The next financial crisis: a veil of mist and a crystal ball
There is a financial crisis from the moment when, on the one hand, there is a sudden drop in the monetary value of certain assets (financial or physical) and, on the other hand, when these losses spread – contamination – towards other sectors of the market, to the point where the stability or even survival of the financial institutions is threatened.
Progress in the euro area
Ten years on, some substantial progress has been achieved both globally and within the euro area. There has been a global reinforcement of banks’ capital, accompanied by more strict stress tests and the establishment of the Financial Stability Board. As for the euro area, three complementary measures (forming a system) have been taken: area-wide implementation of the deposit guarantee scheme, the creation of the European Banking Authority to monitor transnational players, including at the moment of their collapse, and finally the European Stability Mechanism, which can provide the necessary financing to correct fragilities of banking institutions of a certain size.
Significant risk factors remain
Nevertheless, three potential crisis factors still remain in the global economy. The first concerns exchange rates. Volumes more than 30 times greater than the gross world product are negotiated on this market. This gives an idea of the collateral effects that may result for national economies should exchange rates fluctuate suddenly – the euro/dollar exchange rate being particularly important here. At present, the main central banks refuse to enter into a spiral of confrontation, but there are vulnerabilities: the chronic US trade deficit over at least four decades, and the confirmed wish expressed by the Trump administration to boost American exports.
Historically low interest rates
The second cause for concern is linked to the historically low interest rates introduced by the central banks to lubricate the wheels that seized up as a result of the crisis in 2007. This was followed by a decade of “unconventional” monetary policy consisting of providing abundant, very cheap liquidity, leading to more than substantial expansion of the central banks’ balance sheets, likely to make them less agile in future. For savers (and their insurance companies and pension funds), the low rates mean that they no longer get a return on their capital, or a very low one. In order to compensate, they have been turning towards more risky assets. The value of these assets may drop suddenly if interest rates are increased too quickly. The last few days showed that nerves were on edge. The dilemma hangs on the fact that by being too careful where interest rates are concerned, the central banks are supporting a pathogenic situation.
A pathological connection between debt and growth
The third fragility derives from the fact that the crisis has not fundamentally altered the pathological connection between debt and growth. Growth in the US, like that in the euro area, has long been fed by a more than proportional increase in debt. This trend remains a concern, even if it has slowed a little since around 2010. Thus, for each additional unit of gross national product generated (growth), the gross volume of all debt (households, non-financial companies and public bodies) grows by 3 or even 4 units. History shows that the more valuations soar, the greater the risks of a crash.
To recap, the euro area may have benefited from the crisis to significantly reinforce its banking institutions, but the current volumes of credit, as well as the price of the risky assets such as shares, lead to the conclusion that significant destruction of financial capital is inevitable if the global economy is to regain its balance. It remains to be seen whether this destruction will take the violent form of a financial crisis, or whether the private and public players will make a concerted effort to ensure the necessary adjustments, thus avoiding the anticipated crisis.
And what about the Common good ?
The global economy increasingly relishes the liquidity that is tantamount to the permanent possibility of withdrawal, and thus is reluctant to invest in the medium or long term. This could not be more clearly expressed than by the proliferation of financial capital seeking yields. Such development in itself brings a risk of financial crisis, but above all lays the foundations for an anthropological crisis. Without turning their backs on finance, Christians should examine these promises against the question – qui bono? – of whether it is for the benefit of the Common good or solely those who are in a position to be the first to leap on the best bits? A crisis rarely benefits the common people.
Paul H. Dembinski
Professor at the University of Fribourg (Switzerland), Director of the Observatoire de la Finance
Translated from the original text in French
“Le bien commun par-delà les impasses” (The common good beyond the impasse), published under the coordination of Paul H. Dembinski and Jean-Claude Huot. Preface by Mgr Charles Morerod, Bishop of Lausanne, Geneva and Fribourg. Postscript by Most Reverend Justin Welby, Archbishop of Canterbury and Anglican Primate.
EN The views expressed in europeinfos are those of the authors and do not necessarily represent the position of COMECE and the Jesuit European Social Centre.