Ian McGugan
Let's acknowledge all the good news: For the first time since the financial crisis, the global economy is firing on all cylinders. In Canada and the U.S., unemployment has dropped to pre-recession levels while, on Bay Street and Wall Street, stocks seem determined to soar past all previous heights.
Things seem so bright in fact that Deutsche Bank recently decided to look for clouds on the horizon. In a report entitled The Next Financial Crisis, it crunched numbers to demonstrate that economic shocks have grown more common in recent decades.
The bank noted that investors over the past generation have witnessed a Japanese stock collapse (1990), a Mexican peso crisis (1994), an Asian debacle (1997), a Russian default (1998), the dot-com crash (2000), various accounting scandals (2002), the Great Recession (2008) and a near meltdown in the euro zone (2010).
So maybe, just maybe, we shouldn't go down for a nap just yet. If history is any guide, we can expect another crisis sooner rather than later.
The truly worrisome aspect? Right now, the world has far less of a buffer to offset possible shocks than it did during previous emergencies.
In those past downturns, policy makers responded to economic downturns by slashing interest rates and boosting government spending. Neither seems like a realistic option at the moment.
Consider interest rates, everyone's favourite economic medicine. When the financial crisis manifested itself in late 2007, the Bank of Canada's key policy rate stood at 4.75 per cent. Over the next two years, the central bank slashed the rate by more than four percentage points, to 0.50 per cent, as a way to jolt the comatose economy back to consciousness.
If any similar crisis were to erupt these days, the Bank couldn't offer a similar dose of rate-cutting magic. Simple arithmetic would stand in the way. With the key rate now standing at 1 per cent, the Bank would be unable to trim more than a single percentage point before bumping up against the zero bound. Attempts to push rates into negative territory – to charge people for the privilege of saving – would run into resistance, because savers would presumably flee from bank accounts and hold cash instead.
The world's other major central banks face the same issue. Most monetary policy makers are in no position to offer a strong response if the global economy were to hit trouble.
That leaves fiscal policy – in other words, government spending – as the major tool to fight any new crisis. But it, too, may not be up for the job.
Many governments spent big during the Great Recession and now have substantially larger debt burdens than they did 10 years ago. In the United States, for instance, the total amount of federal debt held by the public soared from under 63 per cent of gross domestic product in late 2007 to more than 103 per cent now. Canada and most European countries experienced a similar surge.
At the very least, the growing public debt suggests that many governments would face strong political opposition if they were to attempt to return to lavish public-spending programs.
So, given the current paucity of recession-fighting tools, what can the world do? In a word: hope.
Corporate profits have been strong recently and so have readings from all the world's major economies. If the good times continue, central banks will have time to slowly raise interest rates to the point where those rates will once again offer room for major cuts in the event of a shock. In an ideal world, governments will also have several years to reduce their debt burdens and brace themselves for future upsets.
But we shouldn't grow complacent. The gloom-meisters at Deutsche Bank sketch out many reasons for concern, ranging from a possible crisis in China to the current attempts by central banks to unwind their crisis-era policies and raise interest rates.
Some of the most straightforward causes for concern lie in today's frothy financial markets. By Deutsche's numbers, "an equally weighted bond/equity portfolio has never been more expensive." If U.S. stock prices were to revert to historical norms in terms of valuation, an investor would lose more than 40 per cent of his or her money, in real terms, over the next decade, the researchers estimate.
At least individuals have a bit more room than governments to prepare themselves against future trouble. If there's a personal-finance lesson to be deduced from the Deutsche report, it's to be cautious despite today's balmy economic climate. Reducing debt and holding a bit more cash than usual are always good policies in a world where economic crises have become more common than ever.
Ian McGugan