At present, in February 2016, financial markets the world over are increasingly chaotic. They are either retreating or plunging. The view of many observers is that there is a new gigantic market crash in the not too far future, one that has possibly started now. The main reason for expecting a market crash is simple: Historically, bubbles always burst.
Bubbles arise when asset prices inflate above what underlying incomes can sustain. In the classic case of Tulip mania centuries ago, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman. Then in February 1637 the Dutch woke up one morning and discovered that tulips were simply just flowers after all.
The world has yet to wake up to the mathematical reality that over $200 trillion in global debt and perhaps another $500 trillion of un(der)funded liabilities really cannot ever be paid back with current incomes and low level of economic growth.
No major economy in the world has decreased its debt-to-GDP ratio since 2007. Instead, since the Great Recession, global debt has increased by $57 trillion, outpacing world GDP growth. However, this unpleasant fact is dawning within the minds of more and more people with each passing day.
To reduce debt, Central Banks have tried to modify the phrase “under current terms” through debasing the currency of government bonds by re-introducing inflation. Try as they have, though, across the indebted countries they have been unable to create the intended inflation that would slowly erode that massive pile of debt into something more manageable. On the contrary, in a bid of last resort to reinvigorate the economies. country by country the central banks have ended up experimenting with policies to implement negative interest rates for lending, meaning depositors will have to pay to make deposits. The negative rates punish banks that hoard cash instead of extending loans to businesses or to weaker lenders.
With inflation very low and commodity prices in free-fall, these policy experiments have been low risk and, importantly, partly successful. The global economy not only avoided the Great Depression scenarios which forecasted the global banking system ground to fail, but 2016 is set to be the eighth year since the crisis where global GDP growth has been above 3%. However, this economic growth is happening in the emerging economies in Africa, growing from a low level, and in far-east Asia. Not in the advanced economies.
The advanced economies central banks intended end-effect, wide-spread controlled inflation, has not happened. Why not? Because the current economic stagnation is driven by digital disruption, falling commodity prices and the quantitative easening post-crises does not lead to increased consumer consumption, given the already high levels of debt in most households.
The weakness in most commodity prices, most recently the drastic fall in the price of oil, is lowering input costs for raw materials to the production process in most manufacturing industries. With energy costs near a decade-low and many raw materials prices also falling, firms can maintain profits even if they lower prices simply because input costs are falling.
Digital disruption follows from the unrelenting expansion in technology and its ability to uncut and undermine old ways of doing business. While such progress will increase efficiency and productivity, the transition period can hold back the economy in what for many industries becomes a zero-sum game.
The elites of the post-crises age are prioritised clients of the banks, so by their current monetary policy, the central banks have simply concentrated the inflation to the sorts of assets the wealthy of the world buys: private jets, apartments in London, Monaco and Manhattan, fine art, jewellery, etc. So yes, the central banks post-great-recession efforts produced price inflation, just of the wrong sort.
Monetary policy and tools do not work in the post great recession society when the middle classes are already in mortgage debt and cannot increase their spending. Today 1% of the population of the world owns 50% of all assets and 10% owns 90%. Overall less people are poor, 1 billion have been lifted to middle class in the emerging markets in the past 30 years, but in the west most people are in general off with less money than they used to have.
This is important, both for how financial markets now work, and for which products and services they require. In a society of hyper competition and with on average less affluent people than before 2007, but with a much larger middle class, then e-commerce with low prices and cash becomes king more than assets, and cash moved quickly by efficient payment systems are much sought after.
In today’s hyper-interconnected world of global banking, if one domino falls, it will topple any number of others. The points of connectivity are so numerous and tangled that literally no-one is able to predict with certainty what will happen. Which is why the action now occurring in the banking sector is beginning to feel like 2008 all over again.
The deflation fears which drives the central bank actions have some credence. Most importantly, there appears to be a huge amount of spare capacity in labour markets. This means that wages growth will remain subdued and the wage/price linkage will skew inflation risks squarely to the down side. This means people will increasingly look for low cost options, continuing the internet e-commerce revolution not only by convenience, but also by increasing price concerns.
And this is the nub of digital disruption and slower economic growth. Before Uber, clearly there was spare capacity in privately owned cars, which sat unused for many hours each day. So too with apartments that were empty and unable to be let out by the owners when they were not there. Uber and Airbnb, and others disrupting asset markets, have tapped this idle capacity without adding to investment, and as they take business away from taxi companies and hoteliers, the rate of economic growth will remain held back.
In most financial settings, risk is a bad thing; you have to be paid to bear it, but unfortunately the World has no higher power (that we currently know of) to bail it out