The Coming Crisis: we’re not in Kansas any more
In the surreal world of post-2008 financial markets and monetary policy ‘black swan’ events shouldn’t surprise us any more
The western economic and political world that was in place before 2008 no longer exists and it is not coming back. In retrospect the last supposed boom of the middle years of the first decade of the twenty first century was the death throes of a leviathan roaring out its last fire. The death of the old western economic and political disorder is in part disguised, at least in the United States, under a swathe of ‘recovery’ statistics which focus on apparent employment shown in payroll data. But even on the surface of collective life evidence that something is systematically failing bleeds out for easy observation.
Economically, the narrative of recovery is for millions of Americans a painful illusion, bereft as they are of remotely secure employment and dependent on still growing credit to compensate for stagnant wages as big-ticket costs generated by health care and higher education have exploded. The US labour participation rate is at its lowest level since the autumn of 1977 and the decline cannot be explained simply by the bulging cohort of baby-boom retirees. Total US debt, meanwhile, is around $60 trillion, 27 times higher than in the early 1970s. Since September 2008 outstanding consumer credit has increased by 35 per cent whilst nominal growth has been around 20 per cent. Politically, the American electoral system is buckling under the insurgent candidacies of Donald Trump and Bernie Sanders, both men thriving with significant swathes of voters because they articulate, wildly or moderately coherently, a sense that the American economy is in decay and corporate-fuelled political cronyism, in which influence is bought and sold by an oligarchic class divorced from the struggle of everyday existence, is feeding parasitically on the ruins.
Underneath the surface the cumulative problems on which the old western economic order crashed in 2008 have ensured that the entire policy response to the crisis has been thrust on central banks. The Federal Reserve Board’s moves towards a zero-interest rate policy (ZIRP) and massive quantitative easing (QE) have left the Fed with assets of $4.5 trillion dollars and transformed the structural conditions of international capital flows, the relative position of creditors and savers, the prospects for pensions, the very nature of financial markets, and the fundamental context in which monetary policy makers can judge the likely consequences of their actions.
Indeed, it may not be hyperbole to suggest that in the wake of QE American financial markets as markets with any price discovery function no longer exist. Share and bonds markets in particular now have dynamics permeated to the core by expectations of what the Federal Reserve Board will do in regard to maintaining or reversing its post-2008 extraordinarily expansionist stance. Most dramatically, US bond markets in May 2013 threw what became deemed a ‘taper tantrum’ by sharply pushing up Treasury bond yields when Ben Bernanke said that the Fed planned to taper bond purchases under QE3. In this new financial world share and bond markets are quite likely to respond positively to bad economic news in the real economy because poor data acts as a delay to the day when central banks can move back towards anything like a remotely normal monetary policy. Indeed, for the Fed the constraints of how the share and bond markets will react to even the slightest noise about how it would act became the crucial context that determined the timing of when it could finally make its first small move away from ZIRP. What ultimately transpired was an increase in interest rates in December 2015 by 0.25 per cent, more than a year after it was clear that the Fed wanted to act and at a point in the economic cycle when growth projections were being adjusted downwards and the next recession was starting to become a distinct short-term possibility.
This absorption of monetary policy makers in the surreal world generated in financial markets has been compounded by the manner in which the internal dynamics of those markets have been transformed by the conjunction of QE and ZIRP dependency and high frequency trading. Correlations between movements in different asset classes from shares to bonds to commodities, and locationally between assets in advanced and emerging market economies, have become acute since 2010. A whole range of prices are now driven by common external developments, not least the pronouncements of the world’s central banks, rather than anything particular to the singular fundamentals of each market.
Certainly rising correlation was a predictable feature of periods of high market volatility in the pre-crisis years, but the intensity of the correlation is now levels of magnitude greater than anything we have seen before. In this context the risk of complete systemic crisis through contagion is considerable and the avoidance of such a crisis so far may be considered but good fortune. Over the past six years financial markets have already been producing what would have hitherto been regarded as ‘black swan’ events. ‘Flash crashes’ and trading surges of such size that should be extraordinarily low probability occurrences according to all existing modelling of financial markets are becoming an increasingly frequent feature of financial markets.
If, however, ZIRP and QE have wreaked dysfunctional havoc on the American economy and monetary policy-making, they were also almost certainly the most obvious short-term response policy-makers could have made to the 2008 crash. In an economy in which rising household debt was a minimum requirement for growth under escalating oil prices, the banking sector was riddled with high debts and toxic assets, and the US government’s fiscal position was unravelling, propping up debt with massive monetary accommodation was inevitable. ZIRP and QE also made the shale boom a possibility after conventional oil production peaked in the middle of the first decade of the twenty-first century, a development which as much as rising Chinese and Indian demand made the astronomical price of oil in the first half of 2008 the acute economic problem it was.
In this sense the parallel necessity and disaster of ZIRP and QE is indicative of just how deep present economic problems run. In their wake what should seem like the ‘black swan’ event of a Trump presidency perhaps should not surprise us as a possibility at all.
The Coming Crisis SPERI blog series: In next week’s blog – published on June 1st – Martin Craig will explore how ‘crises’ are diagnosed and understood. Read all of the blogs in the series so far at http://speri.dept.shef.ac.uk/category/the-coming-crisis/Print page
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