Monday, July 19, 2010

What's the Next Crisis?

The past few years have offered a bewildering array of different crisis - credit crunch, financial crisis, currency crisis, economic crisis, sovereign debt default crisis, fiscal crisis, housing crisis.

Of course, many of these overlap, and in some cases are merely different terms for the same event.

In essence, the main crisis we have faced were:
  • Credit crisis / Financial crisis - the raft of bad debts which led to bank losses and a shortage of credit, and banks short of money.
  • Economic Crisis. From this paralysis in the financial sector, the real economy was affected as confidence and investment were hit. The rise in unemployment is main problem of the economic recession.
  • Fiscal Crisis. The economic crisis crystallised some of the underlying fiscal problems in countries like Greece. Before an austere bailout, Greece looked like it may have to default on its debt (it may still have to.
Amongst these big crisis, we have seen lesser crisis like a currency collapse in Iceland (though more a symptom of a huge hole in Icelandic banking system.)

The combination of the credit crisis and economic downturn have affected some housing markets significantly. After booming in the pre-crisis era, house prices in Europe and US have plummeted leaving homeowners with negative equity and banks with more bad debts. UK house prices have been more robust, but, more bad news may occur.

There are three different possibilities being suggested for main economies in Europe, Japan and US.
  1. Real Economic Recovery. Despite austerity packages, it is hoped economies will recover sufficiently to enable a fall in unemployment and growth which helps improve the cyclical budget deficits.
  2. Deflationary Spiral. Economies already weak, may be unable to cope with deep spending cuts. This may cause a double dip recession, with rising unemployment and an inflation rate that becomes negative. With deflation, economies will struggle to recover, national debt to GDP will continue to rise and unemployment could reach crisis levels.
  3. Sovereign debt crisis. Others worry most about levels of government debt. They argue once another government starts to default, markets will not want to buy government bonds. Bond yields will rise and governments will find it hard to sell sufficient bonds to finance their deficits.
  4. A fourth scenario still considered by some analysts (though I find it difficult to see) would be a period of hyperinflation. Faced with growing debt and stagnant economies, governments will resort to increasing money supply through quantitative easing or printing money. This will lead to a huge increase in inflation.
What is most likely scenario?

Probably a combination of Number one and two. I think we will have a double dip recession (Not necessarily a technical recession - but with low growth insufficient to reduce unemployment). But, economies should (hopefully) prove resilient enough to keep growing and eventually bring unemployment and borrowing under control. Maybe this is just because the idea of a global deflationary crisis is too damaging to contemplate.

Origins of Next Crisis

The past few years show the origins of the next crisis are invariably in the last crisis.


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