With August 2017 marking the 10-year anniversary of the global financial crisis (GFC), there are warning signs of another financial meltdown.
As household debt goes through the roof in some countries, a disturbing question is increasingly being asked – could another GFC be around the corner?
First, the Bank for International Settlements (BIS) has identified Canada, China, some Nordic nations and Australia as having worryingly high levels of household debt.
Australia’s household debt-to-GDP ratio has risen 16 percentage points since the GFC to 123 per cent, while globally the BIS estimates the non-financial sector debt in G20 economies is about 220 per cent of GDP, almost 40 percentage points higher than in 2007.
Second, American household debt hit US$12.73 trillion in May, passing its previous record set in the third quarter of 2008, although the monthly income that Americans must spend paying off their debt is smaller. Employment is strong and bankruptcies are down.
Third, China is dealing with an inflated housing market and consumer debt has grown rapidly on the back of loosely regulated peer-to-peer lending platforms.
Should we be worried?
Private-sector balance sheet fears
David Levy, chairman of the Jerome Levy Forecasting Center in New York, is one economist who says a global recession is possible.
He says crises are typically addressed through dramatic interest rate declines and government stabilisation policies.
Eventually, though, there is no more room to cut or move.
While developed market economies still carry the burden of excessive balance sheets – with debt and asset values growing in proportion to incomes and economic output – Levy believes the more urgent threat comes from emerging market economies which, excluding China, borrow heavily in foreign currencies and lack the financial independence to calm their own crises.
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“There’s a sense that they grew very rapidly based on an unsustainable strategy of exporting to global markets as low-cost producers,” he says.
Levy’s main worry is that with emerging market economies now constituting about 40 per cent of global GDP, alleviating any financial crises will require vast resources for a bailout.
Yet he says developed economies such as the US, Japan and Europe are unlikely to have the finances or inclination to manage a rescue.
“They’re probably not terribly eager to go out and make massive loans to emerging market countries that are in bad trouble.”
It’s different this time
AMP Capital chief economist Dr Shane Oliver is less concerned about a GFC Mark II.
While acknowledging high levels of household debt, he says that the chief causes of the GFC were a deterioration of lending standards in the US and opaque financial engineering.
Oliver says lending practices are in much better shape and interest rates remain low.
“If you look at things on a generalised basis it’s hard to argue that we are at a point where things are going to come crashing down again.”
Oliver notes concerns about a high proportion of interest-only loans in the Australian property market.
“Those loans aren’t going to people who live in trailer parks who have criminal records and horrible credit scores,” he says.
“They’re going to normal people who can qualify for loans, who have a job and who can service them.”
The “big debt scare that gets wheeled out,” according to Oliver, is that total global debt outstanding has reached a record of almost US$200 trillion which could, on its own or in combination with big rises in interest rates, trigger a crisis.
He says the argument may be overstated. Debt has been rising, but when it is time to raise interest rates, central banks will take a gradual approach because in a higher-debt environment they do not need to raise rates much to have an impact. Most of the debt increase in recent years in developed countries has come from public debt.
Levy and Oliver both play down concerns about China. China has led the surge in private debt, but largely borrows from itself and the government is ready and able to step in if there is a problem. Oliver says China is a special case.
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Export growth stems debt risk
While Australia’s fiscal position is relatively strong, Treasury secretary John Fraser has warned that high household debt poses an economic threat.
Mukund Narayanamurti, CEO of Asialink Business, is confident Australia can resist a recession or crisis, arguing it can fortify the economy by lifting exports to growth markets such as China and India. Australia’s strong ties with China and high commodity prices helped it stave off fallout from the GFC.
With China now in a domestic consumption boom and the international resources sector in a downturn, Narayanamurti calls for Australia to boost services exports.
“There is significant recognition among policymakers in this country that we do need to diversify our basket of commodities,” says Narayanamurti.
While tourism and international education are strengths for Australia, Narayanamurti believes services exports such as financial services, healthcare and architecture should be the focus.
To this end, post-GFC trade deals with China, Japan, South Korea and ASEAN nations will help. “So I think there will be an ability to trade with a larger group of nations, not just China, to diversify any of our risks going forward.”
Watch this space
Where do we sit now? All eyes will be on the potential economic fallout from factors such as direction set by US President Donald Trump, Brexit, European banking pressures and the ongoing Greek debt crisis.
Although Oliver is confident a financial crisis is not imminent, he says investors should closely monitor debt levels, especially if there is a broad rise in debt in the context of surging asset prices.
“History tells us that somewhere out there there’ll be another crisis and excessive debt will play a role in it.”
For Levy, his focus will continue to be on emerging economies such as Brazil, a big economy that is being buffeted by political instability.
“I don’t want to say that it’s going to be a complete disaster for these countries, but I’m concerned that there might be some countries which do have crises and breakdowns.”
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