Everybody remembers the devastation wreaked by the last global financial crisis of 2008. Before this collapse, credit, which was too easily available, resulted in large inflows of foreign capital into the US, which created a housing and credit boom during the late 1990s and early 2000s. As a result, the housing bubble in the US started to grow and it reached its peak around 2007. By the time 2008 rolled around, major defaults on sub-prime mortgages started to cripple the banking and financial industries in the country, while in Europe, to navigate the global financial crisis, countries started taking in unhealthy sovereign debt, leaving the global landscape balancing on a dangerous cliff. The big question now is will there be another global recession and what is likely to trigger this devastation?
As stated, easy credit resulted in a large increase in mortgage-backed securities (MBS) and collateralized debt obligations (CDO), creating a bubble in the US housing market. When housing prices began to decline, large global financial institutions began reporting huge losses due to heavy investments in MBSs and CDOs. What precipitated, as a result, were large numbers of average people having their homes foreclosed on, with $4.2 trillion being lost in home equity in the US alone. Unemployment shot up and left large numbers of Americans in financial devastation. Stocks, home prices and other asset prices plummeted, spreading across the global financial markets, resulting in a worldwide recession.
In response to the global financial crisis, central banks across the globe, including the U.S. Federal Reserve, began to drastically expand their money supply through purchasing government securities or other financial assets from the market in order to push back on the dramatic decrease in public demand. This tactic, known as quantitative easing, resulted in central banks worldwide purchasing $1.5 trillion worth of preferred stocks in major banks. Additionally, governments across the globe bailed out various firms, resulting in large amounts of debt obligations.
Current Global Debt Situation
Since debt played a significant role in causing the global financial crisis, many investors have been keeping an eye on the worldwide debt levels in order to be ready for the next potential global recession. There are some signs that are emerging which indicate that a global recession may be manifesting once again. In a report published in the beginning of 2019, the International Monetary Fund (IMF) reported that worldwide debt had reached $184 trillion. This is an all-time high, in nominal terms, and is equal to 225 per cent of the GDP in 2017. Also, worrying is the fact that the most important countries to the world financial system are the most indebted countries. The top three indebted nations in the world are the U.S., China and Japan.
China and Asia
One of the potential causes of the next global recession may come from the Asian continent. Particularly worrisome is the situation in China, which is one of the most indebted countries in the world. A large part of the worry is the ongoing trade war between China and the US, another one of the world’s most indebted countries. Many are worried that the trade war will weaken China and its surrounding Asian neighbours, which could reverberate negatively throughout the global economy. Recently, the China Caixin Manufacturing PMI report showed business sentiment in China reaching historically low levels.
Trade War Hurting American Economy
As one would imagine, the trade war between the US and China is not just a one-way street. In response to the US imposing tariffs, China has implemented retaliatory tariffs of its own. Chinese retaliatory tariffs have mostly been aimed at the American agricultural and manufacturing sectors. The negative effects are apparent in recently released macroeconomic reports, including the IHS Markit U.S. Manufacturing PMI, which in July 2019 showed the slowest rate of growth since September 2009, the peak of the financial crisis. Then in August 2019, the economic indicator reported the first contraction, raising fears of an oncoming recession in the US.
United Kingdom and Brexit
With the rise of right-wing populism in the UK, the country is dangerously close to leaving the EU without a trade deal, which will cause widespread uncertainty throughout the European economy. This will surely hurt economic growth and may cause a recession in the EU and the UK. Due to the United Kingdom being a major centre of global finance, this could have widespread repercussions worldwide.
Weakening of the German Economy
Another potential source of macroeconomic weakness, which could plant the seeds of the next global recession, is the recent downturn of the German economy. Recent economic data, suggesting a possible recession in the German economy, is worrisome in the face of Brexit, since Germany is the largest economy in the EU. The country just barely avoided a recession in 2018 and has recently experienced a decline in export growth in the second quarter of 2019. Germany’s gross domestic product (GDP) decreased by 0.1% in comparison to the first quarter of the year. This growing economic weakness has dampened confidence in the ability of Germany and the EU as a whole to withstand the Brexit volatility.
Germany and China
Not only is Germany facing potential economic distress radiating from Brexit, the country’s economy is also facing headwinds caused by US-China trade war. China is significant since it is one of the more significant purchasers of German exports, in no small part due to its preference for German luxury cars. An economic slowdown in the Chinese economy can result in a significant decrease in the demand for the export industries in Germany, further dampening future growth in the German economy.
Worse Than Last Time
Although the last global recession was one which caused unprecedented hardship for people across the globe, the next potential recession may end up being even worse than the last one. The high levels of risky debt have reached dangerous levels in many parts of the world, which could leave many of these economies less able to withstand a large financial shock to the global system. Much of the risky debt is concentrated in China as well as many emerging economies around the world where much of the debt is denominated in volatile exotic currencies.
Not All Is Doomed, Necessarily
Despite all of the existing economic pitfalls around the world, which could potentially cause the next global financial crisis, there are some reasons to be hopeful. For instance, the US Federal Reserve has made great efforts to continue stimulating the economy by lowering interest rates. Also, there are many well-respected economists who do not necessarily see a recession happening in the near future. One of these experts is Nobel Prize-winning economist Robert Shiller who is famous for predicting the last global recession. Shiller believes there is only a 50% chance of a recession in the next year. Until then, global investors are taking advantage of the many trading opportunities, especially in options trading, that the volatility in the markets has created.