EXCESSIVE DEBT – THE GREATEST THREAT TO ANOTHER FINANCIAL CRISIS
It’s Thursday, it’s such a beautiful day, you couldn’t script it if you tried. Everything in the garden seems rosy, or is it? Stock markets in the west are either at record high levels or close to. Conversely, the Shanghai composite has had major issues in the last three years. At the time of the banking crisis in March 2009, the Shanghai composite stood at 2193. Today it stands at 2791 up 27% in that period. However, it did reach 5116 on 20th June 2015. Since that day it is down 45%. That coincides with China’s GDP which stood at a frothy 10% and is now around 6.7%. It should not be forgotten that the Chinese authorities tend to be extremely economical with the truth. Many people challenge the robustness of the banking sector and have expressed concern over a plethora of properties being built all over China – many of them not in use. It is also thought that the banking sector is restricting loans for those involved in retail.
I hate being an anorak, but sometimes its necessary to illustrate what happened 10 years ago at the time of the financial crisis. The great God ‘Quantitative Easing’ was introduced. Like insurance it was a necessary evil. There was no liquidity in the banks and many people probably don’t realise how close we were to having a moribund banking service with no cash available and no bills paid. The US authorities were forced to put $4.5 trillion into their system and by way of comparison the Bank of England put a total of £475 billion in to the UK banks. What no one knows is how damaging the removal of QE will be on the world’s economy. The US has started to taper QE modestly but there is still a long way to go. As for the UK we are still where we were 10 years ago. As for the European Union they only started QE in 2015. However, Mario Draghi the President of the ECB is already talking about cutting back on QE next year.
We need to remind ourselves of who benefitted from QE and who didn’t. The injection of cash into the banking system provided the missing confidence and this triggered their investment divisions and fund managers in general to back the truck up and fill it up with stocks and shares. On 9th March 2009 the day QE started, most global indices were on their knees. Since that fateful day the following had made gargantuan gains – DJIA +265%, S&P 500 +324%, NASDAQ +517%, FTSE100 + a paucity – 113%, DAX +233%, HANG SENG +117%, NIKKEI +232% and the Shanghai composite +27%. There is no doubt the role of private equity, hedge funds and fund managers has contributed to the frothiness of the market. They have exacerbated the strength of this rally. Immediately after the crisis, the banks were unable to fulfil their full role until they had been recapitalised.
Though this extraordinary rally which does not include the benefit of dividends, has triggered a recovery of the world’s economy it has done so rather anaemically benefitting fewer people than is desirable. The situation of course was magnified in some countries by the introduction of necessary austerity. This was particularly the case in the UK where it was felt that Government borrowing had got totally out of hand. George Osborne started the process and Philip Hammond has been more than happy to carry on.
Consequently, the gulf between those that have and those that have not, has widened unacceptably. It has created huge resentment and significant anger. A large percentage of the population has not enjoyed an increase in remuneration in concert with inflation for a few years; hence the rise of Jeremy Corbyn and John McDonnell with their wacky but attractive alternative to capitalism. It has attracted those between the age of 18 and 45, who cannot get on the property ladder, appear to have seen no visible help from the May Government and thoroughly dislike her approach. This section of society erroneously seems more than happy to sup the alternative regardless of the consequences. The fact that Labour’s economic policies have got more holes in it than a sieve and that the maths do not add up for their ambitious programme is a matter of wholesale indifference to this section of society. Labour’s plans to nationalise certain industries, possibly without compensation, to steal equity from individuals and fund managers, for workers’ participation and a humungous welfare programme likely to cost zillions needs paying for. Higher taxation and borrowing will cover it, but at what cost? The pound is likely to fall out of bed. Interest rates will have to rise to protect the pound. UK equities without a dollar denomination will fall sharply and most important of all international investors will head for the hills. We saw similar political behaviour in the US two years ago with the arrival of the Trump band wagon. However, the disenchanted cries for change are slightly different from the Trump voters. There is nothing left wing about Donald Trump’s supporters.
This social divide has very dangerous connotations. Over here in Old Blighty the widening divisions will continue to manifest themselves through the dangerous Brexit negotiations and the threat of the General Election. A Corbyn Government is a real possibility unless the Tories get hold of the bit and realise that their remit is wider than Brexit, which is driving everyone mad – however important they may be. The ‘social divide’ is acutely worrying and it needs dealing with – no platitudes just action.
Is the bull market over? Are equities likely to plateau? Could we have a sharp reversal? The latter seems unlikely, due to interest rates remain relatively low, despite the FED’s intervention. Bonds remain for many investors an unattractive alternative asset. During this recovery process have we learnt anything? Could there be another financial crisis? It couldn’t possibly be dismissed despite global regulatory authorities implementing Draconian measures to stop banks going to the wall.
My big worry about the future is debt. There is far too much of it. In 2007 the global debt stood at $150 trillion. Today global debt sits at circa $250 trillion – up 66%. US debt has ticked up modestly from $50 trillion in 2007 to $70 trillion today, up 40%. The situation in China is even worse, but it comes from a much lower number – up from $10 trillion to $35 trillion in the last 11 years – up 250%! Personally speaking, I am much more worried about the bond markets than I am about equities but that is purely my opinion. This level of debt is at terrifying levels and I feel sure that the central banks are aware of this explosion and hope that the level of communication between them is fulsome. I have no crystal ball and therefore have no idea when another financial debacle will take place. It could be next year, it could be in a decade’s time or maybe 50 years away!
One thing I am quite sure about is that any financial crash is unlikely to be precipitated by the banking sector. Why? These sectors are heavily regulated and tough stress tests have been implemented by virtually every central bank around the world. I might exclude China and as I have already intimated, the truth is hard to get to. Any subsequent crash is likely to emanate from highly sophisticated technology which could easily bypass the banks as this sector slowly but surely seems to be replacing the role of a bank. Cyber crime is discussed rather glibly. It is a really serious problem and I am not sure that even the most brilliant brains have the natural ability to prevent a very nasty financial crash in the years to come. What would help is the will of central banks to persuade governments and therefore the consumer and corporate operations to cease borrowing in such a voracious manner. I have no way of knowing but I suspect it will be China that triggers this crisis. The size of its economy will supersede the US before too long. Even though 40% of Chinese people are inclined to save money, they have no control over government or corporate lending. Technology is the ‘key to the kingdom’, but we can be none too sure that the key fits the lock of the problem. We are all warned! Prenez Garde!
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