This article first appeared in Forum, The Edge Malaysia Weekly on September 17, 2018 - September 23, 2018
George Soros, Bill Gates and other pundits have been predicting another financial crisis. In their recent book, Revolution Required: The Ticking Bombs of the G7 Model, Peter Dittus and Herve Hamoun, former senior officials of the Bank of International Settlements, warned of “ticking time bombs” in the global financial system waiting to explode, mainly due to the policies of major developed countries.
Recent events vindicate such fears. Many emerging market currencies have come under considerable pressure, with the Indonesian rupiah, Indian rupee and South African rand all struggling since early this year. Brazil’s real fell sharply in June, and Argentina has failed to stabilise its peso despite seeking International Monetary Fund (IMF) aid. As Turkey struggles to stabilise its lira, many European banks’ exposure has heightened fears of another global financial crisis.
Why the vulnerability?
Some fundamental weaknesses are at the core of this vulnerability. These include the international financial “non-system” since the collapse of the Bretton Woods system in 1971, and continuing to use the US dollar as the main international reserve currency.
This burdens deficit countries vis-à-vis surplus countries and ensures near-universal vulnerability to US monetary policy. Thus, most countries accumulate dollars as a precaution, that is, for “protection”, eschewing other options, such as investing in socially desirable projects.
Policymakers not only failed to address these weaknesses following the 2008-2009 global financial crisis (GFC), but also compounded other problems. Having eschewed stronger, more sustained fiscal policy interventions, monetary policy virtually became the sole policy instrument. Major central banks, led by the US Federal Reserve, embarked on unconventional monetary policies, pushing real interest rates down, even into negative territory.
Emerging and developing economies (EDEs) offering higher returns temporarily experienced large short-term capital inflows. The external debt of emerging market economies has grown to over US$40 trillion since the GFC. The combined debt of 26 large emerging markets rose from 148% of gross domestic product (GDP) at the end of 2008 to 211% in September 2017, according to the Institute of International Finance (IIF).
Easy money raised household and corporate debt, fuelling property and financial asset price bubbles. According to the IMF April 2018 Fiscal Monitor, global debt peaked at US$164 trillion in 2016, or 225% of global GDP, compared with 125% before the GFC. The IIF reported that global debt rose to over US$247 trillion in early 2018, or equivalent to 318% of GDP.
Rising debt levels pose serious downside risks for the global economy. With easy money coming to an end, as the Fed continues to “normalise” monetary policy by raising the policy interest rate, capital flight to the US is undermining emerging market currencies. When debt defaults increase with interest rates while income growth remains subdued, the world becomes more vulnerable to financial crisis.
Diminished capacities
Both developed and developing countries have less policy space than during the GFC. Most governments are saddled with more debt following massive financial bailouts followed by abandonment of efforts to sustain robust recovery.
According to the IMF’s April 2018 Fiscal Monitor, the average public debt of advanced economies was 105% of GDP in 2017, constraining fiscal capacity to respond to a crisis. Meanwhile, monetary policy options are exhausted after a decade of unconventional monetary policies.
General government debt-to-GDP ratios in emerging market and middle-income economies almost reached 50% in 2017 — a level only seen during the 1980s debt crisis. The 2017 ratio exceeded 40% in low-income developing countries, climbing by more than 10 percentage points since 2012.
Playing With Fire by Yilmaz Akyuz, former South Centre chief economist, has highlighted the self-inflicted vulnerabilities of developing countries. Public debt-GDP ratios in EDEs are likely to rise due to falling commodity prices and stagnant global trade, while they have almost no monetary policy independence due to deeper global financial integration.
Weaker global growth
While corporate sectors have been busy with mergers, acquisitions and share buybacks with cheap credit, instead of investing in the real economy, the financial sector has successfully portrayed sovereign debt as public enemy No 1.
Held hostage to finance capital, governments around the world have wasted the opportunity to improve productive capacities by investing in infrastructure and social goods when real interest rates were at historic lows. At around 24% of global GDP, the global investment rate remains below the pre-crisis level of around 27%, with investment rates in EDEs either declining or stagnant since 2010.
The failure to address the falling wages’ share of GDP, rising executive pay and asset price bubbles, due to “easy” monetary policy, have continued to worsen growing income inequality and wealth concentration. Meanwhile, deep cuts in government spending and public services, while reducing top tax rates, cause anger and resentment, often blamed on “the other”, contributing to the spread of ethno-populism.
In turn, growing inequality limits aggregate demand, which has been maintained by unsustainably raising household debt, that is perverse “financial inclusion”.
Perfect storm?
Turbulence in currency markets is due to developing countries’ limited economic policy space. A decade after the GFC, developing countries still experience lower growth and investment rates.
Financial sectors of emerging market economies now have more and deeper links with international financial markets, also reflected in high foreign ownership of stocks and government bonds, with large sudden capital outflows causing financial crises.
Meanwhile, recent commodity price drops have accelerated the rising indebtedness of low-income countries. According to the IMF, 24 out of 60 (40%) are now either already facing debt crises or are highly vulnerable — twice as many as five years ago, with a few already seeking IMF bailouts.
The problem is compounded by declining concessional aid from Organisation for Economic Co-operation and Development countries. Also, more creditors are not part of the Paris Club, obliged to deal with sovereign debt on less onerous terms. Meanwhile, growing trade and currency conflicts are worsening the woes of those already worse off.
Jomo Kwame Sundaram, a former economics professor, is a member of the Council of Eminent Persons and was UN Assistant Secretary-General for Economic Development. Anis Chowdhury, Adjunct Professor at Western Sydney University (Australia), held senior UN positions in New York and Bangkok.
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