LondonFinance1
New member
- Dec
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Management Consulting
Predicting the future https://canarywharfian.co.uk/threads/my-economic-predictions-for-2023.705/ is fun, but I also wanted to take a look back on the past developments in economics. At first, I thought about looking back on the past decade, but going as far back as 2007/08 makes more sense – the year of the Global Financial Crisis. It seems fairly distant right now, but the reactions to contain the crisis lay the ground for the economic developments in the past 10 years.
Books (“Too Big to Fail”) and movies (“The Big Short”, “Margin Call”) have been written and shot, but let’s have a quick look back to the roots of the crisis: the political will to increase the rate of home ownership met low interest rates which made houses more affordable, fuelling a boom in mortgage finance. To increase market shares, some market players went after low-income homebuyers and other applicants that were not offered mortgages (“subprime”). To counter this excessive risk-taking, mortgage-backed securities (MBS https://www.investopedia.com/terms/m/mbs.asp), mostly tied to American real estate, were introduced. These securities were based on mortgages, so basically the value of the homes that were financed. Not a problem in times of an economic boom with raising house prices, but you can imagine what would happen if prices were to fall (more on this later).
The increased demand for mortgages and houses led to an asset bubble on the housing market (demand was higher than supply, so prices went up). As all large financial institutions were exposed to this market, the downfall of one (Bear Stearnes) led to severe risks of taking down other financial institutions – a potential run on banks https://corporatefinanceinstitute.com/resources/economics/bank-run/ and a meltdown of the whole financial system were a worst-case (but somewhat realistic) scenario. Central banks and governments had to intervene – and they intervened big. The US Troubled Asset Relief Program (TARP https://home.treasury.gov/data/troubled-assets-relief-program) alone was a USD 700bn package to purchase toxic assets and equity from financial institutions in trouble. To put things into perspective: this was equal to the annual GDP of Turkey at that time, the 17th biggest economy in the world. This helped to clear up the balance sheets from risks. The value of the underlying assets for the MBS was reduced, so these securities were valued below their initial value.
The reactions to this crisis were mainly monetary or quantitative easing (i.e. printing of money by central banks https://www.bankofengland.co.uk/monetary-policy/quantitative-easing ) including deep cuts in interest rates. Fiscal policy by governments saw large stimulus packages (i.e. subsidies and cash injections). Some financial institutions were privatised and/or bailed out (the state taken over (parts of) companies or buying some of their assets). With more money meeting the same supply (after all, it takes time to build houses), asset prices rebounded – another housing boom followed in a number of countries, similarly for commodities. Artificially low interest rates also provided little incentives for households to reduce debt. The big packages mentioned above also let government debt increase by a lot – the cause of the European Sovereign Debt Crisis, when mostly Southern European countries were unable to repay or refinance their government debt or to bail out over-indebted banks. When this information was discovered, capital inflows into these countries stopped, exacerbating the crisis even further. Having entered the euro, these states were also unable to devalue their currency (actively or passively) to regain competitiveness, so eventually bail-outs were arranged against the promise of reforms and austerity (a reduction on public spending). The ECB also introduced substantial asset purchase programs https://www.ecb.europa.eu/mopo/implement/app/html/index.en.html. While the adjustment process was painful, these measures were eventually successful.
What followed was an era of relative calm with interest rates kept very low or even at zero, leading to an economic recovery or even a boom. Low interest rates mean that the price of money is low, so borrowing for investments is cheap. This has also profound effects on finance – with an interest rate of zero, calculated net present values do not have a discount (the price of money is zero), leading to asset price bubbles in some areas. We have seen this e.g. in cryptocurrency, venture capital, in some housing markets and some argue even in the stock markets.
This period of relative calm changed with the outbreak of Covid. Lockdowns saw a significant reduction in economic activity. The reaction was (again) a mixture of subsidies, asset purchases/increase of money supply. Furlough schemes helped on the household level while interest rates were kept low.
This Increase of the monetary supply led to higher rates inflation to levels not seen since the 1970s. Central banks had to raise interest rates to tame inflation, leading us to where we are now. The current danger is that this will lead to stagflation, a period of high inflation without any (or only very limited) economic growth which will mean that households will get poorer in real terms. There are signs that inflation will be reduced https://www.ft.com/content/b28eacca-87cb-41ba-9055-12fbe6a12358 (note that a falling rate of inflation still means an increase in prices), especially with energy prices falling, so this high level of inflation might be a passing episode rather than a persistent trend like in the 1920s.
It is interesting to note the different developments in the US, Europe and China – it is also worth noting the abysmal performance of the UK over the past decade (https://www.ft.com/content/2f835691-2824-4f79-8ba0-7969674cdcbd) without any economic growth at all – partly as a result of that disposable household income (adjusted for inflation) has stayed flat over the past 15 years https://www.ft.com/content/ef830f78-75ee-4b91-a48e-04defa0f96d4, i.e. inhabitants of the UK have not seen their disposable income increased for the past 15 years whereas other European countries have seen double-digit increases. On an individual level, this might look different, especially if you are at the start of your career, earning pay raises and getting promoted. One reason for this is the lack of productivity growth over the past decade which is unprecedented in economic history https://www.cambridge.org/core/jour...nprecedented/287949348D9BBA0223B3EA7E532C4B22 Covid and Brexit did not help, but there are a number of other factors causing this: lower human capital, including education and employee skills, insufficient investment in research and development (roughly half of Germany as a proportion of GDP) and low internal demand due to the financial crisis, austerity policies or Brexit amongst others https://cepr.org/voxeu/columns/explaining-uks-productivity-slowdown-views-leading-economists
Let’s see what the next decade brings – I am mildly optimistic that things will get better relatively soon.
Books (“Too Big to Fail”) and movies (“The Big Short”, “Margin Call”) have been written and shot, but let’s have a quick look back to the roots of the crisis: the political will to increase the rate of home ownership met low interest rates which made houses more affordable, fuelling a boom in mortgage finance. To increase market shares, some market players went after low-income homebuyers and other applicants that were not offered mortgages (“subprime”). To counter this excessive risk-taking, mortgage-backed securities (MBS https://www.investopedia.com/terms/m/mbs.asp), mostly tied to American real estate, were introduced. These securities were based on mortgages, so basically the value of the homes that were financed. Not a problem in times of an economic boom with raising house prices, but you can imagine what would happen if prices were to fall (more on this later).
The increased demand for mortgages and houses led to an asset bubble on the housing market (demand was higher than supply, so prices went up). As all large financial institutions were exposed to this market, the downfall of one (Bear Stearnes) led to severe risks of taking down other financial institutions – a potential run on banks https://corporatefinanceinstitute.com/resources/economics/bank-run/ and a meltdown of the whole financial system were a worst-case (but somewhat realistic) scenario. Central banks and governments had to intervene – and they intervened big. The US Troubled Asset Relief Program (TARP https://home.treasury.gov/data/troubled-assets-relief-program) alone was a USD 700bn package to purchase toxic assets and equity from financial institutions in trouble. To put things into perspective: this was equal to the annual GDP of Turkey at that time, the 17th biggest economy in the world. This helped to clear up the balance sheets from risks. The value of the underlying assets for the MBS was reduced, so these securities were valued below their initial value.
The reactions to this crisis were mainly monetary or quantitative easing (i.e. printing of money by central banks https://www.bankofengland.co.uk/monetary-policy/quantitative-easing ) including deep cuts in interest rates. Fiscal policy by governments saw large stimulus packages (i.e. subsidies and cash injections). Some financial institutions were privatised and/or bailed out (the state taken over (parts of) companies or buying some of their assets). With more money meeting the same supply (after all, it takes time to build houses), asset prices rebounded – another housing boom followed in a number of countries, similarly for commodities. Artificially low interest rates also provided little incentives for households to reduce debt. The big packages mentioned above also let government debt increase by a lot – the cause of the European Sovereign Debt Crisis, when mostly Southern European countries were unable to repay or refinance their government debt or to bail out over-indebted banks. When this information was discovered, capital inflows into these countries stopped, exacerbating the crisis even further. Having entered the euro, these states were also unable to devalue their currency (actively or passively) to regain competitiveness, so eventually bail-outs were arranged against the promise of reforms and austerity (a reduction on public spending). The ECB also introduced substantial asset purchase programs https://www.ecb.europa.eu/mopo/implement/app/html/index.en.html. While the adjustment process was painful, these measures were eventually successful.
What followed was an era of relative calm with interest rates kept very low or even at zero, leading to an economic recovery or even a boom. Low interest rates mean that the price of money is low, so borrowing for investments is cheap. This has also profound effects on finance – with an interest rate of zero, calculated net present values do not have a discount (the price of money is zero), leading to asset price bubbles in some areas. We have seen this e.g. in cryptocurrency, venture capital, in some housing markets and some argue even in the stock markets.
This period of relative calm changed with the outbreak of Covid. Lockdowns saw a significant reduction in economic activity. The reaction was (again) a mixture of subsidies, asset purchases/increase of money supply. Furlough schemes helped on the household level while interest rates were kept low.
This Increase of the monetary supply led to higher rates inflation to levels not seen since the 1970s. Central banks had to raise interest rates to tame inflation, leading us to where we are now. The current danger is that this will lead to stagflation, a period of high inflation without any (or only very limited) economic growth which will mean that households will get poorer in real terms. There are signs that inflation will be reduced https://www.ft.com/content/b28eacca-87cb-41ba-9055-12fbe6a12358 (note that a falling rate of inflation still means an increase in prices), especially with energy prices falling, so this high level of inflation might be a passing episode rather than a persistent trend like in the 1920s.
It is interesting to note the different developments in the US, Europe and China – it is also worth noting the abysmal performance of the UK over the past decade (https://www.ft.com/content/2f835691-2824-4f79-8ba0-7969674cdcbd) without any economic growth at all – partly as a result of that disposable household income (adjusted for inflation) has stayed flat over the past 15 years https://www.ft.com/content/ef830f78-75ee-4b91-a48e-04defa0f96d4, i.e. inhabitants of the UK have not seen their disposable income increased for the past 15 years whereas other European countries have seen double-digit increases. On an individual level, this might look different, especially if you are at the start of your career, earning pay raises and getting promoted. One reason for this is the lack of productivity growth over the past decade which is unprecedented in economic history https://www.cambridge.org/core/jour...nprecedented/287949348D9BBA0223B3EA7E532C4B22 Covid and Brexit did not help, but there are a number of other factors causing this: lower human capital, including education and employee skills, insufficient investment in research and development (roughly half of Germany as a proportion of GDP) and low internal demand due to the financial crisis, austerity policies or Brexit amongst others https://cepr.org/voxeu/columns/explaining-uks-productivity-slowdown-views-leading-economists
Let’s see what the next decade brings – I am mildly optimistic that things will get better relatively soon.
