Full effects of global financial crisis may have yet to be felt

Ten years ago, the century-old investment bank Lehman Brothers was allowed to fail, thereby triggering the most acute phase of the global financial crisis. But instead of experiencing another Great Depression, the world ended up with the Great Recession.

After a decade of reform, bailouts, and unconventional central bank intervention, should we count ourselves lucky? The crisis originated in the United States.

The first sign of trouble was the slow-motion demise of its real estate market, which seemed to have defied gravity; and the implosion of subprime mortgage-tied derivatives held by leading institutions. With the Lehman bankruptcy, the US crisis soon morphed into one of sovereign debts across Europe.

Since big banks played a key role in the crisis, many critics had predicted they would have to be cut down to size to reduce systemic risk. Yet, today, America’s biggest banks take in more deposits and enjoy even larger market shares.

Back then, many institutions such as Lehman were leveraged to alarming levels. Most agreed then that high debts were bad, especially when available, and hidden, through the so-called shadow banking sector, and had to be deleveraged.

But thanks to historically low interest rates, the world has loaded up on debt. According to research by Citigroup, global debt has surged to 217 per cent of gross domestic product and is almost 40 percentage points higher than 10 years ago.

What is especially concerning is that China accounts for 70 per cent of the credit creation in the last decade. While President Xi Jinping has taken great pains to rein in the shadow banking system and made deleveraging a priority, the trade war initiated by the US has meant the credit creation machine is being switched on again.

The demise of the Chinese economy has been greatly exaggerated, but economists and policymakers are not wrong to worry about a Chinese “Minsky moment”, when asset values drop abruptly as part of a credit cycle.

Meanwhile, it’s often observed that the Great Depression gave rise to European fascism and posed an existential threat to the Western capitalist and democratic systems. The Great Recession has enabled the rise of far-right groups and parties in the West.

The unconventional use of central banking such as quantitative easing has artificially pushed up global asset prices from equities to property. The result has been the greatest wealth transfer in history from the have-nots and have-littles. Without the benefits of real growth, coupled with inhumane austerity measures, they have been left holding the bag.

Donald Trump could not have entered the White House without them. Their anger may yet herald more danger ahead. To paraphrase Zhou Enlai, it’s too early to know the full consequences of the world economic crisis.

This article first appeared in the South China Morning Post