Is Another Global Fiscal Crisis Imminent?

So claims   Niall Ferguson, professor of history at Harvard. 

(These are notes prepared for a Radio New Zealand ‘Nights’ Pundits conversation with Bryan Crump. Tuesday 12 December 2017.)

Niall Ferguson is known for his provocative, contrarian views and a number of books, including The Ascent of Money. I am not in a position to judge him as a historian – although a chair at Harvard is no mean achievement – but when he got into a blazing economic row with Paul Krugman, in my judgement, he came second.

Recently the provocative contrarian published an article entitled ‘the reasons another global financial crisis is imminent’ – that is, it is about to happen. Of course he could be right – who knows what the future holds? We should explore his argument, in case.

 The article begins by Ferguson claiming that, in effect, he predicted the 2008 Global Financial Crisis. He is not alone; many economists gave similar warnings. They include me, as readers of my now defunct Listener economics column will recall.

This is not to boast; I could tell there was something wrong but I could not tell when it would happen or how exactly it would happen. My task was to draw readers’ attention to the issues, not to predict the future. Most economists who spoke out were like this – aware there was a problem but puzzled about exactly what was happening. (What I missed was subprime home mortgages; they are such a crazy idea that I overlooked them on the basis they could not possibly exist in a rational market. The same thing happened to me before the 1987 sharemarket crash. Again I wrote about the problem, but I never dreamed of corrupted accounting being used to calculate profits.) The basic rule for such forecasting is the more confident the commentator is, the less he or she understands what is going on.

Ferguson sets out three reasons for an ‘imminent’ crash.

            ‘First, the monetary policy party is closing. The [US Federal Reserve] and the Bank of England are raising rates. .... Global credit growth in aggregate is slowing.’

I’ll come back to this. The other two are:

            ‘Second, we are at a demographic inflection point.’

            ‘Point three: a networked world – whose biggest companies are dedicated to reducing the cost of everything from shopping to searching to social networking – is a structurally deflationary world.’

Ferguson finishes

            ‘No two financial crises are the same. But there will be a next one and, as the monetary medication begins to be withdrawn, it draws nearer.’

He is quite right, of course. There will be another big one and it is drawing nearer, but that is not to say it is near. Financial crises happen rather frequently, but they are usually confined to a single or few economies. In the last century there have been only two global ones: that in 1929 which led to the Great Depression and the 2008 GFC.

Notice Ferguson’s analysis confuses a financial crisis with long-term structural change. Only his first trend has the potential to cause a global crisis. The other two presage a transformation of the world economy as we know it. (I would add other such trends, especially the slowdown of technological innovations which can be made commercial, the environmental challenge and affluence turning people away from material output to services and leisure.)

I am surprised that this historian has confused a(n almost overnight) dramatic change with a deep change which transforms the core structures of an economy and society. The eminent political economist, Ralf Dahrendorf, instanced the French Revolution as an example of the first and the Industrial Revolution of the second. I focus on the first – the next global financial crisis which Ferguson promises.

Ferguson sees parallels with the rising interest rates that preceded 2008 and their current rise as central banks unwind their ‘quantitative easing’, an expansionary monetary policy where central banks buy government bonds in order to stimulate the economy. It has left them owning huge quantities of government paper; the old-fashioned term was that they have been financing the government deficit by ‘printing money’. This has been effective, goes the orthodox wisdom (of which Krugman is a leading proponent), because the world economy has been in a liquidity trap when interest rates are so low they cannot be further lowered in order to stimulate a depressed economy.

The great Central Banks think there has been enough quantitative easing and have begun raising interest rates. Ferguson argues that the higher interest rates will destabilise the financial system. He attributes such a raising as precipitating the 2008 GFC with no mention of the instability from subprime mortgages. (You will recall Michael Lewis’s The Big Short showed how a number of investors worked out they were inevitably self-defeating and made their fortunes betting against them.)

This may all seem a bit academic, except in the last week the US Congress has gone about giving huge tax cuts to corporations and the very rich. This will increase the US government deficit which will have to be financed. Given the reluctance of the Fed to continue quantitative easing – that is, print money – the US Treasury will have to sell bonds to the private sector (or other governments). Since there are going to be a lot of bonds, it will have to offer very attractive terms – that is, higher interest rates. Because the US dollar is the international currency of preference, the deficit will flood the world with liquidity which will leading to a speculative boom – followed by a crash. Not imminently, but some years on.

Sound familiar? I have just told you the story from the Bush 2002 tax cuts to the 2008 GFC. We tracked it at the time. We did not know when the crash would happen (September 2008 but there was earlier turmoil). Nor did we guess the exact course of the boom and bust (with the central role of subprime mortgages). We did not have access to the wonderful description of past financial crises summarised in This Time is Different by Carmen Reinhart and Kenneth Rogoff.

Of course each time it is different, which is why booms and busts are so difficult to predict. However the insightful work of Hyman Minsky (who died in 1996) sets out the sequence of these booms and busts; they all follow much the same pattern.

We should learn from history applying robust, evidence-sensitive analysis. As Marx almost said, when history repeats itself, the first time is tragedy, the second time is farce; the next farce is unlikely to be imminent.


Footnote: I have not referred here to the ‘bitcoin bubble’. I cannot tell exactly where the bubble is in the Minsky cycle because it is an unregulated market for which there is neither the data nor financial monitoring. There will be ‘hedge borrowers’ making debt payments from current cash flows, ‘speculative borrowers’ who regularly roll over the principal and ‘Ponzi borrowers’ investing on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but who cannot make sufficient payments on interest or principal from their cash flow. As the balance of investors moves towards the last type, the bursting of the bubble becomes more imminent. However it is likely to be a minor pop compared to a GFC.

(This does not devalue the use of the blockchain technology, which will be around long after the majority of bitcoin investors live in impoverished retirement.)

PS. It has been calculated that the mining phase in the bitcoin game uses as much electricity as Ireland. Its contribution to global warming is not known.