“Folks, we’re going to have a global economic collapse…because that’s precisely what we deserve for our ignorance. We deserve pain.” Those are the words of Jesse Colombo, economic analyst and contributor at Forbes magazine.
Growing domestic bubbles and buckling emerging markets are the makings of an economic firestorm for the West. Preparation is tenuous at best. With historically low interest rates and immense levels of debt overhang, the West is ill prepared.
We used to look at the BRICs (Brazil, Russia, India and China) in envy. Not anymore. All are showing signs of weakness, and that weakness is contagious.
China’s recent collapse in its equity market (the Shanghai Composite Index) has not only wrung echoes through its own economy, but also ours. The Guardian reported that at Jaguar Land Rover, car sales for the three months to 30 June slipped to £5bn, a 7% drop on the same period last year – a worrying statistic for the 25,000 people employed by the company in the West Midlands and Liverpool.
“With historically low interest rates and immense levels of debt overhang, the West is ill prepared.”
And on the flip-side of the globe, in Brazil, their economy is practically in free-fall. Business Insider UK declares that Brazil’s economic activity is falling at almost 5% a year and inflation rages on. This story continues for the likes of Venezuela, Russia and even Dubai (its non-oil producing sectors have also been hit).
Financial contagion is easily received. One only has to look back at Lehman Brother’s collapse in 2008 and how quickly it spread to the UK and the Eurozone to see the threat it presents in a globalised economy. With CNN reporting that 40% of the revenue generated by S&P 500 companies comes from overseas, there is real scope for the West to feel the burn from weak emerging markets.
Combined with surrounding international weakness, the West also face their own domestic problems. The 2008 real estate bubble helped to create the financial turmoil that was coined The Great Recession. But despite this, ballooning property prices are being overlooked by central bankers and politicians alike. The Wall Street Journal illustrates with this infographic that the Commercial Property Price Index was at 118 in July – that’s 18 points higher than the 2007 bubble peak.
“There is real scope for the West to feel the burn from weak emerging markets.”
Such price hikes were not fuelled solely by population growth either. From 2010 to 2014, private equity real estate funding had increased year-on-year, contributing to ever higher prices.
Although we do not have the likes of a totally unregulated Credit Default Swap (CDS) market or risky subprime lending to contend with this time round, halting the growth of an unsustainable bubble is always advised.
This real estate boom is not showing signs of slowing anytime soon. Just when we thought house prices could not rise any further, yesterday the Royal Institution of Chartered Surveyors (Rics) warned of sizeable house price inflation in the future. This comes at a time when Nationwide reports that the pace of increase in UK house prices accelerated by 3.5% in July compared with a year earlier.
“Both government and independent central banks continue to push ahead with cheap credit”
But despite this, both government and independent central banks continue to push ahead with cheap credit. Last week, the Bank of England voted 8-1 to keep UK rates at the record low and George Osborne’s Help-to-Buy scheme still has another year of activity left.
That puts the UK in a difficult position. Following the Great Recession, the Bank of England were able to slash interest rates and the government able to step-up expenditure in a bid to boost consumer activity. But with interest rates at a record low and government debt ballooning by some 157% (since 2008), room for manoeuvre is low.
The most depressing example of a country going into recession with a high pre-existing debt level is Greece. Economist Paul Krugman argues that Britain and the US would not suffer like Greece following a new crisis due to their respective central banks. This should be true. A central bank works in two ways to curb a freefalling economy: they can print money (formerly known as Quantitative Easing) and alter interest rates. Arguably Greece’s biggest weakness in this sense was its lack of a suitable interest rate. The ECB had much less leeway to reduce rates to Greece’s optimal level due to pressures from Germany.
“But with interest rates at a record low and government debt ballooning by some 157% (since 2008), room for manoeuvre is low.”
Hence our toxic mix of weak fiscal governance combined with a central bank that has little room for manoeuvre provides a platform that would amplify any external or internal shocks.
And we are not short on economic shocks. We are surrounded by economies that are facing sinister times: Canada, Venezuela, Brazil and China to name a few. And a growing real estate bubble is yet more worrying, especially when one looks at the aftermath of the last tragedy.
Unless interest rates rise, the rampant housing market is cooled and the emerging markets begin to stabilise, the West is vulnerable and could be facing sinister times ahead.
Image: frankieleon via Flickr