The global economy is strengthening and trade flows also have been showing signs of strong revival. But at the same time stock markets are continuing to rise stoking the fear that a new financial crisis is in the making. This fear primarily arises from the fact that underlying market fundamentals continue to remain weak; yet investor sentiment remains very bullish at a time when corporate debt are not only high but have very low cash reserves. The Bank for International Settlement (BIS) in its latest quarterly review warned that the current situation bore resembles to that what prevailed prior to the 2007-08 crisis.
The US economy appears to be gaining strong momentum and also experiencing a surge in stock prices. One line of argument is that as the economy is showing strong sign of propelling up, rising stock valuations are not unreasonable. The other line of argument is that this credit-fuelled growth is not sustainable and that will eventually tip the balance in the other direction. In between the argument is while excessive risks have been taken on, one can not be sure until that has blown up. Sure it has not blown up yet but jitters are felt already. For how long shall we have to wait and see?
Federal Reserve Chairwoman Janet Yellen in her final appearance before Congress at the very end of November last year described a steadily brightening picture of the US economy. She talked down fears of financial instability. She said that while asset prices were high by historical standard, the risks remained contained. But at the same time she also expressed concerns about the federal debt and social inequality noting that economic growth, productivity and wages remain depressed. She expressed her personal concern that the rising ratio of debt to gross domestic product (GDP) was not sustainable. Public debt in the USA stood at US$20.25 trillion in September, 2017. The estimated public debt to GDP ratio was 106.10 in 2016. President Trump's tax cuts are not going to help on this front nor will it contribute to stem the rising income inequality- if anything, it might add to it.
But Yellen's reassurance seen from the historical perspective is not very reassuring. The policy of cheap money to stem the tide of falling stock prices starting from the October, 1987 stock market crash has continued through the Asian Financial crisis, 1997, dot.com bubble burst, 2000-01 leading to the new speculative venture via the sub-prime mortgage market to very complex financial instruments that we describe as derivatives and collateralised debt obligations. In effect, following each financial crash, the Federal Reserve policy has been to open the tap to supply cheap money to finance next one. That is what was exactly done in the wake of the 2007-08 financial crash.
The policy of quantitative easing (QE) in which the then Federal Reserve Chairman Ben Bernanke reduced interest rates to historical lows and pumped trillion of dollars not only in the US but also global financial markets. That has reignited the financial orgy this time again like before following financial crises. The consequence is an explosion of asset values. The policy of QE continued also under Yellen's chairwomanship while she is now implementing the winding down of QE. She assured such winding down would be gradual. Such gradualism is reassuring to market participants as such gradualism will not derail the economy nor upset the market, rather it significantly reduces risk premia. They also know if crunch comes to the crunch, the Fed will not sit idle further adding to undertaking higher leverage and risk taking.
But a massive amount of money is now floating around the global financial system and that is driving a massive speculative frenzy so much so that investment is flowing into all sorts of obscure assets including cryptocurrencies such as bitcoin. The explosive surge in the value of bitcoin now rising to US$11,000, an eleven times increase in its value alone this year, has, however, moderated a bit in recent times. This is now considered as the largest financial bubble in the contemporary economic history, some even go to draw parallels with the Dutch Tulip bubble of 1636-37 and the South Sea bubble of 1721. This cryptocurrency, bitcoin, enables monetary transactions via internet completely bypassing national or international financial regulatory agencies thereby reducing the transaction costs quite substantially. Now bitcoin is even advocated as a long-term store of value similar to gold. But the outgoing Fed Chair Yellen dismissed bitcoin as a highly speculative asset and not a stable store of value. She further added that the cryptocurrency was not legal tender and played very small role in the payment system.
As financial markets are flush with cash, investors are targeting cryptocurrencies like bitcoin to secure even higher return on their investments despite the Fed chair Yellen's adverse remark on it. This raises the question whether the market or the regulator wherewithal is forestalling a bubble. More importantly, corporations are bulging with money but they are not investing that money in the real economy; rather they prefer to invest in speculative assets. In effect, Trump's tax cuts are likely to lead to more frenzy to invest in speculative assets with extra cash bonanza thus gained, rather than in the real economy.This is also the sign of the time where the most egregious expression of rampant speculation which is dominating the global financial landscape. While financial speculations can create money out of money, eventually this money will make a claim on the real economy. So when the bubble bursts, it will take a very substantial part of the real economy with it with disastrous consequences for very ordinary people.
Given the current integrated nature of the global economy, no economy can insulate itself from a global financial crisis. A global economic downturn resulting from a financial crisis will have varied but wide repercussions across the Bangladesh economy. As a global financial crisis will lead to a global recession, the resulting impact of the financial crisis will be in the main transmitted to the Bangladesh economy through falling trade, investment and remittances.While Bangladesh does not have a highly globally exposed banking industry, yet all of those transmission mechanisms will have an impact on its balance sheet. Therefore, only a resilient banking industry will be able to weather through the crisis.
The transmission of the crisis will hit harder the manufacturing exports, that will mean ready-made garment (RMG) exports. Wage growth has already been stagnant (described as income recession) in the two major markets for RMG, the US and the European Union (EU). If recession hits these two markets, not only unemployment will rise but also the real wages will decline, negatively impacting on RMG imports from Bangladesh The impact of falling trade will translate into job losses and a much lower growth rate for the country. Urban households will suffer more losses than rural households because manufacturing activities are concentrated in urban areas. This will cause an increase in the level and depth of urban poverty.
Remittances have become massively important for Bangladesh constituting the single largest source of foreign exchange earnings. In effect, remittances have now become larger than aid flows. Most Bangladeshi workers are employed in Middle-eastern countries, if recession hits commodity prices (i.e. oil), that may cause some sizeable job losses, but those who are still in employment will find their dollar equivalent income to decline due likely appreciation of the US dollar against oil-exporting countries' currencies. Therefore, remittances are also likely to fall as well.
A global recession will see the collapse of foreign direct investment (FDI) globally, including Bangladesh. This may prove to be potentially more damaging to Bangladesh since investment is already very low. The other form of private capital, portfolio investment, has been less important and will become much less important in the event of a recession for the country. All in all, a slowdown in economic activity resulting from trade, investment and remittances has the potential to turn a financial crisis into a social crisis also.
The writer is an independent economic and political analyst.
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