"This Is Where The Next Financial Crisis Will Come From"

In an extensive, must-read report published on Monday by Deutsche Bank's Jim Reid, the credit strategist unveiled an extensive analysis of the "Next Financial Crisis", and specifically what may cause it, when it may happen, and how the world could respond assuming it still has means to counteract the next economic and financial crash. In our first take on the report yesterday, we showed one key aspect of the "crash" calculus: between bonds and stocks, global asset prices are the most elevated they have ever been.

With that baseline in mind, what happens next should be obvious: unless one assumes that the laws of economics and finance are irreparably broken, a deep recession and a market crash are inevitable, especially after the third biggest and second longest central bank-sponsored bull market in history.

But what will cause it, and when will it happen?

Needless to say, these are the questions that everyone in capital markets today wants answered. And while nobody can claim to know the right answer, here are some excerpts from what DB's Jim Reid, one of the best strategists on Wall Street, thinks will take place.

Below we present the key excerpts from his must read report;

* * *

We think that the post Bretton Woods (1971-) global financial system remains vulnerable to financial crises. A simple internet search of financial crises through history (Figure 1, LHS chart) confirms that the frequency has increased over this period. Examples include the UK secondary banking crisis (1975), the two Oil shocks (1970s), numerous EM defaults (mid-1980s), US Savings and Loans mass failures (late 80s/early 90s), various Nordic financial crises (late 80s), Japanese stock bubble bursting (1990-), various ERM shocks/devaluations (1992), the Mexican Tequila crisis (1994), the Asian crisis (1997), the Russian & LTCM crisis (1998), the Dot.com crash (2000), the various accounting scandals (02/03), the GFC (08/09) and the Euro Sovereign crisis (10-12).

A more quantitative search backs this up (Figure 1, RH chart). We show the number of DM countries (%) in our sample back to 1800 experiencing one of the following on a YoY basis; -15% Equities, -10% FX, -10% Bond move, a sovereign default, or +10% inflation. This is our crisis/shock indicator. 0% equals no country with one of these conditions met, 100% equals all in our sample with one being met.

It would therefore take a huge leap of faith to say that crises won’t continue to be a regular feature of the current financial system that has been in place since the early 1970s. The near exponential growth of finance and its liberalisation since this point has encouraged this trend.

Indeed as we’ll show in this report there are a number of areas of the global financial system that look at extreme levels. This includes valuations in many asset classes, the incredibly unique size of central bank balance sheets, debt levels, multi-century all-time lows in interest rates and even the level of potentially game changing populist political support around the globe. If there is a crisis relatively soon (within the next 2-3 years), it would be hard to look at these variables and say that there was no way of spotting them.

Having said that, crises tend to have a large element of unpredictability. If they didn’t then surely more would predict their imminent arrival. So while we highlight a lot of the main global vulnerabilities in this report, history would tell us that there is still a chance that when the next crisis comes its origin will take us by surprise to a certain degree. As will its timing. In the remainder of this executive summary we highlight the conditions that have encouraged crises through history and the main areas of worry as to why we may be vulnerable for another financial crisis relatively soon.

Periods with a higher number of crises/shocks coincide with higher levels of debt….

…and with it higher budget deficits. G7 Government Debt was only previously higher with impact of WWII and before the early 1970s, persistent budget deficits only really existed in war time. Now a permanent feature.

We think the final break with precious metal currency systems from the early 1970s (after centuries of adhering to such regimes) and to a fiat currency world has encouraged budget deficits, rising debts, huge credit creation, ultra loose monetary policy, global build-up of imbalances, financial deregulation and more unstable markets.

The various breaks with gold based currencies over the last century or so has correlated well with our financial shocks/crises indicator. It shows that you are more likely to see crises/shocks when we break from hard currency systems. Some of the devaluation to Gold has been mindboggling over the last 100 years.

Perversely, the current post Bretton Woods system also allows for huge operations/stimulus to overcome any crisis/shock. We also shouldn’t underestimate the positive impact that this can have on nominal asset prices. Cash is arguably a far more dangerous asset in a fiat currency but unstable regime than it is in a more stable less crisis prone one. However, by continually using stimulus to deal with crises and not letting creative destruction take over, you make a subsequent crisis more likely by passing the problem along to some other part of the global financial system, and usually in bigger size. In a fiat currency world, intervention and money creation is the path of least resistance. In a Gold standard world, mining new gold was the only stable way of increasing the money supply.

We think this leaves the current global economy particularly prone to a cycle of booms, busts, heavy intervention, recovery and the cycle starting again. There is no natural point where a purge of the excesses is forced by a restriction on credit creation.

So we’re quite confident that there will likely be another financial crisis/shock pretty soon with their frequency continuing to be high until we create a more stable global financial framework.

* * *

So where will the next crisis come from?

An obvious issue is how we resolve the combination of the unwinding of unparalleled central bank balance sheet sizes at a time of record peacetime government debt and multi-century record low yields (Figure 5).

We also still have extreme levels of global imbalances (Figure 6) which pose a risk as international capital flows are necessary to support the status quo. These are harder to control by authorities or predict.

All this is occurring at a time of extremely high global asset prices and still low economic growth relative to the past. Could we be vulnerable to a major asset price correction that creates the conditions for a crisis?

Global central banks have facilitated these elevated asset prices. A long series of global financial problems have now been passed through all parts of the financial system with most of these problems stacked up and now resting with central banks and Governments. The buildup of debt that this has created has forced central banks to keep yields at ultra-low levels, thus raising the prices of a variety of other global assets.

Italy and Japan have seemingly unsustainable debt burdens and are likely vulnerable to a crisis outcome. However both have had this for some time which mitigates short-term risks. Italy is perhaps more vulnerable because of precarious and fragile politics, elevated levels of populism and a central bank that is regional and not domestically controlled. Japan shows how long a crisis can be avoided but that doesn’t automatically mean we should be complacent, especially as the BoJ now owns over 40% of the JGB market (from under 10% in 2012).

On populism, our index (Figure 9) tracking its rise across key DM countries shows that we are close to the 1930s highs. Is this a precursor to a big crisis? Does it make for more unpredictable politics, economics and markets?

We see China’s credit growth post GFC as also an area of great concern. As an example, in a recent IMF report they analysed 43 global cases of credit booms in which the credit to GDP ratio increased by more than 30 percentage points over a 5-year period. Only 5 cases ended without a major growth slowdown or financial crisis immediately afterwards.

The IMF also caveated that these 5 cases, considering country specific factors, provided little comfort. If that wasn’t enough, the fund also points out that all credit booms that began when the ratios were above 100% ended badly.

These are perhaps the main observable risks out there but we go through a list of other potential catalysts in the piece. As we discuss at the top, by their very nature, financial crises or shocks are generally unpredictable.

While we can’t be confident of where and when the next crisis will occur we can be pretty confident that the conditions remain in place for a world of frequent crises.


Manthong A. Boaty Tue, 09/19/2017 - 10:04 Permalink

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“unless one assumes that the laws of economics and finance are irreparably broken” I do… at least until somebody takes the Heidelberg’s away from the central banks.

In reply to by A. Boaty

Pairadimes Mr 9x19 Tue, 09/19/2017 - 11:56 Permalink

“Banking was conceived in inequity and born in sin. The bankers own the earth. Take it away from them, but leave them the ability to create money and with the flick of the pen they will create enough deposits to buy it back again. However, take it away from them, and all the great fortunes like mine will disappear and they ought to disappear, for this would be a happier and better world to live in. But if, you wish to remain the slaves of bankers and pay the cost of your own slavery, let them continue to create money.”- Sir Josiah Stamp, Director of the Bank of England in 1928, reputed to be the 2nd wealthiest man in England at the time.

In reply to by Mr 9x19

PrayingMantis Manthong Tue, 09/19/2017 - 10:51 Permalink

... and this is where the petro dollar collapse might've been conceived ... the BRICS leaders China and ... >>> "Russia Leaving Global Banking System: Dumping US Dollar for Gold" ... http://anonhq.com/russia-leaving-global-banking-system-dumping-us-dolla… ...

... >>> "According to a report published last year, more than three hundred banks in Russia have adopted the SWIFT alternative – the System for Transfer of Financial Messages, or SPFS as the Russians call it."

... here as well ... >>> "Gold, Oil and De-Dollarization? Russia and China’s Extensive Gold Reserves, China Yuan Oil Market" ... >>> https://www.globalresearch.ca/gold-oil-and-de-dollarization-russia-and-… ...

... "For several years it’s been known in gold markets that the largest buyers of physical gold were the central banks of China and of Russia. What was not so clear was how deep a strategy they had beyond simply creating trust in the currencies amid increasing economic sanctions and bellicose words of trade war out of Washington."

... and warnings here too ... >>> " ... The global regulator of the “petrodollar system”, this report explains, is the Swiss-based Bank for International Settlements (BIS) (called the “bank of banks”), and who, this past June, issued a shocking report stating that up to 70% of the $700 billion in OPEC's investable US Dollar reserve funds could not be accounted for—with their further discovering that one-tenth of the world’s GDP is held in offshore tax havens—and their yesterday, too, uncovering a staggering $14 trillion of global US Dollar debt hidden in derivatives and swap contracts—a startling sum that doubles the underlying levels of offshore US Dollar credit in the international system." ... >>> http://www.whatdoesitmean.com/index2387.htm ...

... in some elite clubs, (((Red Shield)))'s collective huge noses are all out of joint ... pissed off and panicking ... one of the reasons for all the MSM's non-stop Sino-Russo-bashing ... and more useless DC Swamp sanctions ...

... and btw, the war on credit cards has started ... >>> "Russian Mir cards to replace Visa, MasterCard soon" >>> http://www.presstv.ir/Detail/2017/09/10/534666/Russian-Mir-cards-to-rep…- ...


In reply to by Manthong

BennyBoy PrayingMantis Tue, 09/19/2017 - 11:46 Permalink

 "...we can be pretty confident that the conditions remain in place for a world of frequent crises." Jimmy boy, This version of a financial system is designed to have frequent crises. Over and over and over....look at history.Most big banks profit (the owners of the FED), companies and people lose. Its a simple system. And you get fucked.

In reply to by PrayingMantis

Father ¢hristmas WTFRLY Tue, 09/19/2017 - 14:19 Permalink

Lol@ this article being pinned for five hours, having only 95 comments, and WTFRLY shitting on Jews being the first one.Lol@ the down votes too.  Like it's a cabal of Scots-Irish bankers who've historically had their asses booted from multiple countries throughout world history for usurious and fraudulent financial/political shenanigans. 

In reply to by WTFRLY

LawsofPhysics Tue, 09/19/2017 - 09:26 Permalink

Blah, blah, blah......don't overthink this "folks".  The banker and financiers of the world have been (and continue to) create trillions of new paper/digital promises that they give THEMSELVES with NO REAL WORK and NO REAL RISK.They continue to BUY OWNERSHIP of the products of YOUR REAL LABOR and take REAL WEALTH.For now the majority of those paper/digital claims are sloshing around in their paper/digital system/market on the books of all the central bankers and government bond ledgers, but eventually all those bullshit promises will start seeking out REAL ASSETS required for suvival...In the meantime..."Full Faith and Credit"

Dammit Walter Government nee… Tue, 09/19/2017 - 15:21 Permalink

... and some Bitcoin like currency might replace fiat.  The money masters are getting annoyed by the non-fiat-monies popularity. Bitcoin 1.0 is to non-fiat-blockchain-money as Excite! or AltaVista was to search engines v1.0.  Where is Excite or AltaVista now?  The dust bin.  The conept of internet search is obvious and important, but it has gone through several transofrmations to where we are with Google, or DDG, or Bing (or whatever).  Non-fiat-blockchain-money is still young and needs to go through refinement to eliminate flaws and build trust... as I see it, the big flaw with Bitcoin (and derviatives) is that it fails on "Limited Supply" requirement or scarceity.  It has bit scarecity via mathematical functions, but it does not have atomic scarcity.  Infinite bitcoin derivatives (Etherium, LiteCoin, MyCoin, YourCoin, ChinaCoin, etc...) can be created.  You must have atomic scarecity in order for digital currency to satisfy all properties of money.  Tie a coin to a physical substance such as gold, for example, and then it satisfies properties of money, plus it has the nice properties of digital transactions of block chain.  Goldmoney seems to be very promising in this respect!

In reply to by Government nee…

AE911Truth Dammit Walter Wed, 09/20/2017 - 08:12 Permalink

The entity providing gold backing introduces counterparty risk. Gold has intrinsic value. Its presentation in refined form is proof of work. Plus it does not require any energy or communications infrastructure. Big plus. Downside is it can be detected and confiscated at hostile borders.Bitcoin has intrinsic value. Its presentation is proof of work. Plus it can be transmitted quickly over long distances, even through hostile borders. Plus it is difficult to detect and confiscate. Big plus. Downside is it requires working communications infrascructure in cases where multiple verifications are needed. 

In reply to by Dammit Walter

The Wizard LawsofPhysics Tue, 09/19/2017 - 09:59 Permalink

"Full Faith and Credit"Well stated. The perceptual faith in the currency allows it to continue to be used for value.The question is where is the true value? They continue to BUY OWNERSHIP of the products of YOUR REAL LABOR and take REAL WEALTH.Far too much wind in this article. Someone likes to hear themself talk. Let's make it simple, it's called DERIVATIVES.

In reply to by LawsofPhysics

RighteousDude Tue, 09/19/2017 - 09:29 Permalink

The ONLY solution to this dilemma is to grant a universal JUBILEE....There is no other answer.  Any attempts to normalize interest rates will initiate a Worldwide Depression.

justdues Putrid_Scum Tue, 09/19/2017 - 13:11 Permalink

Shout out for Putrid to fellow ZHers.If you havn,t read his books then check them out , they are awesome , pertinent and urgent ..as in, get family and friends to read them now . Like 10 years of ZH articles and comments distilled and condensed into relevant and insightful knowledge. Thanks Putrid , you ol,scumbag :)

In reply to by Putrid_Scum

CPL RighteousDude Tue, 09/19/2017 - 10:22 Permalink

Who gives a shit and that would solve what exactly?  Nothing.  Now shut up and sit down before someone nails your dress wearing jew faggot ass to a cross.  The printing will continue to DJIA 36000 until all the trillionaires are as important as a zimbabwe trillionaire and as 'wealthy'.  This is for the best, if they want to eat everything.  Then shovel it by the bucket load down their piggy throats until they die of consumption.Remember, they wanted all of it.  Give it to them and watch.  Then we can all line up to piss on their graves and enslave their children after when they are crushed, defensless and weak without any capital means to protect themselves. 

In reply to by RighteousDude

OpenThePodBayDoorHAL JohnGaltUk Wed, 09/20/2017 - 01:51 Permalink

The Chinee do not give a single solitary f*ck about the USTs they bought because they got the good stuff in return: brand new roads, bridges, airports, highways, telco, subways, ports. Not to mention the entire world's manufacturing base and market share.Ride the gleaming new high-speed train straight from the airport downtown sometime over there, all while streaming high-speed internet and watching one new BMW or Porsche or Mercedes after the other whiz by.300 M people went from a mud hut with a dirt floor to having a fridge, a TV, and a car in less than 30 years.'Murkans? They bought giant smoking holes in the ground in a desert 8000 miles away with an impoverished dead guy with a turban at the bottom. LOL. Hey, you voted for it (Clinton, Bush, Obama, Trump).Suckers.

In reply to by JohnGaltUk

Clowns on Acid RighteousDude Tue, 09/19/2017 - 13:21 Permalink

RD - You is correct. However...it won't be a "jubilee" it will be Yellen and Co. trying to convince markets that the Fed will allow present QE (illegal and UnConstitutional money printing to save the Bank Hoilding  companies - since repeal of Glass Steagal) bonds and MBS to mature on their books (which is Monetization of the debt) and sell a nominal amount back into the market - an amount like $20B / month.However...how will the market know? The Fed will not allow a monthly audit of their Blanace sheet, but will jawbone that amount for credibility to support the USD and their own existence. It will be a marketing exercise for credibility. Of course with NoKo going on...and all the chicken lips at the UN promising to do...whatever ....anticipate a Central Bank marketing campaign to euthanize any large equity / bond market impact, with the Media screaming about Noko and middle east conflicts.It just a quesiton of market credibility. ....if that fails they will indeed print more surreptiously. All Bank Holding compnay CEO's know this.

In reply to by RighteousDude