Are we nearing another financial crisis?
The supply-side story for oil prices is heavily skewed to the upside, with production losses from Iran and Venezuela causing a rapid tightening of the market. But the demand side of the equation is much more complex and harder to pin down.
Economists and investment banks are increasingly sounding the alarm on the global economy, raising red flags about the potential dangers ahead. Goldman Sachs and JPMorgan Chase recently suggested that a full-scale trade war would lead the steep corporate losses and a bear market for stocks.
The Trump administration just took its trade war with China to a new level, adding $200 billion worth of tariffs on imported Chinese goods. That was met with swift retaliation. Trump promised another $267 billion in tariffs are in the offing.
JPMorgan said that after scanning through more than 7,000 earnings transcripts, the topic of tariffs was widely discussed and feared. Around 35 percent of companies said tariffs were a threat to their business, JPMorgan said, as reported by Bloomberg.
But the risks don’t stop there. The Federal Reserve is steadily hiking interest rates, making borrowing more expensive around the world and upsetting a long line of currencies. The strength of the U.S. dollar has led to havoc in Argentina and Turkey, with slightly less but still significant currency turmoil in India, Indonesia, South Africa, Russia and an array of other emerging markets. Currency problems could morph into bigger debt crises, as governments struggle to repay debt, and companies and individuals get crushed by dollar-denominated liabilities.
Finally, the economic expansion is very mature, now about a decade old. Another downturn is only a matter of time. Global “synchronized growth” ended earlier this year, with emerging markets running into trouble. The U.S. is largely alone with robust GDP figures, and it is hard to believe that this rate of growth can be sustained with the expansion slowing elsewhere.
More to the point, the U.S. tax cuts in late 2017 opened up a wave of cash on the corporate sector, a steroid that will lose its efficacy, especially if it the resulting deficits result in higher interest rates or fiscal austerity down the road. To top it off, stock markets are very frothy, and already overpriced.
That sentiment is growing. “We’re not that bullish on equities anywhere globally at Morgan Stanley right now,” Jonathan Garner, chief strategist for Asia and emerging markets, told Bloomberg on September 13. “The latest move that we made on the U.S. side was to recommend reducing positions in U.S. equities.”
The icing on the cake could be high oil prices. The supply losses from Iran and Venezuela are tightening the market, draining inventories and forcing Saudi Arabia to cut into spare capacity levels. High prices could trim demand growth, but that hasn’t happened in a big way just yet. That puts the market on track for higher prices in the months ahead, which could be ill-timed if the global economy takes a turn for the worse.
The stage is set for a downturn in the next year or two. “[B]y 2020, the conditions will be ripe for a financial crisis, followed by a global recession,” Nouriel Roubini and Brunello Rosa wrote in a recent piece for Project Syndicate.
JPMorgan mostly agreed, arguing recently that another financial crisis is possible by 2020, and the lack of monetary and fiscal firepower to respond to such a crisis creates a “wildcard” on how severe the downturn might be.
Even though interest rates are rising, they are still low by historical standards and public debt held by so many governments around the world leaves little room for fiscal stimulus measures. Roubini and Rosa argue that “financial-sector bailouts will be intolerable in countries with resurgent populist movements and near-insolvent governments.”
Roubini and Rosa worry that backed against a wall, politically-endangered Trump administration might lash out against Iran in order to “wag the dog,” a scenario that would have catastrophic consequences. “By provoking a military confrontation with that country, he would trigger a stagflationary geopolitical shock not unlike the oil-price spikes of 1973, 1979, and 1990,” they argue. “Needless to say, that would make the oncoming global recession even more severe.”
The current economic indicators paint a false sense of security. The seeds are already in place for another downturn in the next year or two. A financial crisis – or even a more modest recession – would severely undercut oil demand forecasts, which have been steady and strong for several years.