t is the time of year to make predictions so my contribution is to warn of the possibility — though not the likelihood — of a financial crash. The last one in 2008 was born out of leverage; there was simply too much debt. People then squirrelled away savings, companies cut back on jobs, and banks lent to no-one until conditions improved. That way, gradually, the system righted itself. Or at least we persuaded ourselves that we were getting on course.
Except that this time it is not so obvious: 2008 was the worst example of drowning in debt that the modern world has seen, when, as a percentage of GDP, it reached 269%. But in the first quarter of last year total debt was 318% of GDP, which is not far short of 20% more. If 2008’s debt brought the world to its knees, what might this year do?
Hans Hoogervorst, once a Dutch politician and now the chair of the International Accounting Standards Board, presented these figures last year at an accountants’ convention in America. From 2008 to 2018 consumer debt rose from $33 trillion (£26 trillion) to $47 trillion; non-financial companies’ debt went from $38 trillion to $74 trillion; financial institutions went from $37 trillion to $61 trillion and government went from $33 trillion to $67 trillion. In short the debt increases were right across the board.
The main reason is quantitative easing — the central banks have printed money to stop the economy from imploding. Now they are trying to unwind their measures and return to normality. But they are cautious about raising interest rates because so many people and institutions binged on debt, as they were supposed to do, and these people can only service their debts if interest rates remain low. Central bankers want the economy to be normal again, but they are fearful of raising rates and causing accidents along the way.
It reminds me of former Federal Reserve chairman Paul Volcker’s take on quantitative easing. It is, he said, like an aeroplane which may be theoretically sound but no one actually knows how it will fly. We have got it into the air, but now it has to be landed. No one knows where the airport is, nor how long it is before we get there. And the pilot has never flown something like this. He is making it up as he goes along.
It might be all right, says Volcker. Or it might not.
In contrast Hoogervorst’s prediction is that major accidents will be hard to avoid. “It is very unlikely that the huge mountain of debt that we have created can ever be repaid in an orderly fashion,” he says.
Though banks are much better capitalised than they were in 2008, they will have to follow new accounting rules which will show their expected losses earlier rather than, as was the case, showing their incurred losses later.
The scale of the losses could be huge and it is by no means certain the banks will cope, even with their additional capital.
So that is one problem. Michael Lewis, author of The Big Short, Flash Boys, Liar’s Poker and other seminal books, has another. In the latest edition of Prospect, the current affairs monthly, he warned that Donald Trump might be on a collision course to renege on America’s debt, which is 100% of GDP and rising. Lewis thinks Trump could stand up at a rally some time when things are not going his way and say: “We don’t actually owe the Chinese that money. They stole that money in bad trade deals.” And the Trump supporters say: “Yeah. That’s right.” Thus, armed with their supportive response, Trump will tweet it to the world. It is not just the Chinese who will have reason to be concerned in that event.
The point is that the US does not have to renege. The US Treasury, the Federal Reserve and dozens of others might have something to say about it if it did. But the fact the possibility exists could seriously spook the financial markets.
“This guy does not pay back his loans,” Lewis says. “Trump is a trust-devouring machine. He has destroyed trust in one thing after another. Money could be next.’’
That may be a bit harsh but then again the whole world might learn to its cost just how debased promissory notes can become. When promises made by the man in charge are literally not worth the paper they are written on, the system is in trouble.
The collapse in stock markets, if such were to happen, might be the least of our worries.