It is increasingly difficult to justify the complacency in global financial markets in the light of the magnitude and potential significance of events in the United States, Europe and beyond which could be defining elements of the next global financial crisis.
Having studied, analysed, and worked in financial markets since the late 1960s, I have drawn two clear conclusions – basically, financial markets, including key regulatory authorities, do not understand “risk”, and they certainly do not “price” it correctly.
There is a genuine danger of drifting into a global trade war, given US President Donald Trump has finally imposed the long-promised tariffs on steel and aluminium imports from the European Union, Canada and Mexico. If not handled by all sides with considerable care, this could precipitate a global slump such as that created by protectionist legislation in the US in 1930.
The Eurozone also faces a potentially existential crisis as the result of the new anti-austerity, anti-EU, heavily indebted government in Italy. As the Eurozone’s third largest economy (ranking 7th or 8th globally, and six times the size of Greece) the risk is of a debt crisis that would dwarf the Greek debt crisis in severity and threaten the future of the Eurozone (and perhaps of the EU).
As if all this uncertainty isn’t enough, there is renewed concern aboutoil prices, global (especially Chinese) debt, the transition – being led by the US Federal Reserve – to “normalise” interest rates, and key elections in emerging markets (Turkey, Brazil and Colombia), with other key emerging nations in dire, debt/inflation-ridden economic circumstances.
On trade, the key issue now is how those affected by the Trump tariffs, directly and indirectly, respond. So far, Canada has said it will impose similar tariffs on US imports, and additional tariffs from July 1. Clearly, Canada and Mexico hope to get exemptions under a revised North American Free Trade Agreement, although negotiations have stalled.
Europe is taking a particularly hard line in response. They havealready identified a “politically clever” list of US imports to target – such as bourbon from Tennessee and Harley Davidsons. Europe has no choice but to retaliate. It is concerned by the potential “double-whammy” of tariffs on their exports plus China redirecting/dumping their targeted exports at under-market prices.
However, the Chinese seem willing to try to strike a bilateral deal based on quotas, although Trump’s list of “demands”, including substantial annual reductions in the trade deficit, and open investment access to China, are ambitious, to say the least. Trump has also promised to announce (on June 15) further tariffs on an additional US$50 billion ($65 billion) of Chinese imports, in retaliation for alleged intellectual property theft.
Trump has also launched an investigation into auto and truck imports that would hit Europe, especially Germany. More threats and counter threats are emerging almost daily.
The Italian situation is particularly volatile, with the new government a “fragile” and probably unsustainable“liaison” between the Five Star Movement and the Northern League (Lega). The coalition concerns both Brussels and Berlin, because both parties ran a hardline right wing, populist, xenophobic, anti-European agenda. Their “agreed” policy platform is anti-austerity, including tax cuts for the wealthy, significant boosts to public spending and some form of universal basic income.
While the new coalition is not advocating an exit from the Euro, anti-Euro sentiment in Italy is high and mounting, as the country recognises the (politically and socially difficult) need for an “internal devaluation”. Since 1999, real gross domestic product in Italy has increased by only 6.3 per cent, compared with 27 per cent in Germany and 39 per cent in Britain. They have already endured one recent banking crisis, national debt is in excess of 130 per cent of GDP, overall unemployment is 11 per cent ( and about 32 per cent for those under 25), and the latest consumer confidence data reveals a sharp fall.
Although there was some initial blow-out in Italian 10-year bond yields relative to German ones, that has partially reversed, as has the stockmarket, partially reversing its fall, probably more out of relief from what was threatening to be a serious constitutional crisis, rather than a genuine assessment of Italian challenges and prospects. A collision between Brussels, Berlin and Rome seems inevitable, but the capacity of the European Stabilisation Fund would prove inadequate to deal with an Italian financial failure.
Against this background I was particularly struck by, and disturbed by, our Reserve Bank’s comment on the global situation in this week’s announcement on the cash rate. “Financial markets have been affected by political developments in the eurozone, particularly in Italy,” it said. “There are also concerns about the direction of international trade policy in the United States and economic developments in a few emerging market economies.”
These “weasel words” have become so typical of Reserve Bank/ Treasury ease. While making absolutely no attempt to spell out the risks and potential consequences for Australia, indeed to actually take account of them formally in their forecasting and advice to government, they nevertheless feel self-assured that if ever questioned in the context of a crisis, before a Senate Committee, or even in public, they can say, “Yes, we took account of those risks. We ticked that box – we did mention that in our press release, or in some budget paper.”
This attitude is even more concerning in a world where voters are demanding transparency and accountability, having lost faith in politics and key institutions, and where much of our economic difficulties in housing affordability and household debt stem in part from the likes of the Reserve Bank being “asleep at the wheel”.
Exactly what would they do to handle another global financial crisis?
This article appeared on The Sunday Morning Herald on 6 June, 2018.
View the original article here.