by Michael Roberts
During the current Chinese Communist party congress, Zhou Xiaochuan, governor of the People’s Bank of China, commented on the state of the Chinese economy. “When
there are too many pro-cyclical factors in an economy, cyclical
fluctuations will be amplified…If we are too optimistic when things go
smoothly, tensions build up, which could lead to a sharp correction,
what we call a ‘Minsky Moment’. That’s what we should particularly
defend against.”
Here Zhou was referring to the idea of Hyman Minsky,
the left Keynesian economist of the 1980s, who once put it: “Stability
leads to instability. The more stable things become and the longer
things are stable, the more unstable they will be when the crisis
hits.” China’s central banker was referring to the huge rise in debt in
China, particularly in the corporate sector. As a follower of
Keynesian Minsky, he thinks that too much debt will cause a financial
crash and an economic slump.
Now readers of this blog will know that I do not consider a Minsky
moment as the ultimate or main cause of crises – and that includes the
global financial crash of 2008 that was followed by the Great Recession,
which many have argued was a Minsky moment.
Indeed, as G Carchedi has shown in a new paper recently presented to the Capital.150 conference in London,
when both financial profits and profits in the productive sector start
to fall, an economic slump ensues. That’s the evidence of post-war
slumps in the US. But a financial crisis on its own (falling financial
profits) does not lead to a slump if productive sector profits are still
rising.
Nevertheless, a financial sector crash in some form (stock market, banks, or property) is usually the trigger for crises,
if not the underlying cause. So the level of debt and the ability to
service it and meet obligations in the circuit of credit does matter.
That brings me to the evidence of the latest IMF report on Global Financial Stability. It makes sober reasoning.
The world economy has showed signs of a mild recovery in the last
year, led by an ever-rising value of financial assets, with new stock
price highs. President Trump plans to cut corporate taxes in the US;
the Eurozone economies are moving out of slump conditions, Japan is also
making a modest upturn and China is still motoring on. So all seems
well, comparatively at least. The Long Depression may be over.
However, the IMF report discerns some serious frailties in this
rose-tinted view of the world economy. The huge expansion of credit,
fuelled by major central banks ‘printing’ money, has led to a financial
asset bubble that could burst within the next few years, derailing the
global recovery. As the IMF puts it: “Investors’ concern about debt
sustainability could eventually materialize and prompt a reappraisal of
risks. In such a downside scenario, a shock to individual credit and
financial markets …..could stall and reverse the normalization of
monetary policies and put growth at risk.”
What first concerns the IMF economists is that the financial boom has
led to even greater concentration of financial assets in just a few
‘systemic banks’. Just 30 banks hold more than $47 trillion in assets
and more than one-third of the total assets and loans of thousands of
banks globally. And they comprise 70 percent or more of international
credit markets. The global credit crunch and financial crash was the
worst ever because toxic debt was concentrated in just a few top banks.
Now ten years later, the concentration is even greater.
Then there is the huge bubble that central banks have created over
the last ten years through their ‘unconventional’ monetary policies
(quantitative easing, negative interest rates and huge purchases of
financial assets like government and corporate bonds and even corporate
shares). The major central banks increased their holdings of government
securities to 37 percent of GDP, up from 10 percent before the global
financial crisis. About $260 billion in portfolio inflows into emerging
economies since 2010 can be attributed to the push of
unconventional policies by the Federal Reserve alone. Interest rates
have fallen and the banks and other institutions have been desperately
looking for higher return on their assets by investing globally in
stocks, bonds, property and even bitcoins.
But now the central banks are ending their purchase programmes and
trying to raise interest rates.
This poses a risk to the world economy,
fuelled on cheap credit up to now. As the IMF puts it: “Too quick
an adjustment could cause unwanted turbulence in financial markets and
international spillovers … Managing the gradual normalization of
monetary policies presents a delicate balancing act. The pace of
normalization cannot be too fast or it will remove needed support for
sustained recovery”. The IMF reckons portfolio flows to the emerging economies will fall by $35bn a year and “a
rapid increase in investor risk aversion would have a more severe
impact on portfolio inflows and prove more challenging, particularly for
countries with greater dependence on external financing.”
What worries the IMF is that this this borrowing has been accompanied by an underlying deterioration in debt burdens. So
“Low-income countries would be most at risk if adverse external
conditions coincided with spikes in their external refinancing needs.”
But it is what might happen in the advanced capital economies on debt that is more dangerous, in my view. As the IMF puts it: “Low
yields, compressed spreads, abundant financing, and the relatively high
cost of equity capital have encouraged a build-up of financial balance
sheet leverage as corporations have bought back their equity and raised
debt levels.” Many companies with poor profitability have been
able to borrow at cheap rates. As a result, the estimated default risk
for high-yield and emerging market bonds has remained elevated.
The IMF points out that debt in the nonfinancial sector (households,
corporations and governments) has increased significantly since 2006 in
many G20 economies. So far from the global credit crunch and financial
crash leading to a reduction in debt (or fictitious capital as Marx
called it), easy financing conditions have led to even more borrowing by
households and companies, while government debt has risen to fund the
previous burst bubble.
The IMF comments “Private sector debt service burdens have
increased in several major economies as leverage has risen, despite
declining borrowing costs. Debt servicing pressure could mount further
if leverage continues to grow and could lead to greater credit risk in
the financial system.”
Among G20 economies, total nonfinancial sector debt has risen to more than $135 trillion, or about 235 percent of aggregate GDP.
In G20 advanced economies, the debt-to-GDP ratio has grown steadily
over the past decade and now amounts to more than 260 percent of GDP. In
G20 emerging market economies, leverage growth has accelerated in
recent years. This was driven largely by a huge increase in Chinese debt
since 2007, though debt-to-GDP levels also increased in other G20
emerging market economies.
Overall, about 80 percent of the $60 trillion increase in G20
nonfinancial sector debt since 2006 has been in the sovereign and
nonfinancial corporate sectors. Much of this increase has been in China
(largely in nonfinancial companies) and the United States (mostly from
the rise in general government debt). Each country accounts for about
one-third of the G20’s increase. Average debt-to-GDP ratios across G20
economies have increased in all three parts of the nonfinancial sector.
The IMF comments: “While debt accumulation is not necessarily a
problem, one lesson from the global financial crisis is that excessive
debt that creates debt servicing problems can lead to financial strains.
Another lesson is that gross liabilities matter. In a period of stress,
it is unlikely that the whole stock of financial assets can be sold at
current market values— and some assets may be unsellable in illiquid
conditions.”
And even though there some large corporations that are flush with cash, the IMF warns: “Although
cash holdings may be netted from gross debt at an individual
company—because that firm has the option to pay back debt from its stock
of cash—it could be misleading”. This is because the distribution
of debt and cash holdings differs between companies and those with
higher debt also tend to have lower cash holdings and vice versa.
So “if there are adverse shocks, a feedback loop could develop,
which would tighten financial conditions and increase the probability of
default, as happened during the global financial crisis.”
Although lower interest rates have helped lower sovereign borrowing
costs, in most of the G20 economies where companies and households
increased leverage, nonfinancial private sector debt service ratios
also increased. And there are now several economies where debt service
ratios for the private nonfinancial sectors are higher than average and
where debt levels are also high. Moreover, a build-up in leverage
associated with a run-up in house price valuations can develop to a
point that they create strains in the nonfinancial sector that, in the
event of a sharp fall in asset prices, can spill over into the wider
economy.
The IMF sums up the risk. “A continuing build-up in debt loads
and overstretched asset valuations could have global economic
repercussions. … a repricing of risks could lead to a rise in credit
spreads and a fall in capital market and housing prices, derailing the
economic recovery and undermining financial stability.”
Yes, banks are in better shape than in 2007, but they are still at
risk. Yes, central banks are ready to reduce interest rates if
necessary, but as they are near zero anyway, there is little “scope for monetary stimulus. Indeed, monetary policy normalization would be stalled in its tracks and reversed in some cases.”
The IMF poses a nasty scenario for the world economy in 2020. The
current ‘boom’ phase can carry on. Equity and housing prices continue
to climb in overheated markets. This leads to investors to drift beyond
their traditional risk limits as the search for yield intensifies
despite increases in policy rates by central banks.
Then there is a Minsky moment. There is a bust, with declines of up
to 15 and 9 percent in stock market and house prices, respectively,
starting at the beginning of 2020. Interest rates rise and debt
servicing pressures are revealed as high debt-to-income ratios make
borrowers more vulnerable to shocks. “Underlying vulnerabilities are exposed and the global recovery is interrupted.”
The IMF estimates that the global economy could have a slump
equivalent to about one-third as severe as the global financial crisis
of 2008-9 with global output falling by 1.7 percent from 2020 to 2022,
relative to trend growth. Capital flows to emerging economies will
plunge by about $65 billion in one year.
Of course, this is not the IMF’s ‘base case’; it is only a risk. But
it is a risk that has increasing validity as stock and bond markets
rocket, driven by cheap money and speculation. If we follow the
Carchedi thesis, the driver of the bust would be when profits in the
productive sectors of the economy fall. If they were to turn down along
with financial profits, that would make it difficult for many companies
to service the burgeoning debts, especially if central banks were
pushing up interest rates at the same time. Any such downturn would hit
emerging economies severely as capital flows dry up. The Carchedi
crunch briefly appeared in the US in early 2016, but recovered after.
Zhou is probably wrong about China having a Minsky moment, but the
advanced capitalist economies may have a Carchedi crunch in 2020, if the
IMF report is on the button.
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