Another economic recession in 2022?
In 2008, economists were caught off guard by the Great Recession that followed the Lehman Brothers bankruptcy. The main reason for this failure was that they had turned a blind eye to the acute vulnerability of the financial sector to the potential bursting of the housing bubble and the credit market in the United States. In fact, this eruption resulted in a deep and painful economic recession.
Today, it seems that many economists have learned little from their forecast failure of 2008. Instead of focusing on the vulnerability of the US and global economic financial systems to the potential bursting of the global asset and price bubble. credit market, too many people worry about the risk of a return to the inflation problems of the 1970s. Many economists brace for another major forecast failure when the inevitable burst of the current bubble finally arrives and upsets global economic recovery.
One reason to be surprised at the current complacency of economists is that the current asset and credit market bubbles are much more widespread than they were in 2008. Another reason is that the levels of The debt of the United States and the world today to GDP is much higher than it was then. According to the Institute for International Finance, the global debt-to-GDP ratio increased by 35 percentage points during the pandemic to a record high of 350%.
As the 2008 economic recession approached, bubbles were largely confined to the US housing and credit markets. But today, bubbles are present in virtually every corner of the global asset and credit markets. It’s not just that today’s inflation-adjusted home prices in the United States are higher than they were in 2006 or that U.S. stock valuations are at high levels. they’ve only known once in the past 100 years. This is because large sums of money have been loaned to borrowers with questionable repayment capacity. These sums were loaned at very low interest rates which hardly compensate the lenders for the risk of default.
A particularly disturbing example of gross credit misallocation is that which characterizes emerging market economies, which now represent about half of the global economy. These economies are now more indebted than ever at relatively low interest rates as global investors seek returns. This has been the case despite the fact that the pandemic has wreaked havoc on their economies and, in many cases, put their public debt on an unsustainable trajectory.
Two factors have made the global asset and credit markets strong candidates over the past year. One is the large amount of money printed by the world’s major central banks, and the other is the strength of the global economic recovery from its March 2020 COVID-19 low. This makes today’s widespread complacency about the risk of an economic recession in 2022 even more surprising given that we appear to be on the verge of a reversal of these two supporting factors.
With inflation now hitting a rate well above their inflation targets, it is only a matter of time before the world’s major central banks turn off the monetary policy taps that fueled the all-round bubble. “. Already at its last meeting, the Federal Reserve announced an acceleration in the reduction of its bond purchase program with a view to ending it in March. This could pave the way for a more aggressive cycle of interest rate hikes than the market currently expects, especially if the omicron variant prolongs disruptions in the global supply chain and causes the market to rise again. ‘inflation.
Another factor that could trigger the bursting of the global “everything” bubble could be a significant slowdown in the global economy. Against this backdrop, markets appear overly complacent about the risks to the global economic recovery from the current omicron variant push and a possible sharp slowdown in the Chinese economy due to the acute problems in its real estate sector.
Economists and the Federal Reserve take comfort in knowing that the US banking system today is much better equipped than it was in 2008 to handle the bursting of an asset price bubble. -the banking part of the financial system. This could set us up for a series of long-term capital management (LTCM) moments for which US and global economic policymakers seem wholly unprepared.
Desmond Lachman is a Principal Investigator at the American Enterprise Institute. He was previously Deputy Director of the Policy Development and Review Department of the International Monetary Fund and Chief Emerging Market Economics Strategist at Salomon Smith Barney.