The fact that the world did not experience a systemic financial crisis in 2022 is a minor miracle, given the surge in inflation and interest rates, not to mention a massive increase in geopolitical risk. But with public and private debt having risen to record levels during the now-bygone era of ultra-low interest rates, and recession risks high, the global financial system faces a huge stress test. A crisis in an advanced economy – for example, Japan or Italy – would be difficult to contain.
True, tighter regulation has reduced risks to the core banking sectors, but that has only led to risks shifting elsewhere in the financial system. Rising interest rates, for example, have put huge pressure on private-equity firms that borrowed heavily to buy up property. Now, with housing and commercial real estate on the cusp of a sharp, sustained drop, some of those firms will most likely go bust.
In that case, the core banks that provided much of the funding for private equity real-estate purchases could be on the hook. That has not happened yet, partly because lightly regulated firms are under less pressure to mark their books to market. But suppose interest rates remain stubbornly high even during a recession (a distinct possibility as we exit the ultra-low-rate era). In that case, widespread payment delinquencies could make it hard to maintain appearances.
The United Kingdom’s recent financial misfortunes demonstrate the kind of unknowns that could pop up as global interest rates increase. Although former Prime Minister Liz Truss took all the blame for the near-meltdown of her country’s bond markets and pension system, the main culprit turned out to be pension-fund managers who essentially bet that long-term interest rates would not rise too fast.
Japan, where the central bank has kept interest rates at zero or negative for decades, might be the world’s most acutely vulnerable country. In addition to ultra-low rates, the Bank of Japan has also engaged in yield curve control, capping five-year and ten-year bonds at around zero. Given the increase in real interest rates around the world, the yen’s sharp depreciation, and high inflationary pressures, Japan may finally exit its near-zero era.
Higher interest rates would immediately put pressure on the Japanese government, as the country’s debt amounts to 260% of GDP. If one were to integrate the BOJ’s balance sheet, roughly half the government debt bought by the private sector is effectively in short-maturity bonds. A 2% interest-rate increase would be manageable in a high-growth environment, but Japan’s growth prospects will most likely decline as long-term real interest rates continue to rise.
Japan’s enormous government debt almost certainly constrains policymakers’ options for managing long-term growth. Still, given the government’s taxation powers and the possibility of inflating away the debt, the problem should be manageable. The real question is whether there are hidden vulnerabilities in the financial sector that could be unearthed if inflation continues creeping up and Japan’s real interest rates increase to US levels. That has been the norm through most of the past three decades, even though Japan’s inflation expectations are currently much lower than in the US.
The good news is that after nearly three decades of ultra-low interest rates, Japanese expectations for near-zero inflation are well anchored, albeit likely to change if today’s inflationary pressures prove long-lasting. The bad news is that the persistence of these conditions could easily lure some investors into believing that rates will never go up, or at least not by much. This means that bets on interest rates remaining relatively low might become rampant in Japan, as they previously had in the UK. In this scenario, further monetary tightening could blow things up, creating instability and adding to the government’s budget problems.
Italy is another example of latent risk. In many ways, ultra-low interest rates have been the glue holding the eurozone together. Open-ended guarantees for Italian debt, in line with former European Central Bank President Mario Draghi’s 2012 promise to do “whatever it takes,” were cheap when Germany could borrow at zero or negative rates. But this year’s rapid interest-rate hikes have changed that calculus. Today, Germany’s economy looks more like it did in the early 2000s, when some called it “the sick man of Europe.” And while Europe is comparatively new to ultra-low rates, one has to be concerned that a sustained wave of monetary tightening could, as with Japan, reveal enormous pockets of vulnerability.
If there is a global recession without a financial crisis, there is a decent chance that the coming economic downturn will be milder than expected. In an environment of negative growth, high inflation, and rising real interest rates, that would be a very fortunate outcome.
*J Kenneth Rogoff, a former chief economist of the International Monetary Fund, is Professor of Economics and Public Policy at Harvard University.. Copyright: Project Syndicate, 2023, and published here with permission.
78 Comments
Japan is proper f##ked unfortunately. The population decline is accelerating and there are not enough people to pay the tab. Look for (further) ramping up of inheritance taxes and perhaps a US-style global tentacle income tax on its citizens.
Japan is also a leading creditor nation and a primary holder of US debt. It seems that the idea has shifted towards an argument that the world doesn't need creditor nations--we all create our own debt and somehow that will enable us to create the best of what Japan has done like world-leading infrastructure. Somehow I don't think it's that easy.
"But suppose interest rates remain stubbornly high even during a recession (a distinct possibility as we exit the ultra-low-rate era). In that case, widespread payment delinquencies could make it hard to maintain appearances"
...finally an article where the author does not bury his head in the sand, and where he takes a more realistic approach to longer term interest rates prospects. The era of crazily ultra-low interest rates is gone for the foreseeable future, simple as that.
There is a as good chance interest rates will stay stubbornly high. Also there is a good chance something big might break and interest rates will fall very fast as wealth destruction becomes the greater fear.
The only thing I actually know for sure is currently, nothing is as simple as that.
Yes, and a financial crisis would be very good at destroying demand and sucking the life out of inflation.
While acknowledging interest rates may well stay higher for longer than I think, my view hasn’t fundamentally changed that interest rates will start being cut, quite rapidly, come late ‘23 early ‘24.
"hidden vulnerabilities in the financial sector" is a good way of putting it.
They are usually visible to most but also overlooked or the risk not sized correctly.
I like the pile of sand analogy, where you can keep adding a grain of sand and then all of a sudden but inevitably there's a wider collapse (Mauldin?)
People here are at all stages of life and in totally different financial positions. The world practically needs a nuclear meltdown before it affects me but plenty of others are living paycheck to paycheck and it hardly needs anything to tip the scales for them. Unfortunately people in my position usually end up with their head stuck up their arse and think everyone out there is doing just dandy. 2023 is not going to be a fun year for many people so yes lets get realistic.
In that case, the core banks that provided much of the funding for private equity real-estate purchases could be on the hook. That has not happened yet, partly because lightly regulated firms are under less pressure to mark their books to market. Indeed:
Of course, the Fed doesn’t mark to market, nor have banks done so since the early-2009 market low, when the Financial Accounting Standards Board relaxed FAS Rule 157 (which is actually what ended the global financial crisis – by making bank insolvency opaque). Link -Hussman
We had Stage 3 Economic Cancer in 2008; it had been metastasising over the previous 25 years, and tried to cure it with monetary witchcraft. Now we realise it hasn't work and Stage 4 is upon us. Desperate times are calling for desperate measures, and the chemotherapy we should have uses 15 years ago is all we have. Stage 4 invariable kills the patient. All we hope is that it isn't in 2023, albeit the chances look like, that it will.
The can got a good kicking and here we are. The main difference is that since 2008 my financial position has changed so much it is unrecognisable. Back then I was doing it solo, finding it tough in work with a maximum mortgage. If the shit that looks to be going to happen now happened back then with the size of peoples mortgages these days its wipeout time.
Most likely the book you are referring to is Twilight In The Desert, which was published in 2006.
And yes, what happened after 2005 was the shale boom took off in the USA, returning them to being the largest oil producer in the world due to their 'non-convential' sourced oil.
The shale boom is now on the decline and there is no obvious successor, certainly none that can ramp up at the rate at which mature oil fields all over the world are declining (including Ghawar, the oil field that is the primary subject of Twilight In The Desert).
We will have oil for decades yet. The question is how long it will be traded for US$ on freely open markets, and how the global economy reacts to there being less oil supplied than demanded. Biden has already tapped the SPR in the US, so it's now at its lowest levels since the 1980s.
https://www.sciencedirect.com/science/article/pii/S2666049022000524
More oil, gas, coal consumption, the more reserves we have found. It is increasingly appearing the more we consume, the more reserves increase. And technology continues to improve. Ingenuity continues. Peak oil is another fear tactic, kinda like Covid, or global warming! Drill baby drill.
Three Veg,
I have stage 4 cancer, but no chemo. I am being treated with drugs; Pembrolizamub (Keytruda) and Lenvatanib-taken orally- and is a targeted therapy. So far, so good, though sadly, they are not yet funded by Pharmac.
At some point, traditional chemo will disappear, as drugs become much more targeted to the individual.
As the Bank of England explains, monetary policy and the adjustment of interest rates is designed to control the demand for credit and so its creation by the banks. When a bank issues a loan it creates a new bank deposit and this is essentially new money.
Not that many years ago banking didn't operate like this, if we needed to buy a house we would go to the State Advances Corporation or find a friendly solicitor who had a client with money to lend and so the system of banking that we operate now seems designed to cause economic instability.
The rate of interest – the price of money – is said to be a key policy tool. Economics has in general emphasised prices. This theoretical bias results from the axiomatic-deductive methodology centring on equilibrium. Without equilibrium, quantity constraints are more important than prices in determining market outcomes. In disequilibrium, interest rates should be far less useful as policy variable, and economics should be more concerned with quantities (including resource constraints). To investigate, we test the received belief that lower interest rates result in higher growth and higher rates result in lower growth. Examining the relationship between 3-month and 10-year benchmark rates and nominal GDP growth over half a century in four of the five largest economies we find that interest rates follow GDP growth and are consistently positively correlated with growth. If policy-makers really aimed at setting rates consistent with a recovery, they would need to raise them. We conclude that conventional monetary policy as operated by central banks for the past half-century is fundamentally flawed. Policy-makers had better focus on the quantity variables that cause growth. Link Werner
Back in 1981, my neighbour got the last POSB Wellington housing loan, as they had run out of money temporarily. As deposits built up again, they would then restart the lending. Not a big deal. With deregulation, the NZ banks are disadvantaged, and the foreign banks have flooded New Zealand with cheap overseas sourced funds. The house prices have responded accordingly. With so much money sloshing around the world, looking for a place to get a return on, it will be so interesting this year to see what sort of fake, fraudulent practices will be used to create this return. The usual borrow a fortune using a pack of lies , take half for oneself, and put the rest in a project that fails will be preeminent, I suspect. Sam BF springs to mind. Every SPAC in the US over recent years springs to mind.
Credit creation for the property ponzi by commercial banks through the mortgage mechanism was unleashed in the early- to mid-90s, partly through deregulation. What people fail to understand is that while all this wealth creation is good for those who own the assets, it is essentially manufactured inflation and has been supported by the govts (a happy flock of sheeple is a vote winner). Now, in the case of NZ, I think our particular ponzi has meant that we have foregone public (and private to some extent) investment. And this is problematic because we also want the migration fraud to deliver (now more than ever). But people tend to forget that increasing popn without a requisite investment in infrastructure means that the quality of life deteriorates for everyone.
Did the 'property ponzi' steal money from productive investment, or was the economy in such a state that the only place left for money to go was property?
Credit creation can be allocated towards productive or non-productive purposes. Richard Werner's Quantity Theory of Credit is a good place to start for understanding the differences in terms. Quoting from the following link:
“The vast majority of bank lending in advanced economies does not support new business investment but instead funds either increased consumption, or the purchase of already existing assets, in particular real estate. Real estate is relatively fixed in supply, and consequently the transfer of funds to this sector leads to asset price increases that induce yet more credit demand and more credit supply, which is at the core of financial instability in modern economies”.
shorturl.at/ceCDS
Still begs the question.
In the 80s, there was a stock market crash of a magnitude that deterred people buying shares.
The 80s also saw the beginning of manufacturing exodus from NZ as part of the neolib agenda
Apparently we have more cash in savings than property debt, so it's not as if there's a lack of funds, just no where for them to go, it's either conservative low returns or risky moonshots.
So opportunities for decent commercial capital investment, have likely been on the wane. You can see variations of the same issues going on through many (most) advanced economies, debt, asset inflation, stalled (or negative growth). What people like to determine as purely a property ponzi is actually likely a chunk of a much larger issue facing advanced economies. Namely, they're out of puff and living beyond their means.
So opportunities for decent commercial capital investment, have likely been on the wane. You can see variations of the same issues going on through many (most) advanced economies, debt, asset inflation, stalled (or negative growth). What people like to determine as purely a property ponzi is actually likely a chunk of a much larger issue facing advanced economies. Namely, they're out of puff and living beyond their means.
If you read Werner's theory, you will understand that credit creation for non-productive purposes is assoicated with financial crises, inflation, and boom-bust episodes; whereas credit creation for GDP-qualifying purposes enables growth within a lower inflationary envrionment.
Not saying he's right or wrong. It's a perspective.
'acquire debt to increase income rather than blow it on consumption' is a fairly basic principle.
I guess after seeing what commercial basket-cases my Economics and Finance lecturers were, I tend to not put much stock in graphs and theories. A qualitative, rather than quantitative approach appears to yield better real-world results, the numbers mean little without context.
I guess after seeing what commercial basket-cases my Economics and Finance lecturers were, I tend to not put much stock in graphs and theories. A qualitative, rather than quantitative approach appears to yield better real-world results, the numbers mean little without context.
I don't suspect you've read 'Princes of the Yen.'
Not really my sort of vibe, its the non central bank aspects of Japan's stagnation I find more interesting
POTY is not solely about central banking. It is a masterpiece of writing about economic history and is very relevant to now. The book explains how the Japanese asset price bubble happened because of speculative credit creation. Very relevant for NZ and people like yourself to understand.
A mature economy that has fostered lazy investing. Go back 50 years, if you had money you could start a business selling timber, groceries, tools, manufacturing. Today we have big chain box stores that have cornered the easy segments. e.g.
- 1953 - 300 "Self Service" grocers (10% of the grocery stores in the country) (3k). Population 2m.
- 2020 - 180x Countdowns, 60x Supervalues. Foodstuffs have 400 stores. Approx. 4k dairies (4.6k) Population 5m.
- If we had the same number of "grocers" per capita as 1953, we'd have an extra ~3k "businesses".
https://comcom.govt.nz/__data/assets/pdf_file/0033/229857/Market-study-…
https://teara.govt.nz/en/food-shops/page-6
https://retail.kiwi/wp-content/uploads/2020/09/RetailNZReport-TheFuture…
Even worse when you consider that my 1953 numbers don't include "dairies", I'm sure they existed but couldn't find the data. If I could include dairies in 1953, then that makes it look even worse for today. Or do I just remove dairies from 2020's numbers, as they're not "grocers" for the weekly household shop?
In theory, that's a good thing, as big box retailers bring efficiencies having a whole bunch of smaller retailers lacks. Same thing goes for manufacturers and suppliers.
What it does likely point out is the number of stakeholder/shareholder positions in society likely diminishes over time. Instead of making a good living running your own hardware store, it's minimum wage plus a few bucks at Bunnings.
Yes certainly some efficiencies. E.g. big supermarkets can ensure that even perishables are generally in good supply e.g. bread and milk. It's a lot easier to cost the waste/expired goods into the price when you're selling 200 loaves of bread a day and binning 10, vs a grocer carrying 10 and binning 2.
Yet despite all in the article above there will be profits slash positive outcomes for those that can adapt and play the field. For those that have been too narrow in their outlook it will also be a lesson. Some folk seem to want to blame the loose availability of credit or the war in wherever or some other crisis but fact is putting all your eggs in 1 basket was never going to be without risk. Folk like to talk about reality but how many here will be dragged unwillingly into whatever prevails this year? How many saw house prices climbing non stop into oblivion and interest rates sitting at near zero forever? How many liquid rich suffered the indignity of the credit wave that saw them mocked by borrowers and thrown into the gutter by the financial institutions via meagre returns ? Nothing has changed despite the forecast, the rules are still the same . Capitalism must win and if it means pain suffering and a tumble for many then so be it. Folk can humanize the situation as much as they like but at the end of each day it is fools and their money that is easily parted. We can ponder what the low income earners will do when prices inflate but we must keep in mind we are in NZ not Zimbabwe. Funny when house prices were riding a wave how careless the propertied folk were of others position . Now it seems many are fearing what may or may not develop. You dont have to be wealthy to survive a recession or a depression ,those of us that have seen hard times know what it takes. The world has seen a nuclear crisis before and if some idiot does push the button all the savings and assets you have wont be worth worrying about. Some of what I read is just plain hysteria....lol.... No small wonder things are as they are presently... Whos reality will you be living ? Capitalism 101 'You have no friends'....lol
Capitalism must win...
But it's not really 'capitalism'. It's more like a command economic paradigm.
.....and if it means pain suffering and a tumble for many then so be it.
The command economic paradigm has made the potential pain and suffering worse.
Can you see a recurring theme here?
Yes, I can hear the engines pinking already. We're trying to run a premium lifestyle (vehicle) economy on dirty fuel. Not to mention the fact that dirty fuel has also shot up in price. As PDK would say ''You can't run an economy forever on planet Earth.'' And he's right. We just don't have that many finite resources left.
As some have already posited - 2023 is going to be an interesting chapter.
Wrong John,
Much of what PDK writes makes sense, but he is much too rigid in his thinking. He believes totally in Clugston's Blip, which has 2050 as the end point for the global economy. Of course our natural resources are not finite, but nor have we yet exhausted them. Look up Guyana and oil for just one example. From nothing, they are about to become a major oil producer with over 18bn barrels of recoverable sweet, light crude. More will be found.
We waste prodigious amounts of everything and over produce much that is unnecessary. That will gradually change and our lifestyle will adjust. The evidence is that renewables are unlikely ever to be as energy dense as oil and that will force a great deal of change-in time.
I don't think any sane person has that sort of plan. The plan would be to stop people on this planet breeding like rabbits, in particular countries where they die less than 6 months later. The aim would be to tip the world into serious population decline as we are hardly going to go extinct with 1 billion people left but the world would be one hell of a lot better off. The problem with people now is its all about me and what I want, there is zero thought given to the impact on the planet so untill that changes and soon, we are doomed as a species by 2050.
Heh, that is not at all what PDK "wants".
That is what PDK is warning will be required if everyone wants to keep BAU going at our current standard of living.
If you think that we can't kill 7 billion people, then the only alternative is for a lower standard of living in the future. Pick your poison.
Nah if were were a higher order species then we would have set a population cap on this planet 20 years ago and we wouldn't be in this mess now. Basically its to late now and all the attempts now to fix it is just fiddling round the fringes. Its one giant train wreck waiting to happen but hopefully I will not be around to see it.
Look up Guyana and oil for just one example. From nothing, they are about to become a major oil producer with over 18bn barrels of recoverable sweet, light crude.
Which adds how much heating to the world when it's burned?
At what rate will it be produced? A quick google suggests that by the end of 2025 the oil fields developed by ExxonMobil will be producing 880,000 barrels per day.
Russia's production has dropped by 200,000 by the end of 2022 compared to the start, and they're threatening production cuts of 500,000-700,000 barrels per day in 2023 in response to price caps from the US.
This is even before the West's sanctions and businesses pulling out of Russia really start to bite into their oil production capabilities.
In other words, Guyana becoming 'from nothing' a 'major oil producer' is not likely to offset the decline of Russia's oil output.
We waste prodigious amounts of everything and over produce much that is unnecessary.
Yes, this is called "the economy".
Let me know when you come up with a way to design an economy where we only produce what is necessary and don't waste anything. And then tell me how you're going to get the public to vote for it.
That will gradually change and our lifestyle will adjust.
I think it is going to change much more quickly than you are anticipating. And yes, lifestyles will of course 'adjust'.
The evidence is that renewables are unlikely ever to be as energy dense as oil and that will force a great deal of change-in time.
Ok, 'when' do you think that this 'in time' is going to be? Apparently 2050 is too soon?
https://www.nzherald.co.nz/nz/mandatory-covid-19-testing-for-china-trav…
Kill off the Oldies, No Sweat, says NZ....Poor judgement...but.......Meant.
Seymour does not see more than the end of his Nose. But New Covid Variant may change that perspective, to closing the Borders to this new rampant China Infections. Why do we have to put up with Variants and no Testing....David. What do we Gain from spreading Infections. Act quick or go Home.
The Reality is not what it Seems.
Jacinda and yes....See less Seymour are a Pair of Dip-sticks...but in reality Covid cases on Rise from our Dear Neighbours, who want to come and Play Havpc with Jacinda and Co....With .....NO, repeat NO....Limitations, from Gum Dropping ...Jacinda Lovers.
I could explain, more...but Your Brain is stuck in the Past....Gum Drops Gall_law are now China Made Imported Sickness Benefits...
Personally I do not WANT em. Or Jacinda ...ever again.
And here is a Different Perspective. Zero Hedge. Believe China...like a Broken Record.
And here is another version of "The Truth"
https://www.nzherald.co.nz/world/celebrity-deaths-trigger-questions-ove…
https://www.zerohedge.com/covid-19/senior-who-official-says-china-under…
It is My Health....Not Yours. Covid is a Spreader....and it is.
https://www.calculatedriskblog.com/2023/01/covid-jan-6-2022-update-on-c…
Indeed the Property Ponzi is isolated from all other financial markets..... re productive lending, retail banks do not lend to small business startups, unless you have property to secure against. so a whole lot of debt that went into the Ponzi could never have been borrowed in NZ as it would have had no security.
Enjoyed the article. I'd be more concerned if a world of low interest rates persisted. As someone fortunate enough to have benefitted substantially from low interest rate policy, and the everything bubble, even I have to admit that those policies has an increasingly deleterious economic consequences for society (e.g. wealth distribution.)
I would welcome a reset.
Not only economic consequences for a society but the mental balance of society itself.
Easy money makes society financially illiterate. This is how the banks and elite make more for themselves.
I can only hope that some literacy is left in inge families and they pass it on to their next generation and to spread it around the society. We only see greedy spreading their own agenda in name of financial advice.
The monetary policies of a country doesn't only impact their business or the financial stability of the country but the mental health, culture and thinking of its people.
Giving free money to people at very low interest rates in the name of stability is very wrong and this creates so much mental imbalance in the public. The unintelligent human race is not made to handle too much easy money. They go crazy with it.
The long term impacts of easy money on human psychology can be easily researched in NZ where we have the Dole system going on for a while with no controls but it increases with every budget.
The world has created a monster financial system which will eat itself very soon.
I moved to Italy recently. A lot of nice new EVs about & new developments going on but very hard to judge. The roads are a mess, just terrible. Rubbish stacked up or thrown out the car window. Then there's the beauty about the place, hard to reconcile. I suspect Italy will never change & it perhaps doesn't have a place in the EU like many other non German or French economies. Eitherway, my short experience here is the EU is a bi product of ww2 & loosing its relevance unfortunately.
Don't remember any rubbish back there 1990 but I do remember every car being old and full of dents that nobody bothered to fix because they all just smashed into one another at their crazy roundabouts. Apparently things change but not necessarily for the better. I think you are better off with a banged up old Fiat and clean streets.
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