Reports from the previous few weeks point to the fact that the global economy is on a course for one more monetary crisis. As a matter of fact the global debt levels have risen above those of 2008, but with one major difference; it is the poorer countries which are currently leading debt creation. EU and the USA are not safe though, they are dancing a perilous waltz near another steep precipice. And the latest World Economic Outlook from the International Monetary Fund (IMF) does not look promising.
While the IMF views the Eurozone as one of the biggest risks to the world’s economy, it has also pointed a slowdown in major less developed countries such as Brazil and Russia.
Despite all this, stock markets are exuberant akin to that faithful orchestra which kept playing on a sinking Titanic. The Dow Jones is hitting record highs this year. A growing concern, however, is that the enlargement of the so-called shadow banking, an unregulated and off-balance sheet activities undertaken by certain monetary establishments. These activities emulate the traditional banking industry, permitting (for example) loans to be created and assets to be listed, however it does not operate under the same strict laws which usually apply to ‘normal’ banking. Shadow banking establishments are usually based mostly in tax havens such as Cayman Islands, Lichtenstein, etc.
Before the last crash, the U.S.A. shadow industry grew to around two and half times the scale of the standard banking. Globally, around $70,000bn of economic assets are betrothed in shadow banks. That’s akin to half bank assets worldwide!
Shadow banking could be a catalyst, which will pull down the regular banking system with it and plunge the entire world into another financial crisis. Prior to 2007 crash regular banks used shadow banking as a loan supplier (mortgages for example) but when the shadow banking collapsed it pulled down the conventional banking system with it – the consequences of which are all too familiar.
The shadow banking system has bounced back since then thanks to ultra-low interest rates, and the use of quantitative easing (QE) by governments across the world. Low interest rates have lowered the earnings people make on their investments, causing financial markets to look for other, higher-return activities. QE, through involvement of central banks which print new money, has given private banks huge sums of cash to play with while (minimal) new regulations have pushed financial institutions into searching for loopholes. Although QE coupled with low interest rates was meant to encourage economic activity in the real world the financial regulations were intended to stop this risky behavior.
Each of these measures is now producing precisely the opposite effect.
By the same token, attempting to repay debt thwarts growth by diverting money from investment, a generator of new income. Without new income and fresh tax money the governments are less able to repay the debts thus throwing the entire economies into a downward spiral of increasing public debt and decreasing employment.
Since 2008, the overall quantity of debt across the planet, relative to global GDP, has grown 38%, to 212% – excluding debt owed by shadow banking. However, the growth of debt in the developed countries has slowed down while debt in emerging economies such as China has risen by as much as 50%. Turkey is also seeing a sharp increase in indebtedness.
It is now the lower income economies which are deriving their growth via increased indebtedness, similar to what took place in the richer economies in the early 2000s. However the debt creation cannot be higher than the real economy, sooner than later this steam engine will be stopped in its tracks by debt repayment and interest rates. Considering that many Western banks operate in less developed economies and possess huge financial assets (actually liabilities!) in those countries makes them extremely vulnerable.
What makes this upcoming crisis even more ominous is that this time around it won’t be just one side of the world – higher income economies – that plunges the global economy into financial crisis. This time it will be a unison effort of all major world economies in a global dance of overheated debt growth, endless drive for short term profits, and an enormous and lethal shadow banking behind the scenes.