The 2008 global financial crisis is considered the most devastating since the Great Recession during the 1930s, and it almost brought the world financial system to its knees. It generally started in the US, where the effects of financial deregulation hit hard, and spilled over to Europe, and then practically to the entire world. In the United States, the banking and financial industries were hit hard by widespread defaults on sub-prime mortgages, and stock trading was halted, while in Europe, the defective figure of the Eurozone allowed countries, such as Greece, to take in unhealthy sovereign debt. It took the intervention of governments to avoid a total collapse.
Quantitative Easing
In the US, the Federal Reserve implemented several rounds of quantitative easing (QE) to bring the economy back to its feet. QE is an unconventional monetary policy that is usually applied when conventional policies collapse. QE involves large scale asset purchases by the Central Bank, such as bonds and treasury bills. Its effect is essentially to inject liquidity and to simultaneously lower interest rates. Theoretically, QE will stimulate the economy by encouraging borrowing and boosting spending. The global economy rebounded after all these measures were taken by various governments around the world. It could fairly be concluded that QE worked to get the financial system out of the woods.
The Next Recession?
But a little over a decade later, we are staring at the prospect of yet another recession, with all indicators pointing to an even scarier situation than in 2008. In the last global financial crisis, Central Banks were able to respond quickly and aggressively, and they only managed to reduce the effects, and not avert the situation. An asset bubble triggered the 2008 recession, but this time, it’s the ballooning global debt levels that threaten to spark off the fire. The IMF (International Monetary Fund) has reported that global debt (in nominal terms) is at the highest levels ever at $184 trillion, with major nations (USA, China and Japan) accounting for more than half the amount, which is effectively more than their combined economic output.
The Asian Financial Landscape
For China, the debt picture is a lot gloomier. The Asian nation’s overall debt level is at 300% of its GDP, and accounts for 15% of the global total. Its economic performance has now been on the decline for a few years now, even pre-dating the trade war rhetoric with the US. China already reported a GDP growth of 6.2% in the second quarter of 2019, the lowest since the country started making public its quarterly growth numbers. Manufacturing, a key sector in the nation, is slowing down, but wages have been rising. It is low wages that initially made China a manufacturing powerhouse, and with that reversing, business sentiment will continue weakening further.
The European Financial Landscape
Away from Asia, there are also worrying signals from Europe. In Germany, the economy already contracted in the second quarter of 2019, and afterwards, it only managed to post a weak rebound. Germany’s major export market is China, whose economic woes are having trickling effects on the European giant. The primary definition of a recession is an economic contraction of 2 quarters (6 months), and if weak figures continue in Q3 2019, it will confirm the situation in Germany. The situation is more or less the same in the UK, where weak economic figures, coupled with the high probability of a no-deal Brexit, is painting a bleak future. In the US, manufacturing posted the weakest pace of expansion in over 3 years in August 2019, and consumer demand turned lower, despite employment numbers remaining largely unchanged.
A Ticking Time Bomb?
Quantitative Easing was the magic wand that somehow nipped the 2008 fiasco in the bud. But the rod may not be as powerful this time around. To start with, the US will be starting at an interest rate of around 2-2.25% compared to 5-5.25% in 2007; there is only so low the rates can get. In the UK, new Prime Minister Boris Johnson has already ramped up government spending, even before confirmation of a technical recession, widely expected to happen in November 2019. This essentially means that if a recession actually happens, there would be less muscle for Central Banks to flex.
The Final Word
It is not all doom and gloom though. It does not have to follow the straight path to depression as it did in 2008. To start with, there is greater financial scrutiny this time, which makes the overall economic system more ready to absorb shocks. Business confidence, at least in the US, is holding up pretty well and the US-China trade war risk is being proactively addressed. There is also the political issue of the US general election set for 2020; an economic slowdown would reduce the chances of the incumbent’s re-election, a situation the administration would be keen not to happen. For investors though, there is still appetite for risk; a factor that may well prevent, or at least, delay any potential recession.
