The coming year has the potential for a combination of major risks to the global economy coming together to cause a financial crisis rivaling that of 2008-09. The mortgage bubble that burst in 2008 led to multiple failures of financial institutions, major downturns in global markets, and sweeping regulatory and legislative responses. While the same exact conditions might not apply to the current economy, there are other materials and real risks.
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Economist Peter Hooper of Deutsche Bank Securitieshas reported on three of the major risk factors currently facing the current global economy.
A Possible Brexit Disaster
First, if a “No Deal Brexit” comes to pass, European markets could be thrown into disarray. The current state of the nature of the Brexit from the EU is uncertain, and that uncertainty causes distress in European and global markets. Ever since the original Brexit referendum, different factions within the UK and the EU have been battling through different proposals for how the UK’s withdrawal from the EU will be managed.
There still exist possibilities of everything from a “hard Brexit” (that is, one with no substantial new trade agreement with the EU) up to a whole new public referendum on whether to leave or remain in the EU. The British government has up to March 29 to determine the path forward, and in the meantime, uncertainty and doubt surround the European market.
Trade War Fallout Concerns with China
Second, if trade relations between the United States and China deteriorate, global markets could suffer significant downturns. The status of trade between the US and China have become highly politicized recently, causing uncertainty and concern. Rather than a negotiated trade agreement between the countries, currently the political landscape for the two huge economies is one of tension, if not outright hostility.
The current US political motivation, as shown by the Trump administration, is to negotiate by way of aggressive tariffs and threats of tariffs. The US Congress has shown deference to the administration in dealing with China in this way, rather than be attempting to enter into stable and thorough long-term trade agreements. The markets of both countries and the entire world suffer from instability and the possibility of large downturns without trade agreements in place.
Monetary Inflation Bleeding Across Global Economies
Third, if the Chinese economy slows as a result of the monetary inflationary policy, the global economy, and especially the US, could feel the effects. After the 2008 financial crisis, China’s national bank greatly loosened lending and credit to boost growth.
Some of the resulting capital investments have proven to be beneficial to the Chinese economy. However, many of thecapital improvements have not panned out, as there are millions of empty residential developments and transportation infrastructure that is either underutilized or not used at all. China’s debt to GDP ratio has increased by more than 120 percent as a result.
In recent years the Chinese national bank has significantly tightened up credit markets. The risk is that reopening credit markets might lead to a great reduction in capital investment in Chinese markets. Uncertainty about China’s monetary stimulus policies could lead to downturns in the Chinese economy, and by turn, global markets.
Are Global Policy Responses to Current Year Crises Up to the Challenge?
In addition to these, there are other risks involved with typical policy responses and how they affect global stock markets.
Late in 2018, and over the objections of the Trump administration, the Fed increased interest rates. As 2019 began, the Fed decided to change course. Rather than continuing to increase rates, the policy announced is a continuation of the quantitative easing (QE) seen in the aftermath of the 2008 crisis, when interest rates were already reduced about as low as they could possibly go.
As a result, the Fed’s balance sheet will continue to grow in size, rather than be reduced according to the policy of most recent years. So far since the 2008 financial crisis, monetary expansion has not resulted in substantial price inflation, although inflation is a serious concern under current conditions.
World central banks are continuing some of the general responses to the 2008 crisis: reducing interest rates, QE monetary inflation, financial institution bailouts through public funding, and deficit financing. In the current year world economy, however, interest rates are already essentially zero in many economies and QE is losing its ability to provide punch to economies because of already inflated money supplies. Also, nationalism and populism have had some negative impacts on global trade between many countries.
Many experts believe that world economies are currently in much worse positions to deal with a significant crisis at the level of 2008. Faced with major downturns, central banks around the world might be faced with cutting interest rates all the way into negative rate territory. Additionally, if the only apparent tool is QE, nations may go with what they know, heating up the inflation of the global money supply even more. Deficit spending would be an almost certain response.
Another possible method of stimulus could be some mixture of immediate tax cuts and increased deficit spending. If the risks described pan out in combination, portfolios overly reliant on the stock market could see devastating effects. As always, diversity is the key to your successful portfolio.