The bubble, that’s about to burst
View(s):Dr. Howard Nicholas from the International Institute of Social Studies, the Netherlands had informed me of his visit to Colombo. Whenever, he comes here, I usually ask him if he has time to visit the University of Colombo and give a lecture. Usually, he doesn’t say no.
Born in Sri Lanka, I knew his affectionate heart to Sri Lanka as well as to Colombo University where he served about 10 years since the mid-1980s. Together with Emeritus Prof. W.D. Lakshman who was the Head of the Department of Economics at that time, he was instrumental in capacity building in the Department of Economics and laying the foundation for its postgraduate studies.
Howard’s world view is beyond the conventional theoretical abstracts so that we always considered it a privilege to listen to his real-world economics based on his own research.
The big wave in 2008
It was in 2004 – four years before the outbreak of the global financial crisis in the US, that Howard was here in Colombo. I never forget his lecture that day, which inspired me to study business cycles.
As usual I had invited him to deliver a special lecture for economics postgraduate students at the university. He agreed and, said that he would speak on the same issue that he was interested in and delivered lectures in some other places in Europe.
The title of the lecture was “The Coming US Crisis: Nature, Causes and Consequences.” The lecture was about the inevitability of a forthcoming economic crisis from the US, as an inherent feature of long-term business cycles in the world economy!
Predicting the crisis
The world has been reaching the bottom of a long-term business cycle over the past few decades after the 1980s. The changes in the world economy – all were pointing towards one thing, as Howard revealed in his special lecture: The coming US crisis, which would be inevitable now.
As a result of the downward path of the US economy, one of the fascinating outcomes was the unprecedented escalation of the total US debt: It increased to over 260 per cent of GDP during the time of the Great Depression in the 1930s; now it has already increased to over 330 per cent of GDP by 2003, and was still rising. What does it mean?
The US economy was at the verge of a crisis which would be inevitable within the next couple of years, and the world economy has to face with its negative repercussions. And here comes the big wave in 2008, as we all saw it – the US financial crisis, as Howard predicted it four years before.
While the US lost about US$ 360 billion real income from its GDP, the entire world lost over $3,000 billion in just one year – 2009.
Flood gates of money
This time, Howard’s special lecture which was held on July 13, was on “the great monetary experiment” – a source of another big wave in the world economy. In fact, even a bigger wave than the previous global financial crisis. In other words, the world is heading towards a big financial crash.
I thought of elaborating today on some important factors that form the source of the forthcoming financial crisis, as revealed in Howard’s lecture.
And, this is a “man-made” crash with a foundation in a monetary policy experiment, unlike the previous global financial crisis.
File picture of currency printing at a Biyagama Zone plant. The writer says that increased money would lead to inflation or higher growth.
The great monetary experiment is the unprecedented increase in money in the world, led by the loose monetary policies and “quantitative easing” in advanced countries. The central banks in advanced countries have been injecting massive amounts of cash into their economies. They lower the short-term interest rates through repurchase agreements, drive down the long-term interest rates through buying bonds, and further pressurise the interest rates through direct lending to commercial banks.
All of the above lead to more and more money – a strategy that was adopted to stimulate growth and job creation in the aftermath of the 2008 global financial crisis. Consequently, the financial assets of the major four central banks in the world – Federal Reserve Bank, European Central Bank, People’s Bank of China, and Bank of Japan, increased three times during 2008-2018. The total assets of the all four banks together increased from 15 per cent of GDP in 2008 to over 40 per cent of GDP in 2018.
Interest rates were already down during the financial crisis. As a result of injecting more money by the central banks in the four biggest economies in the world, in fact the interest rates decreased further and, in some countries turned to negative. Under negative interest rates, borrowers are rewarded and savers are penalized!
Contrary to anticipation
What do we expect by opening the flood gates of money flows by the four big economies in the world? We would expect some inflation, by ending the deflationary pressures especially in the aftermath of the global financial crisis. There is more money and lower interest rates so that theoretically there should be more borrowings and more purchases causing the prices to go up. But there is no inflation!
We would also expect stimulation in investment and businesses, because there is plenty of money to borrow at lower or negative interest rates.
Banks got plenty of money to lend for investment and businesses but there is no borrowing for productive purposes.
Simply, more money should lead to higher growth and higher prices, particularly during a downturn of the world economy. But it is strange enough that neither growth accelerated nor prices increased. But money is still flowing in 2019 through opened flood gates, leaving an important question with us: Where did all that money go?
Speculative investment
Increased money would lead to inflation or higher growth, if that money ends up in the hands of the people who constitute consumers and producers or households and business firms. But the bulk of money did not go to their hands.
Money went into the hands of speculative investors: They borrow at lower or even negative interest rates, and invest in stock markets and bond markets! As a result, the money flows have boosted stock prices and bond prices. When such assets prices rise, usually it makes the rich richer and hurt the poor.
As financial assets are held by a smaller group of rich people, when the asset prices rises the rich become richer. The flip side of the coin is the decline in interest rates, perhaps, even to negative rates, hurting the ordinary people whose savings and pension funds generate little interest income.
Asset bubble
All ended up in a blowing asset bubble! It is not only in advanced countries, but also in China and emerging economies as part of the money originated in advanced countries flowed globally.
Still everything begins in the US economy: The value of the US financial assets amounted to 350 per cent of GDP at the time of the Dot-Com crisis in 2001; it was 375 per cent of GDP at the time of the Global Financial crisis in 2008. Now it is already over 425 per cent of GDP as of 2018.
What does this mean? An inflated financial bubble with “the great monetary experiment” in advanced countries. The future of the global economy is about a massive “financial collapse” with continued quantitative easing. This will be followed by a major economic stagnation in advanced countries.
By the way, there is always a silver lining in a dark cloud: The economic recessions are also accompanied by capital outflows from advanced countries to developing countries. The developing economies which are ready to accommodate foreign direct investment flows will be the beneficiaries of productive capital outflows in the world.
(The writer is a Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk).