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In 1933 Sir John Templeton, the renowned fund manager, famously remarked that the investor who says ‘this time is different’ has uttered among the four most costly words in the annals of finance.
He might well have been speaking about modern policy-makers and investors, who try to convince themselves that the bubbles in the global economy will have a happier ending than previous ones. They do so despite the numerous good reasons to fear that, if the consequences of today’s global bubble are indeed different from 2008, it may be because it is more dangerous.
Bubbles are much more pervasive today than in the run-up to the 2008 financial crisis, when they were contained to the US housing and credit markets. Now they can be found in almost every part of the world economy.
Years of unorthodox monetary policy by the world’s major central banks have created an unprecedented global government bond bubble, with long-term interest rates plumbing historically low levels. Global equity valuations are at levels only experienced three times in the last century. House-price bubbles are evident in major economies like Australia, Canada, China and the UK, while interest rates have been driven down to unusually low levels for the high-yield debt and emerging-economy corporate debt markets.
If one had any doubt that global credit markets have lost touch with reality, all one need do is to consider some recent international bond issues. Argentina, which has distinguished itself by defaulting no less than five times in the past century, managed to issue a 100-year bond. War-torn Iraq or little-known Mongolia not only placed bonds in the market, but had them massively oversubscribed.
That the world is much more indebted than it was on the eve of the Lehman Brothers crisis aggravates matters further. High levels of Chinese non-public sector debt, Italian sovereign debt, and emerging market corporate dollar-denominated debt are especially troublesome.
Changes in leadership at the Federal Reserve and US Treasury mean neither institution has the experience to craft a swift and decisive response to the bursting of a global bubble. There is reason to fear, too, that President Donald Trump’s ‘America first’ administration would be averse to orchestrating an international response in the event of market panic. This is particularly the case considering that Trump is not known for his depth of economic thinking, his forward planning, or his leadership skills in the international economic arena.
Those who argue that this time is different for the better seem to rest their argument on the US banking system’s improved regulatory system. They contend that, thanks to the Dodd-Frank Act, US banks are much less leveraged than they were before and less prone to taking on excessive risk.
While there is truth to these claims, the key point that the optimists overlook is that the major part of US credit is intermediated by shadow banks rather than regulated institutions. The collapse in 1998 of Long-Term Capital Management, the ubiquitous Wall Street hedge fund management firm, should have taught market watchers that hedge funds and other parts of the shadow banking system are highly interconnected and can be subject to the same sort of deposit runs as banks.
Long before Templeton issued his ‘this time is different’ warning, Leo Tolstoy wrote that ‘happy families are all alike; every unhappy family is unhappy in its own way.’ When analysts look back on 2018’s global financial markets, they might find that Tolstoy’s dictum was as relevant as Templeton’s as a cautionary tale for both investors and economic policy-makers.
Desmond Lachman is a Resident Fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the Chief Emerging Market Economic Strategist at Salomon Smith Barney.
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