The Great Recession of 2008 has never really ended – it has just been postponed. Since 2008, the world’s major central banks – the Fed, ECB, and BoJ – have massively intervened in the global economy in an unprecedented way, masking the structural unsustainability of the debt fueled financial capitalism that caused 2008 in the first place. To use an analogy, it’s like 2008 was a cliff that we walked off while blindfolded and the central banks have created a rickety bridge in empty space in front of every footstep over the void. But the central banks are starting to believe that the empty void is actually solid ground, and they are about to stop building the bridge while we continue to walk onwards.
The Great Recession was sparked by a complex network of financial products linked to the US housing and debt bubble that popped late in the summer of 2007. Essentially, a bubble is when financial markets inflate prices far above the actual value of something. But what supercharges bubbles is when debt is created to invest in the bubble in the mistaken belief that it cannot pop. When the housing asset bubble popped, it took the credit bubble with it because the massive amount of debt invested in the housing market was now enormously overvalued compared to the fundamental value of real estate that was backing it as collateral. When creditors have to write huge sums of money off their balance sheets, financial panic is born and a financial crisis starts. A financial crisis is really a crisis of liquidity, as nearly everyone is unwilling to lend, spend, or invest money because they either don’t have it or they’re trying to protect whatever they have left.
The problem in 2008 was structural – it was caused by runaway debt invested in overvalued financial assets and financial instruments combined with low growth in productivity, wages, and population (in the developed economies). Much of the “wealth” created was fictitious, in that it only existed on balance sheets that reflected financial asset prices rising further and further above their true value. The high levels of debt rising far above fundamental growth meant that the ability to service this debt continuously decreased as debt increased. The only thing propping up this unsustainable disconnect was rising asset prices that ensured liquidity, because if you had too much debt you could always sell your assets to repay the debt or borrow more against your assets. The fictitious capital exists on the balance sheets of lenders as an asset – money that they own. But the value of debt is theoretical – the future interest and principal payments do not yet exist, so if the true value backing debt (earnings and collateral) aren’t enough to cover the theoretical value of the debt it has to be written off – in other words, the formerly “real” money gets destroyed. Just like stocks where the value is theoretical until you sell, and your money can be destroyed if you sell at less than what you bought it for.
After the global financial contagion from the subprime mortgage crisis spread, the central banks decided to double down on the structural deficiencies of the system in order to stop the free-fall. Instead of trying to reduce debt in the system and bring asset prices in line with their actual value, the central banks decided that they had to stimulate asset prices (to boost balance sheets) and stimulate lending (to boost liquidity). Their only tool to work with is monetary policy because fiscal stimulus through government investment – like the New Deal Keynesianism of the 1930’s – is not within their purview. The neoliberal governments of major countries like the US, Germany, France, the UK, and Japan chose austerity. Thus the twin monetary policies of Quantitative Easing (QE) and low, zero, or negative interest rates were born. The PBOC, China’s central bank, has not cut interest rates to 0 but has stimulated credit growth on a n incredibly massive scale since 2008, which plays a similar role of liquidity injection to QE. My argument is that QE and Low, Zero, or Negative interest rates have created a feedback loop of asset price inflation and extremely cheap credit that has inflated asset and credit bubbles around the world. Deutsche Bank analysts recently reported that “we’re in a period of very elevated global asset prices – possibly the most elevated in aggregate through history.”
Quantitative Easing, or QE, is an unconventional monetary policy that has been continuously pursued since 2008 by the Federal Reserve, since 2010 by the ECB and since 2011 by the the Bank of Japan, . Other central banks such as the Bank of England, the Swiss National Bank, and the Swedish National Bank also heavily engaged in QE. Its goal is to boost balance sheets by inflating asset prices. The central bank creates electronic currency and uses it to buy vast quantities of financial assets (stocks, bonds, or debt) issued by financial institutions (retail and shadow banks), corporations, and governments. This floods these lenders, corporations, and governments with money with the intention of stimulating more lending (i.e. money creation) and more therefore more investment in the real economy.
Low interest rates cause corporations, households, and governments to take on increasing amounts of debt. While interest rates are held down around 0% these debts are sustainable as interest payments are low and debts can be refinanced on the promise of future growth. Continuously rising asset prices due to QE make creditors believe their loans are backed by enough collateral to be low-risk. This has led to an explosion of debt overall since 2008 in the government, corporate, and household sectors. In addition, low or negative interest rates push investors to seek riskier and riskier assets in search of yield that they cannot get from ‘safe’ investments like US Treasury Bonds. This leads to incredibly strange outcomes like some European junk bonds having almost as low a yield as US Treasury Bonds, not to mention the Italian, UK, Singaporean, and French government bonds with lower yields than US Treasuries. Argentina recently issued dollar-denominated 100 year bonds with a yield of only 7.9%, which is obviously irrational because Argentina has defaulted on its debt multiple times within the past 100 years. Because investors have easy access to credit, yields from risky products, and the QE tide lifts asset prices, this financial charade can continue for a long time as investors get complacent. But as the world’s central banks signal a return to hawkishness – raising interest rates and reducing their balance sheets – all this debt and risk will become unsustainable.
When a market system is unsustainable and driven by irrational feedback loops, bubbles can exist for a long time before something brings them crashing down. The proximate cause of the bubble bursting is not as important as the fundamental structural conditions. In this way, financial instability is like a tower of Jenga blocks – once it has reached a peak of structural instability, you can remove a single block from many different places and the end result would be the same – the structure will fall. It doesn’t particularly matter which specific block took it down because the system was primed to collapse anyways.