Bad Financial Moon Rising: OECD Chief Economist Warns World On “Extremely Dangerous Path”

Wednesday, October 3, 2018
By Paul Martin

by William White via Project Syndicate,
Wed, 10/03/2018

A decade after the collapse of Lehman Brothers, global debt levels are higher than in 2008, lending has moved into the opaque realm of asset management and private equity, and the dollar is surging. Given the proliferating risks, another financial crisis and downturn could be in store.

No one should overestimate economists’ powers of understanding. Just as the magnitude of the global downturn that began in mid-2008 took most economists completely by surprise, so did the sclerotic nature of the recovery. Similarly, economic forecasts today appear to be nothing more than hopeful extrapolations of recent growth.

In reality, all is not well beneath the surface. Should another financial crisis materialize, the subsequent recession might be even costlier than the last one, not least because policymakers will face unprecedented economic and political constraints in responding to it.

Some take comfort in post-crisis improvements to global financial regulation, on the assumption that these measures will prevent financial distress from spilling over into the real economy. This is an ill-advised stance. The analytical foundations of many of these “improvements” appear shaky, and the challenges of implementing the new regulatory regime have proven formidable.

Perhaps most important, ultra-easy monetary policies have encouraged precisely the risky financial behavior that regulations were supposed to limit. With monetary policy firmly on the accelerator, and regulatory policies firmly on the brake, the likeliest result is heightened instability.

The most worrisome side effect of recent monetary policies has been a continuous increase in the ratio of non-financial debt to global GDP. Though the 2008 crisis offered an opportunity for deleveraging, the opposite has happened. Debt has piled up worldwide, with the biggest increases found in emerging-market private sectors.

The recovery in emerging-market economies was supposed to be part of the post-crisis solution. Now, these economies are part of the problem. The fact that much of this dollar-denominated debt has been issued by non-US residents means that another costly currency-mismatch crisis could be in store.

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