They say generals always expect to fight their last battle again. By contrast, all those attending Redcliffe Training seminars will get to realise the importance of good strategic forecasting. Nothing is more important to business than the overall future of the global economy. But opinion is divided. Notwithstanding the generally successful global policy response to the last global crisis, what chance of a repeat any time soon?
In the bearish corner, Milton Ezrati and those many who think like him, that Europe – not the world – will endure another financial crisis based on a toxic combination of consumer debt and sovereign irresponsibility, especially in Greece, forcing an exit from the Euro and a possible breakup of the EU. If not that, then perhaps Brexit and an international trade war. Or perhaps a failure of one or more of the major European lenders.
In the other corner, the bulls argue that the global financial crisis of 2007-8, when the UK economy shrank 6%, was a once-in-a-generation phenomenon. The combination of the long-term Kondratieff wave with a real estate cycle and a number of purely localised phenomena, such as the sub-prime drama, the failure of Lehman Brothers, huge levels of off-balance sheet lending, high oil prices, and the inadequacy of Basel II, which permitted banks to use subordinated debt and convertible preferred shares as capital, instead of ordinary shares, all contributed to the crisis – and all have gone.
Who is right? The reasons why another financial crisis does not lurk around the next corner lie in the full explanation of the events of a decade ago, and the circumstances of today. The bearish arguments must be unpicked.
First, for sovereign debt. Growth is more important as an indicator of future recession than actual output. The Greek economy is now pulling through and is now growing faster, 1.4% in 2017, an expected sustainable growth path – than the UK. Energy prices are reassuringly constant and attractive whilst investment in new sectors, such as renewables, has more than doubled since the crisis. European governments have plenty more policy options available, such as loosening restrictions on business formations, amending labour laws, and cutting corporation taxes. Even the unlikely spectacle of the collapse of the Euro and even an EU break-up could liberate economic growth, especially in devaluing countries. Pessimists forget inflation, too: the real value of debt is now being steadily reduced worldwide as optimum levels of inflation for investment finally arrive to replace quantitative easing. Second, Brexit. The evidence is now clear that the economic – as opposed to the political – impact of Brexit was wildly exaggerated. London house prices are down and some financial institutions are shifting their HQs out of the City, but equally, UK overall indicators such as unemployment, currently around 4.3%, are holding steady, whilst the level of government debt, whilst still far too high, has stabilised as a percentage of GDP and in the UK, even mortgage debts are down from 113% of households’ average income in 2008 to around 110%. As for international trade, the rules of the WTO, together with a multiplicity of bilateral arrangements, are probably sufficient to prevent a repeat of the Great Depression, as the EU has already discovered with its proposals to retaliate against recent US steel tariffs, themselves actually rather more targeted and permissible under WTO rules than much recent reporting has suggested.
Finally, it should be noted that whilst some major lenders’ share prices are still at 30-year lows, the rash of litigation over market-fixing is now also coming to a close. Lower bank share prices may be a price to pay for stability, however: Mario Draghi of the ECB recognises that after a decade of work, the present Basel system is now much more resilient, especially in terms of prudential mortgage lending criteria, far more persistent than forecast even four years ago, and core capital requirements, which have doubled in a decade: the ‘output floor’ aims at stopping banks from risk weighting an asset at less than 72.5% of the standardised model. The system also now encourages new participants into European lending, which helps spread risk around the banking system so that ‘too big to fail’ may eventually become a thing of the past. Add to this less off-balance sheet borrowing by corporates with the fall in securitisation possibilities and it might even be that systemic risk is now lower
No, the evidence suggests that the great problem confronting the global economy now is not an imminent financial crisis, not even a prolonged slump. It is the gradual erosion of full-time employment and the break of the link between employment and wealth. The time when government policy designed to ameliorate the social issues that have emerged worldwide as a result is coming. When fund managers and insurance company investment analysts start to talk about the inevitability of wealth taxes, it is time to sit up and take careful note.