modified the economic cycle. An extreme interpretation would be that there will no longer be boom cycles, only credit cycles, that the traditional models of development have collapsed in the last decade, and that credit cycles move with the monetary policy of the central banks; if the US Fed pushes its interest rates to extremely low levels (and buys assets), then the only purpose would be to induce enterprises and consumers to borrow money and stimulate economic growth. Conversely, if the Fed raises its rates again and sells assets then liquidity falls. The incentive to create debt falls, and the growth impulse disappears. In this view, the credit system and the role of the central banks are overestimated.[5]
       In boom cycles, recessions lead to falling market values, since consumer spending and investments decrease, enterprise profits collapse, and the stock prices plummet. However, if a credit cycle prevails, then falling asset values are said to be the cause and not the result of recessions. Just as growing liquidity and debt drive up the prices of asset values, rising interest rates and the depletion of central bank balances squeeze these values – and a recession follows.
       According to this view, the financial market actors determine the course of events. The concept of a ‘financial cycle’ essentially signifies the self- reinforcing interaction between valuations, the perception of risks, the actual risks assumed, and financing conditions. This interaction can reinforce boom oscillations and precipitates into the likewise mutually interrelated developments of loans and asset prices. Due to a series of important changes since the beginning of the 1980s, financial factors have become more important as an influence on boom oscillations. At the same time, inflation as an indicator of non-sustainable growth has become less important. The cause: the liberalisation of the financial markets and the deregulation of the relations of wage labour and capital. To the extent that insufficient flanking protective measures were taken, the liberalisation of the financial market led to a potential for bigger upswings and consequent downturns in the development of loans and asset prices.

    Interest rates and the normalisation of the ‘system’

    Most economists anticipate a weakening of the boom in the course of 2019. However, they are only assuming a slight cooling down. Nevertheless, there are a few serious warning signs. With their monetary policy after the financial crisis, central banks have massively distorted the bond markets and with it the interest-rate curves. In the period after the crisis interest rates are markedly lower, which limits the possibilities for the central banks to react to a slowdown (by lowering rates and expanding credits) (see graph).

       The last few years were excellent for entrepreneurs and investors, with considerable economic growth, high stock prices, and low interest rates and risk premiums. After the stabilisation of the global financial system a new normalisation is overdue: ‘After the long period of ample and unconventional monetary accommodation that helped economies recover from the Great Financial Crisis (GFC), the incipient policy normalisation in the major advanced economies stands out in important respects. It involves normalising both policy rates and balance sheets; it is highly asynchronous, with the Federal Reserve raising policy rates while the ECB and the Bank of Japan continue with large-scale asset purchases and negative rates […].[6]
       This change of trend is a delicate balancing act for global capitalism. A too rapid normalisation could trigger market turbulence and endanger cyclic recovery – not least because global debt in relation to GDP has continued to rise, and the assessments of asset values on the financial markets are excessive. Political shocks like Brexit or the election of Donald Trump were well withstood. At the same time, debt, and with it the credit sector, has further expanded (see graph). Modern capitalism cannot survive without a credit system – but the tendency to ever greater debt makes the system more unstable. Thanks to credit, capital that is not being used in one place can be passed on to another place where it can then be deployed productively, with the result that the prosperity of the whole system increases.

       Largely decisive for the hazard potential arising from debt is productive use, thus the expansion of added-value creation. In an environment of rising interest rates, most importantly in the US, and an economic growth that appears to be losing momentum the danger is growing of overstress through debt repayment and of a devaluation of debt securities. A clear picture emerges for the US. The country is in a debt trap. Many of the outstanding government bonds (Treasuries) have been issued at very low interest rates. 60% of them had to be refinanced up to 2020 at presumably much higher rates. But already now interest payment amounts to over 9% of the federal budget – it could rise to 16%.
       With the public/state-credit and debt policy since the Great Crisis, some things are now out of whack. The weak points of the international financial and banking system could generate a system crash. The large banks are showing a disproportionately high level of debt as well as insufficiently stable sources of refinancing. The losses caused by the crisis quickly became greater and carried over to other markets and countries, forcing the public sector to intervene.
       According to the Bank for International Settlements, the dimension of the asset holdings of the banks of issue in the last nine years in the most important highly developed economies (the US, the Euro Zone, and Japan) grew by 8.3 trillion US dollars – from 4.6 trillion US dollars in 2008 to 12.9 trillion US dollars by the beginning of 2017.

       The current dangers include this record-high global debt – above all private debt. Added to this is the pronounced growth of the money supply as a result of the central banks’ extremely loose monetary policy. A large part of liquidity has not flown into the real economy but into stocks and other financial assets. The world economy is running on credit, and the increase of debt is precipitating into a relative decoupling of asset prices (securities and real estate) from the real economy. According to the Institute of International

       Finance, the total debt of all countries, enterprises, and households increased by 8 trillion US dollars in the first quarter of 2018 to 249 trillion US dollars. The debt increase runs through all areas of the economy – through payment commitments states, companies, banks, and households have mortgaged further parts of the future wealth still to be produced.
       Total debt in relation to gross domestic product has risen after a slight fall last year. Despite great efforts to remove weak spots in the global financial and banking system, we can see today that in view of the growing weight of the financial sphere the vulnerability to crisis and instability has become greater. Anti-crisis mechanisms – in terms of both fiscal and interest-rate policy – are presently more limited than they were before the Great Crisis, and the long-term growth potential is lower today among other reasons because policy neglected to deal with the structural deficits. Added to this are increasing protectionist tendencies in the international trade system, which are transforming modern capitalism into a ticking time bomb.

    International interest-rate increase

    Interest rates in the US are currently pointing upward, and with some delay the other central banks will follow. After years of liquidity glut, the Fed is finally headed towards ending its extremely loose monetary policy. At the end of 2015 it carried out the first interest-rate increase since the Financial Crisis. Further steps followed.


       Through the US’s expansive tax policy (involving both tax cuts and higher expenditures) the growth phase of the current cycle has been prolonged. The contribution to growth of the tax cuts passed by President Trump and the newly enacted expenditures has been assessed at 0.8% in 2018 and 1.3% for 2019. Such a comprehensive growth-promotion package in the late phase of an economic cycle is unprecedented. In the post-war period we are clearly seeing a lengthened boom cycle, which nevertheless has gone beyond its peak.

    Strain on companies

    At first glance, US enterprises seem to have massively reduced their liabilities since the global Financial Crisis of 2008. This means that they do not need to worry so much about the interest-rate hikes expected in this year. But this appearance is deceiving.
       Indebtedness of non-financial corporations as a per cent of GDP is an indicator of whether firms are overindebted. If we factor out the financial service providers, we see that the debt figures of US corporations are no cause for optimism. The only reason why they appear bearable now is the current low cost of borrowing.

       The debt boom setting in for companies once again after the 2008 Financial Crisis will be one of the important fire accelerants in the next upswing. Low interest rates cheapen credits relative to risk-bearing equity capital. They thus lead to a creeping growth of risk – all the more so the more successful the low interest-rate policy is, that is, the more it initiates credit-financed investments.

    High foreign-currency debts

    Growing mountains of debt and rising interest rates – this is an explosive mixture, above all for the emerging economies whose capital markets have come under stronger pressure.

       Ever more investors are asking themselves whether the interest-rate premiums for emerging-market bonds are still compensating for the weaker creditworthiness of these countries.
       According to the assessment made by the banking association, Institute of International Finance (IIF), Turkey is especially vulnerable with its foreign- currency credits, which amount to more than 70% of GDP. It is especially firms and the financial sector that have become heavily indebted in foreign currencies. This raises the risk of refinancing. New creditors have to be found by the end of 2019 for 47% of the debt incurred in US dollars.
       Among the emerging countries, the situation in China is also interesting; since 2009 it has registered a tremendous rise in total debt. Nevertheless, the IIF has observed a slight decrease in corporate debt since the first quarter of 2017. On the other hand, the debt ratio of private households has risen to almost 50% of GDP. The growing foreign-currency debt of the Chinese financial sector is a risk. According to the IIF, foreign-currency debt since the beginning of 2010 has risen from 110 billion US dollars to, most recently, 785 billion US dollars. This increases the vulnerability of the financial sector to oscillations of the renminbi yuan.

       In the second quarter of 2018, the gross domestic product of the world’s biggest economy grew by 6.7% in comparison to the same quarter of the previous year, that is, slightly more slowly than in the previous three months. The government’s measures for combating credit risks had a braking effect. Despite the intensifying trade dispute with the US, exports remained stable in June.

       In June, the volume of the newly granted loans was 11.1% higher than it was in the same period in the previous year and thus grew the slowest since 2005. In 2017 the newly undertaken material capital investments were at their lowest level since data began to be collected. The head of state and party general secretary Xi Jinping had emphasised several times in the previous months that a stable financial system is a central pillar of his future policy. This requires that China push forward debt reduction of the local governments and state enterprises in the coming months. These two sectors are responsible for about a third of economic investments.

    Trade war

    Ever since Donald Trump assumed command in the US, the possibility of 1930s-style trade wars can no longer be excluded. Trump has imposed punitive tariffs on important trading partners such as Canada, Mexico, China, and the European Union. The countries concerned have, for their part, put punitive tariffs in force and lodged complaints against the US with the WTO. As a result, the global trade dispute is spiralling into a trade war. The US president wants to reduce the US’s trade balance deficit, which he regards as a sign of weakness and the cause of the decrease in industrial jobs. Apart from the fact that a balance-of-trade deficit is in itself not something bad, the US profits from openness, even if services, foreign assets, and financial streams are included in the calculation. Washington’s demand for fair trade rings hollow because this is supposed to blur the truth that it is simply American interests that are at stake here, fully in the sense of Trump’s ‘America First’ presidency. However, for this Trump receives not only his electorate’s approval; domestic political opponents as well as many allied governments would have to support the US government’s efforts to ‘bring Beijing around’ to more openness.
       The GATT/WTO system is a central pillar of the liberal post-war order and has had major impact. For example, since 1947 tariffs on industrial products have fallen to an average of 4%, and 164 economies are members of the WTO by now. Moreover, up to now there have been no true trade wars, although there were some serious endurance tests quite early on. Nevertheless, the WTO system contains conspicuous problems, which need to be addressed by reforms. A constant point of conflict, for example, is the protection of intellectual property in the WTO’s practice, which from the rich countries’ point of view is too weak and for the poor countries too strong. Similarly problematic are the WTO subsidy regulations, which especially China, in particular, is trying to circumvent with its state enterprises.
       Up until 1994, the GATT continued to evolve through many years of trade rounds. The aim was to continually make more areas of economic life accessible to free trade. With the WTO further rounds were supposed to follow. However, already the first of these, the so-called Doha Round, which started in 2001 in the capital of Qatar, failed to progress. Since 2016 the rounds have been regarded as failures. Progress is actually only still seen in free trade agreements, which in the GATT had been provided only as a rare exception of the most-favoured-nation principle. An important reason for this is, naturally, that the WTO is a victim of its own success, since further tariff reductions become increasingly difficult with each round of liberalisation. But another reason is that with 164 members it is hard to reach consensus on liberalisation measures that go beyond traditional tariff reductions.
       Donald Trump has no discernible concept for an international trade regime. He is undermining the WTO but has also blocked the development of regional agreements. The impending end of the WTO and, despite its world power status, the US’s lack of overall concept is raising other problems. For instance, at its founding the trade and monetary regime was part of a comprehensive peace project. It was conceived at the famous Bretton Woods meeting in 1944. The US, Great Britain, and 42 other countries wanted to create a stable economic order for the period after the war. In the future, new institutions were to prevent the kinds of economic turmoil and trade disputes that had broken out in the 1930s, which were considered contributors to the Second World War. In Bretton Woods, the International Monetary Fund (IMF) and World Bank were created. Because a world trade organisation was considered too ambitious a project, an interim solution was found – the GATT as a pure customs agreement. But even this nearly collapsed due to disagreement between the US and Great Britain. Only in 1948, when the Cold War was proclaimed, did the Americans give in. The WTO could have learned from the experiences of this period. Instead, it went too far in foreign-trade questions and in so doing led to its own downfall – a downfall that is now being accelerated by Donald Trump.
       If the US does not start moderating its stance, the escalation of the trade war will, for one thing, have an effect on the global boom, and the recessive effects along with the punitive tariffs will affect the majority of the other countries. Furthermore, the development of a stable economic order that includes China and Russia is on the global political agenda.

    Outlook

    World economic growth for now appears robust enough to withstand a tariff dispute, as long as it does not get out of control. After a long period with ultra-expansive global monetary-policy strategies, the time now appears to have come to introduce normalisation. China has also become more restrictive, like the US. It would be possible to prevent a new financial and economic crisis by reducing excessive debt. In order to brake speculation and exuberance, the protagonists would have to use their own money before they invest foreign money.
       We have to expect future turbulence in the financial markets. This is based on three factors: There are overvalued markets in the advanced national economies, much too loose financing conditions, and too high debt levels in the world economy. Since interest rates are still extraordinarily low and the central bank balances more bloated than ever, there is no tool in the medicine cabinet to help the patient back on to his feet or take care of him in the event of a setback.
       We are now in a phase in which many protagonists are becoming conscious of that fact that the high liabilities are a problem. Against the background of the recent signals from the US central bank, a soft landing of the US and thus of the global boom is certainly possible. But the economic and political elites of the core capitalist countries are not prepared for worse times.

     


    NOTES

    1. For more details see Joachim Bischoff, Tickende Zeitbombe Finanzmärkte. Bankenkrise, globale Kreditketten und Alternativen im Post-Kapitalismus, Hamburg: VSA, 2019.
    2. Bank for International Settlements, Annual Economic Report 2018, <https://www.bis.org/publ/arpdf/ar2018e.pdf>, p. 1.
    3. In its 2018 Forecast <https://www.bundesbank.de/resource/blob/743990/121da3a61d41345f3448ccc83ee32f8c/mL/2018-06-prognose-data.pdf>, the Bundesbank modified its growth prognosis for Germany in 2018 from 2.5% to 2.0%. It reports that the slowdown of the boom is stronger than was expected. It goes on to say that positive economic development cannot go on indefinitely, and that it is especially the protectionist trade policy of the US government that can damage the German economy. The federal government, it warns, must prepare for worse times; this is true because the European Central Bank (ECB) can hardly react to the next downturn. More time will be needed, it states, before monetary policy re-enters normal navigable channels, and since the ECB in cases of doubt can hardly act against a new crisis, it is financial policy that has to take over this task.
    4. Economic development is characterised by cyclical fluctuations. Nevertheless there is no unified concept for defining and identifying cycles. The upswing in the US has by now lasted 107 months – since June 2009 the growth of the US economy has been trending upward. The upswing is thus officially the second longest since the recording of cycles began in 1850; only the ten-year upswing starting in 1991 was longer. If the dynamic maintains itself through July 2019 it will be the longest in history. Then in only a few more months the US economy could complete its first decade ever without recession. This is impressive – up to the 1930s the US economy suffered on average almost three recessions per decade, after which the average was two. See Joachim Bischoff, ‘Endless Recovery?’, Transform! 2018 yearbook.
    5. Joachim Bischoff, Finanzgetriebener Kapitalismus: Entstehung– Krise– Entwicklungstendenzen, Hamburg: VSA, 2014.
    6. Bank for International Settlements, Annual Economic Report 2018, p. 25.