There is a complacency in the air as we stumble into 2018.
Global economic forecasts are coated with sugar. Stock markets keep heading skywards and borrowing is at an all-time high. Brexit may be a brick through the window of the UK’s economic outlook, but for the rest of the developed world, the view is decidedly rosy.
Such is the exuberance among those with plenty of spare cash that there is a return of borrowing with the sole purpose of betting on stock market gains. To this end, investors are using any asset to hand – their house, their pension or their deposit savings – to get a boost from the alpha funds that promise stellar returns. Bitcoin is another feature of this relaxed attitude to risk. Who needs safety nets when there is no prospect of a fall? It’s not hard to see why the picture looks so rosy and why it is likely to conclude with an ugly denouement.
Underpinning everything that makes life easy are the ultra-low interest rates of the past 10 years. Borrowing has become cheaper and cheaper as banks have used low rates to first get their balance sheets in order and then compete to offer better deals to businesses and consumers.
The Bank for International Settlements, known as the central bankers’ bank, has charted the real interest rates offered globally and concluded this month that they were at their lowest level since records began.
It didn’t matter that the US Federal Reserve started raising interest rates in 2015 and has so far pushed the base rate from 0.25% to 1.5%. Banks have continued to cut each other’s throats in the retail and corporate marketplaces for loans, offering lower and lower rates each month to secure new business.
Analysis by the financial data provider Dealogic shows that companies and governments have pushed their collective borrowing to a new high this year. The firm’s estimate of $6.8tn of borrowing includes the debt issued by countries like Argentina and Saudi Arabia and mortgages sold as securities on financial markets. It excludes the safest government debt, such as US treasuries and UK gilts, and debt issued by local authorities.
A different measure of debt used by the Institute of International Finance estimates that a credit binge in emerging markets led by China has pushed the global level of debt from 276% of global GDP to 324%.
The Trump tax cuts are another spur to those investors who would wish away the prospect of a recession or, worse, a financial crash.
Donald Trump’s proposals are expected to be signed into law sometime over the Christmas break or early in the new year and look like injecting $1.5tn into the US economy.
Wealthy Americans are expected to gain the biggest benefit and will most probably invest it in financial markets. They don’t need the money to finance their lifestyles, so why not speculate with it?
Already the Dow Jones index, the main securities market in the US, is soaring to new highs. In just five and a half years it has doubled in value to almost 25,000 points.
Third on the list of catalysts is the eurozone, which has woken up after years of intermittent crisis following the 2008 crash.
With the US accelerating on the back of the Trump tax bill and China re-energising its manufacturing sector, many European companies are in demand, particularly if they have machine tools, cars, pharmaceuticals or marketing services to offer. Even Brexit is seen by investors as a parochial event that can do little harm to global growth.
All these forces delay a recession that should be around the corner after nine or 10 years of increased borrowing. The usual course of events would dictate that a shake-out of debt-funded companies drags on growth and even sends the economy into reverse.
The late arrival of the eurozone to the growth party, the Trump tax cuts and the modest increases in interest rates (carried out by the Federal Reserve and signalled by the European Central Bank), have all delayed the day the shake-out occurs. And that means the recession, when it comes, will be deeper and more harmful.
Maybe investors are right to heed Janet Yellen’s valedictory message. The departing US Federal Reserve chief said the signals from the bond markets of a slowdown should be ignored. There was, she said, a historical correlation between what was going on in the bond markets at the moment and a recession, but no “causality”.
But listening to the Bank for International Settlements might be wiser, given that its former boss, William White, warned about an impending financial crash 12 years ago. In its latest global health check, it says the situation is similar to 2005, when interest rates were rising and investors were ignoring the situation by borrowing more and taking bigger risks with the cash.
That gives governments and regulators two to three years to prevent a full-scale crash. At the moment nobody appears to be paying any attention. White is now at the OECD and making the same warnings. Beware 2020: it could be a very bad year.
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