The Next Economic Correction
By Keith Rankin.
In September I published a chart showing that, over a century-and-a-half, economic growth has been lower in years ending with an ‘8’. It’s suggestive of a fundamental capitalist cycle that repeats around every 10 years. The 10-year cycle has a name, the Juglar Cycle.
In 2008 we had the global financial crisis. In 1998 it was the East Asian financial crisis. In late 1987 we had the global share market panic. The 1987/88 crisis hit New Zealand especially hard. The 1998 crisis was smaller than the others, but did have quite an impact on New Zealand. While the 2008 world crisis began early in New Zealand – finance companies started to fall in 2006 and the economy went into full recession at the beginning of 2008 – overall it affected New Zealand less than most developed economies.
While there will most likely be an ongoing Juglar Cycle, each event in the cycle will be different. I’m picking that the next corrective event will be somewhat muted at the global level, but may affect New Zealand more than many other developed economies. The developing economies will be hit more than the developed economies, most likely.
At the global level, there has not been the rapid growth of household financial deficits that preceded the global financial crisis. With respect to spending, there remains pronounced caution in Europe, North America and much of East Asia. Most importantly, interest rates in the developed world remain very accommodating (ie historically low). The global financial crisis was triggered largely by interest rate increases from 2005.
Much of the developed world’s unspent income has been advanced to the developing world and to countries like New Zealand which have offered high returns in real estate. The correction will be characterised by withdrawal from those speculative funds; profit-taking by risk-seeking savers who will park their funds for a year or two before embarking on further ‘investment’ ventures. Capital losses in some speculative markets will precipitate further asset sell-offs. Saver economies will experience rising exchange rates – especially the Euro – while countries like New Zealand can expect relatively weak currencies until their economies revive as a result of those weak currencies. Thus momentum in New Zealand will shift, through a sharp correction in real estate, in favour of traded goods and services.
The big danger that could turn a normal cyclical downturn into a major world crisis is deflation. Massive increases in the world money supply only just averted a deflation crisis earlier this decade. After the present peak of the global economic cycle (world inflation is probably peaking now), a drop-off in consumer spending means zero percent inflation if we are lucky, deflation otherwise.
One of the characteristics of the Great Depression of the 1930s was the debt-deflation spiral. As deflation takes hold, debts become bigger in real terms, as do savers’ hoards of uninvested money. Existing imbalances exacerbate, creating conditions that are even more prone to deflation. The good news is that a number of countries have already adopted negative interest rate policies, and these policies worked. Thus the reticence around cheap money that may have existed – and that definitely still exists in New Zealand – will be less than it might have been.
In a period of market recession, what is needed is negative real interest rates (meaning interest rates lower than the inflation rate); an incentive to bring forward spending (including government spending) and a disincentive to delay, defer or avoid spending. Savers’ hoards need to depreciate in terms of what they can buy, to dissuade spending deferral. Negative interest rates provide just such a penalty on unspent money. At times of deflation, deposit interest rates need to be even more negative than the inflation rate. It also means that penalties on cash hoarded outside of the banking system need to be greater than penalties (negative interest) on bank deposits.
The interest rate is the price of ‘inter-temporal trade’. This is trade across time; earning in one time‑period and spending in another. If, when interest rates are zero, more people want to defer spending than to bring spending forward, then interest rates at zero are too high, and should be allowed to fall. Negative interest rates encourage more people to spend in the present (by borrowing more, by saving less, or by withdrawing past savings) and fewer people to defer spending.
Through this market-price mechanism, an interest rate (a price) is eventually struck whereby spending deferred and spending brought forward will balance. That’s the ‘equilibrium’ rate of interest. The interest rates that we are used to, however, have been managed above the equilibrium rate (as an effective ‘price floor’); such disequilibrium encourages speculative borrowing (for capital gain) rather than investment or consumption borrowing (which is to buy, in the present, newly-produced goods and services).
The last time interest rates were at their equilibrium level was in the late 1970s. That precipitated the global neoliberal revolution, led by rich people who regarded interest as an entitlement (a ‘free lunch’) rather than as an equilibrating price. Monetarist policies were implemented; these were all about forcing interest rates up, in the guise of a democratically-mandated attack on inflation.
This decade, mortgagee sales will be kept to a minimum by banks offering distressed borrowers extended interest-only loans at low rates. Mortgagee sales consequent on rising interest rates were the main trigger for the 2008 global financial crisis. While a possible debt-deflation crisis will most likely be nipped in the bud this decade, it is most unlikely that policymakers and financial analysts will learn the lesson about interest rates that needs to be learned.
I expect there will be a general dip in financial asset prices (including real estate) this decade, followed by a resurgence of financial speculation in the first half of the 2020s. Poor people will continue to survive in the early 2020s through evermore debt. I also expect that there will be pressure, by the overpaid, on the monetary authorities to raise interest rates, significantly, in the mid-2020s.
My call is that the big global financial and economic crisis will begin in (or around) 2028, not 2018. Unless there’s a world war before that. The world economy this decade faces very similar tensions to those that existed prior to World War One.