Opinion: Is the Global Balance Sheet Crisis Over?
With financial markets still going gangbusters, one needs to ask whether the global financial crisis is truly over, or if we are on the brink of another crisis.
Certainly, the appointment of Jerome Powell as the next Chairman of the Federal Reserve signals that President Trump prefers a dove on interest rate increases, since he does not want a sharp slowdown in the economy, in the event he cannot deliver his tax cuts or push through his infrastructure spending program.
The concept of a balance-sheet crisis was first raised by Dr. Richard Koo, chief economist of Nomura Research Institute, in describing how after the Japanese stock market and property bubble burst in the 1990s, the corporate and household sectors spent two decades rebuilding their balance sheets, refusing to invest and spend, culminating in what outsiders called Japan’s “Two Lost Decades.” Dr. Koo has since argued that slow growth in the U.S. and European economies after the 2007 global financial crisis was also due to balance sheet malaise, as their financial and household sectors spent a decade rebuilding their balance sheets, cutting back investments and paying down debt.
There is a classic joke about the U.S. and European bank crises by a former central bank wit, who remarked that on the right side of their balance sheet, nothing was right, and on the left side of the balance sheet, nothing was left. Small wonder that since 2007-2008, central banks had to guarantee the left side of the liabilities to stop a massive liquidity crunch, and also take huge amounts of assets off the banks onto their books, with unprecedented inflation of central bank balance sheets.
What is seriously problematic about the current global balance sheet is that governments or central banks have implicitly guaranteed the left side of the financial system balance sheet – deposit liabilities – while the valuation on the asset side – real estate, stocks and bonds – is dependent on continued low interest rates. No central banker is fully confident that there is proper theoretical guidance on how to exit unconventional monetary policy. Whether an exit to normal interest rates will be possible depends on the political will to reform the real side of the economy. This means higher taxes and dealing with distortions such as overcoming vested interests. Since the current U.S. administration is advocating mainly for tax cuts for the rich, the market anticipates that there will be continued reliance on loose monetary policy.
In other words, interest rates and growth will be lower for longer than anyone expects.
What are the main effects of a balance sheet crisis? The fundamental symptoms are low levels of corporate investments and low levels of growth. Since governments are already stretched fiscally, with OECD government average debt nearing 100% of GDP (as against European Maastricht agreement of “safe” levels of 60% of GDP), there are limits to governments further increasing investments, as advocated by Keynesian economists.
There is currently little fear of consumer price inflation, because there is excess productive capacity everywhere, from commodities to electronic goods and services. With low and negative interest rates, it costs very little to speculate, which is why stock market valuations are higher than ever. Indeed, the Bank of Japan actively buys Nikkei Index Exchange Traded Fund stocks as part of its quantitative easing policies. Traditional central bankers would have turned in their graves if they thought central banks would buy equity stocks.
The U.S. has the most comprehensive balance sheet among developed countries. A study of the latest series of balance sheets would show that the 2007 subprime crisis was due to a combination of excessive household debt in terms of mortgages, and a sharp rise in real estate valuation. Between 1997 to 2007, real estate values more than doubled to $52.9 trillion, or more than 365% of GDP, while national liabilities rose by more than 200% of GDP, mostly incurred by households and the financial sector. In the decade to 2016, federal government debt rose by more than $10.5 trillion to reach gross liabilities of 100% of GDP, compared with only 65.8% of GDP in 1997. The debt was incurred to bail the financial system out of trouble, but it incurred populist anger that spilled out only in 2016 with the election of President Trump.
We are not yet out of the woods of the global balance sheet crisis (which is longer in the making). The issue that no one has a handle on is the trigger for such a crisis.
You only begin to understand inequality when you start having national balance sheets and find out who owns what, such as 1% of the wealthy owning more than half of global wealth. Inequality or imbalances occur not just at the income or wealth level, but also at the geographical level.
The next stage of a national and regional balance sheet is to construct a “social balance sheet,” since the biggest asset of any nation is not physical assets, but human talent.
All Chinese understand that to get on in the world requires education, but no one has tried to estimate what and where the stock of that knowledge (including practical skills) is located, and what could be done to enhance our human competitive skills. Having a social balance sheet of human talent and skills would be like mapping our own brain, locating how the whole learns, learning to learn and learning to apply knowledge into real-life challenges.
One would immediately notice that knowledge skills cluster together, which is why cities are the centers of great creativity and innovation. At the same time, the network effect of telecommunications and social media ensures that innovation and ideas can come from rural areas, so the right application of knowledge and training in the right spots at the right time would release more energy, talent and innovation than ever before. Even Chinese dynasties start with the compilation of dictionaries, libraries and knowledge.
Getting better statistics on fundamental human knowledge, including social balance sheets, would be a step in the right direction.
Andrew Sheng is Distinguished Fellow, Asia Global Institute, University of Hong Kong.
A distinguished fellow of the Asia Global Institute at the University of Hong Kong and a former chairman of the Hong Kong Securities and Futures Commission.
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