The next financial crisis: the ‘great unwind’

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Illustration: Volker Straeter

The next financial crisis: the ‘great unwind’

Was it hopeless central banks? A trade war? Southern debt? Ten years after the last crisis, leading economists think about where the next crisis might come from...

The ‘great unwind’ – by Alfie Sterling

For economists, looking for the next crisis is very difficult. Perhaps it is a good idea to look for the causes of a future crisis from the actions of policymakers and not bankers.

One of these causes is the ‘great unwind’. This means when almost every big economy is plans to raise interest rates at the same time. This is one of the most risky and uncertain policies of modern times.

The great unwind is necessary after almost ten years of supporting the economy. In the US, in Europe, and in Japan, central banks have done everything to support the big economies since the crisis.

There have been two plans. First, keep low interest rates lower than before (including negative interest rates in places such as Japan and Switzerland). This makes it cheaper for banks to borrow money from central banks. Second, cheap money for banks in the form of quantitative easing or printing money. These fill markets with new cash, which can lead to inflation and dangerous new asset bubbles. Most central banks are nervously looking at the effects.

China has given us an idea what could come. Between 2014 and 2015, with cheap credit people borrowed to invest in the country’s stock market. Corporate share prices rose 150 per cent in just 12 months, with little change in the value of companies. This led to the bubble bursting, and Chinese stock markets lost 30 per cent of their value in just three weeks.

Interest rates need to rise, but this is almost as risky as keeping them low. The International Monetary Fund says global debt is now at a record high of $164 trillion, or 225 per cent of world GDP. This is much higher than before the beginning of the 2007 crisis.

Raising interest rates too quickly in just one country risks bringing a big number of families and firms higher debt repayments, and, possibly, recession. But nobody knows what will happen if almost every major economy raises interest rates or reverses quantitative easing at the same time.

Unfortunately for us all, policymakers can’t slowly and carefully find their way to higher interest rates. Raising rates too slowly can be a disaster. Cutting interest rates is the biggest way to fight recession. This means that governments need rates to rise to a high enough level before the next crisis so that cutting them will help. The problem for most countries is that interest rates are still at a level below which more cuts have little or no effect on spending.

There are global downturns every ten years on average, and this low level is a worrying place to be, 10 years after the last recession. There is a big need to raise interest rates quickly before the next recession comes.

Not to unwind low interest rates risks too much inflation and asset bubbles. But policymakers have a problem - raise interest rates too slowly and they risk not fighting the next downturn, raise rates too quickly and they risk creating the next recession. Central bankers and politicians are used to thinking about crises as something which happens to them – like those that come from automation or climate change. But the next crisis is likely to be a crisis they make.

Alfie Stirling is head of economics at the New Economics Foundation in London. @Alfie_Stirling


(This article has been simplified so the words, text structure and quotes may have been changed)