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The Next Financial Crisis

Financial Crisis

The Making of a 2020 Recession

“Remove the crutches that have supported global growth for a decade, throw in a trade war between the world’s two largest economies, add a dash of wage inflation and a side dish of Brexit and you have a recipe that may prove rather unpalatable to global markets in 2019.”
— Bonham Carter Vice Chairman Jupiter Fund Management PLC

he 2008 financial crisis dealt the biggest blow to the world economy since the Great Depression. It followed on a series of crises experienced around the world, including the East Asia crisis, the Mexican crisis, the Russian crisis, and the Latin American crisis. However, the world started recovering and although growth, over the years, has returned and the job market has tightened, the reverberations of the crisis continue to affect us in ways both obvious and indirectly connected. But, now the storm clouds of the next global financial crisis are gathering despite the world financial system being unprepared for another downturn. This is what David Lipton, the first deputy managing director of the IMF, pointed out when he said, “As we have put it, ‘fix the roof while the sun shines’. … I see storm clouds building and fear the work on crisis prevention is incomplete.”

Although the global economy has been undergoing a sustained period of synchronized growth, it will inevitably lose steam as unsustainable fiscal policies in the US start to phase out. Come 2020, the stage will be set for another downturn and, unlike in 2008, governments will lack the policy tools to manage it. But, no one is pointing to the erratic approach to ensuring a smoothly working global economic system that actually made this crisis inevitable.

What drives a financial crisis?

Primarily, there are three factors that can be held responsible for recession.

1. Demand-side policies

Demand-side policies that lead investors and citizens to believe that ‘there is no risk’, are the most prominent factor. Complacency and excess risk-taking cannot happen without the existence of a widespread belief that there is some safety net, a government or central bank cushion that will support risky assets. Terms like ‘search for yield’ and ‘financial repression’ come precisely from artificial demand signals created from monetary and political forces.

2. Excessive risk-taking

Excessive risk-taking in assets that are perceived as risk-free or bullet-proof is the second on this list. It is impossible to build a bubble on an asset where investors and companies see an extraordinary risk. It must happen under the belief that there is no risk attached to rising valuations because “this time is different,” “fundamentals have changed” or “there’s a new paradigm.”

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