Wednesday , 22 May 2024

The Next Financial Crisis: What Will Cause It? What Will It Look Like? When Will It Happen?

The question is not whether there will be a crisis, but when. In the past 50 years, we have seen more than 8 global crises and many more local ones, so the likelihood of another one is quite high…because the factors that drive a global crisis are all lining up.



This version of the original article, by Daniel Lacalle, has been edited* here by for length (…) and clarity ([ ]) to provide a fast & easy read.  For the latest – and most informative – financial articles sign up (in the top right corner) for your FREE bi-weekly Market Intelligence Report newsletter (see sample here)

What are the main factors that could trigger the next financial crisis?

  • Sovereign Debt
    • The riskiest asset today is sovereign bonds at abnormally low yields, compressed by central bank policies.
    • With $6.5 trillion in negative-yielding bonds, the nominal and real losses in pension funds will likely be added to the losses in other asset classes.
  • Incorrect perception of liquidity and VaR (Value at Risk)
    • Years of high asset correlation and synchronized bubble led by sovereign debt have led investors to believe that there is always a massive amount of liquidity waiting to buy the dips to catch the rally. This is simply a myth.
    • That “massive liquidity” is just leverage and when margin calls and losses start to appear in different areas -emerging markets, European equities, US tech stocks- the liquidity that most investors count on to continue to fuel the rally simply vanishes. Why? Because VaR (value at risk) is also incorrectly calculated.
    • When assets reach an abnormal level of correlation and volatility is dampened due to massive central bank asset purchases, the analysis of risk and probable losses is simply ineffective, because when markets fall they fall in tandem, as we are seeing these days, and the historical analysis of losses is contaminated by the massive impact of monetary policy actions in those years.
    • When the biggest driver of asset price inflation, central banks, starts to unwind or simply becomes part of the expected liquidity -like in Japan-, the placebo effect of monetary policy on risky assets vanishes and losses pile up. … is being given away – check it out!

…What will the next crisis look like?

  • Nothing like the last one, in my opinion. Contagion is much more difficult because there have been some lessons learnt from the Lehman crisis. There are stronger mechanisms to avoid a widespread domino effect in the banking system.
  • When the biggest bubble is sovereign debt the crisis we face is not one of the massive financial market losses and real economy contagion, but a slow fall in asset prices, as we are seeing, and global stagnation.
  • The next crisis is not likely to be another Lehman, but another Japan, a widespread zombification of global economies to avoid the pain of a large re-pricing of sovereign bonds, that leads to massive tax hikes to pay the rising interests, economic recession and unemployment…

The next crisis…

  • will be blamed on a symptom (Lehman in that case), not the real cause (aggressive monetary policy incentivising risk-taking and penalising prudence)…[and]
  • will find central banks with almost no real tools to disguise structural problems with liquidity, and no fiscal space in a world where most economies are running fiscal deficits for the tenth consecutive year and global debt is at all-time highs.

When will it happen?

We do not know, but if the warning signs of 2018 are not taken seriously, it will likely occur earlier than expected. The governments and central banks will not blame themselves, they will present themselves -again- as the solution.

(*The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.)

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