The headlines look eerily familiar: global growth is stalling, stocks are tumbling and peripheral bond yields are rising sharply. As the Federal Reserve winds down its asset buyback scheme and the Ebola outbreak and geopolitical instability spook investors, fear once again grips world markets. “The market pathologies we all grew to know during the crisis of 2008 are returning,” writes the Financial Times. The question is no longer if there will be another crisis, but when and where it will strike first.
The bottom line is that the global financial meltdown of 2008-’09 and the European debt crisis of 2010-’12 have never truly been resolved. After governments disbursed record bailouts, the world’s leading central banks simply papered over the remaining weaknesses by subsidizing essentially defunct financial institutions to the tune of trillions of dollars, buying up swaths of toxic assets and providing loans at negative real interest rates in the hope of reviving the credit system and restarting private lending.
But instead of fixing the underlying problems of structural indebtedness, record unemployment, rampant inequality and a seemingly never-ending recession, these measures have only made matters worse. For one, they have fed an enormous credit bubble that dwarfs even the previous one, which nearly sank the world economy back in 2008. The latest Geneva report by the International Center for Monetary and Banking Studies notes that total world debt — excluding that of the financial sector — has shot up 38% since the Wall Street crash, reaching new historic highs. Last year, global public and private debt stood at 212% of global output, up from 180% in 2008.
With this tidal wave of cheap credit sloshing through the world financial system, investors went looking for the highest yields. Since the US housing market and European bond markets were still reeling from the last crisis, they turned towards the stock exchange. Between mid-2013 and mid-2014, the average global return on equity rose to a whopping 18 percent. Yale economist Robert Shiller has shown that “the gap between stock prices and corporate earnings is now larger than it was in the previous pre-crisis periods,” and “if markets were to return to their normal earning levels, the average stock market in the world should fall by about 30 per cent.”
At the same time, trillions of dollars found their way into the housing markets of emerging economies. In Brazil, foreign investment in urban transformation projects for the World Cup and the Olympics led to a speculative housing bubble that saw residential property prices rise by more than 80% between 2007 and 2013. In Turkey, too, a massive influx of foreign credit fed a construction boom that has dramatically transformed the urban landscape, with skyscrapers, shopping malls and infrastructural mega-projects mushrooming across the Istanbul skyline. In both countries the resultant social displacements have led to sustained protest and social unrest.
The mother of all credit bubbles, however, has been quietly building up elsewhere, in China, where the government — in a desperate bid to ward off the spillover effects of the Great Recession — has pumped over $13 trillion worth of credit into the economy. This has in turn given rise to a monstrous $4.4 trillion shadow banking system and a housing bubble of truly epic proportions, leaving ghost towns sprawled across the country. It has also turned China into one of the most indebted developing countries in the world, with total public and private debt (excluding financial institutions) skyrocketing to 217% of GDP last year, up from from 147% of GDP in 2008.
The shadow banking system is not just a Chinese problem. In the United States and Europe, debt creation is also increasingly the product of off-balance sheet lending by non-bank financial institutions like hedge funds, insurance companies, private equity funds and broker dealers. The shadow banking system remains largely unregulated, allowing lenders to take much greater risks than ordinary banks could. For this reason, the IMF has warned that the world’s $70 trillion shadow banking system poses a major threat to global financial stability. In the US, shadow banking activities already amount to 2.5 times the size of conventional bank activity.
Meanwhile, troubling signs are emerging in Europe, where four years of austerity have trapped the world’s largest economy in a debilitating deflationary spiral. Even Germany, the EU's economic powerhouse, is falling back into recession, while Greece has returned to the eye of the storm after its stock market went into free fall on Wednesday. Greek bonds are now trading far above the 7% mark that, back in 2011, was widely considered to be “the point of no return.” Investors appear to be concerned over the health of Greek banks, the rising popularity of the anti-austerity party SYRIZA, and government plans to exit the bailout early in order to stem SYRIZA’s rise in the polls.
Add to this growing concerns over the Ebola epidemic and serious geopolitical instability in Eastern Europe and the Middle East, and the conditions appear to be ripe for another major bout of market panic. Sooner or later, one of the credit bubbles is bound to pop — and the consequences will not be pretty. Moreover, what is different from 2008 is that today total debt levels are even more unmanageable and states even less capable of mounting a proper response, having already used up most of their fiscal and monetary firepower over the past six years. We may not yet know when or where the next crisis will strike, but when it does it will be big. This time around we better come prepared.
Jerome Roos is a PhD researcher in International Political Economy at the European University Institute, and founding editor of ROAR Magazine.