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tristan-parsons
21st December 2015

The oncoming crash

Tristan Parsons on the dangerous ground on which an economic recovery is apparently being built, and the risk this poses in the event of another financial crash
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TLDR

The stock markets grinned when the US Federal Reserve increased its interest rate range by 0.25% on the 16th of December. The FTSE 100 went up 1.4%, and Frankfurt’s Dax went up by more than 3%. It has been expected for while, and should put pressure on other banks, such as the Bank of England and the ECB, to raise rates too. But this raise must be put in context: The Bank of England’s 0.5 rate is its lowest in history. The duration of this low rate is one of the longest.

Broadly speaking, interest rates control the amount of investment in an economy by determining the levels of payments on debts and loans. But in the extraordinary circumstances that followed the last financial crash, economies have benefited greatly, and arguably relied on, using low interest rates to prevent higher repayments on their own national and personal debts.

But low inflation rates continue. In the west, the US heads the pack, with just 0.5% inflation. The UK recently came up to 0.1%, reassuring some with regard to fears over deflation. Here lies the first of several problems with our economies; that is, the contradiction of low interest rates with low inflation rates. It suggests some gap in output that would otherwise bring inflation to the Bank of England’s guideline levels—around 2%.

Many suggest that this is the result of the government’s austerity policies. The lack of support for new technical industries, lack of general investment, and resulting concerns over productivity growth levels (15% below pre-crash trend), all contribute towards low growth and low inflation, despite the low interest rates.

Indeed, the recent fall of unemployment to a nearly 10-year low is linked to this. Low productivity means lower wages and lower output. Therefore, this has to suggest that our seemingly good employment record actually hides the fact that it is constituted by low-wage, unproductive labour. Low productivity can become engrained in the economy if not dealt with. Failures to develop capital-producing industries, high-tech industries, and high-skilled labour are long-term issues that will take a long time to solve.

The wobbly foundations that our economy is being built on are concerning for the future.

The weak foundations of many of the developed economies go to a far grander scale than domestic economic performance. There is the elephant in the room: national debt. The UK’s 89.4% debt-GDP ratio is one of the more severe, but it trails behind the extraordinary levels of countries such as the US and Greece. The bigger picture of why this debt is so terrifying is rarely discussed.

It has been 8 years since the last financial crash begun in the subprime mortgage crisis in the US. There is another coming. This is according to the IMF, not exactly the most historically socially caring institution. They claim that the cheap money provided through extensive printing using the Quantative Easing programs has created risky bubbles in several markets. One such example is the London housing market. It is true to say that crashes come and go as years go by, typically in fairly cyclical patterns. But this next one is more concerning because it will come before we have fixed the problems that the last one left us.

The first major problem is that when the crash comes, the debts and deficits of most economies will still be very high. Naturally, as tax income falls and social security payment rises, deficits will become larger. Furthermore, we will be left with the decision of introducing stimulus packages and facing higher debts, or lower stimulus in order to maintain a lower debt.

This only adds to claims that many developed economies are simply insolvent—they can never pay their debts back, even with the most extreme of austerity measures.

One of the reasons for the rise of the Federal Reserve interest rate is the fear of a liquidity crisis. This is the situation that arises when a crash comes and interest rates cannot be pushed any lower than zero—as negative rates mean paying people to borrow. But there is still a long way to go to get interest rates to safe levels. Before the last crash, UK rates were between 4% and 5%. This point again exposes the contradiction of the interest rate and inflation rate relationship. If interest rates were to rise, we would assume that inflation would fall, which would increase the risk of deflation.

We are told our economy is recovering. Yes, economic growth and increasing levels of employment are improvements, but the foundations of that growth are too often ignored.

I have selected just a few of the financial issues we have. The left should be severely disappointed in itself for not addressing them. Whilst many of the issues the Corbyn-led movement is campaigning for are noble—the NHS, social security, or action on climate change, to name a few—they are avoiding one of the major issues that the developed world faces.

The left, looking back on this period, will be hit by a pang of guilt. Their anti-establishment movement and many of the issues they are campaigning for have their roots in the broken financial system.


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