Global reckoning is unavoidable; we will now have to sit down to a banquet of consequences

The reckoning may not be immediate. The Great Depression, 2000/2001 tech bubble and 2008 mortgage problems took years to develop. But there is no escaping it, writes Satyajit Das.

Published: 04th August 2022 11:05 AM  |   Last Updated: 06th August 2022 08:58 PM   |  A+A-

Illustration: Soumyadip Sinha

Alongside pestilence (Covid-19), war (Ukraine and unreported hidden Middle East and Africa conflicts) and famine (real in emerging nations, high food and energy prices elsewhere), the spectre of financial crisis now looms large. While the IMF entitled its latest economic forecast 'Gloomy and More Uncertain', there is general complacency.

Proximate noise -- day-to-day gyrations and speculation -- masks the underlying changes underway. The chances of a major re-set and reckoning are higher than at any time since 2007. As one observer noted about the bursting of the 1920s bubble: "Everyone was prepared to hold their ground. But the ground gave way."

End of Magical Economics

There are two primary drivers. First, magical economic thinking is coming to an end, bringing to a close the era of ultra-cheap money.

Since 2008 and more recently the onset of the pandemic, unprecedented government spending, low interest rates and liquidity injections by central banks have underpinned a large proportion of activity. These factors created excess demand which combined with supply shortfalls due to Covid-19 disruptions, the Ukraine conflict, especially poorly thought through sanctions, lack of investment in energy, and extreme weather caused sharp price increases.

Otiose debates about the definition of recessions notwithstanding, a slowdown is already evident. One factor is states embarking on some budget repair. Another is central banks increasing interest rates to counteract inflationary pressures, although how this will resolve supply-side issues, the ravages of the pandemic, climate change or wars is unclear. Overzealous rate rises risk exacerbating the downturn undermining employment which remains strong especially in developed economies due to labour shortages reflecting reduced post-pandemic mobility.

Significantly, China, a major engine of global growth, faces difficulties. The reasons include its disruptive zero-Covid policy, the unwinding of a large, debt-fuelled real-estate bubble and Western restrictions on technology and market access driven by American fear of losing its global dominance. As the world's factory, China matters, remaining pivotal to supply chains. It is also a major trading partner and debt provider of developing countries.

There are significant long-term headwinds. Adverse demographics in many countries will create unsustainable dependency ratios with shrinking numbers of workers expected to support a growing aged population which is living longer.

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There are the accelerating costs of climate change, where the planet is now increasingly unliveable. The mega-rich are already planning their escape, colonising outer space. Scarcity of food, energy, water and other resources is emerging. There is the expensive, slow and bungled transition away from fossil fuels, exacerbated by shortages of essential materials (lithium, cobalt, rare earths).

Rising geo-political tensions, sanctions and trade barriers are driving de-globalisation and moves to attain national self-sufficiency.

Future growth, which modern civilisation relies on to solve all problems, will be patchy and volatile.

Financial Fantasies

Second, cherished financial fantasies will be found to be ludicrous. Everything and everywhere asset price bubbles, fuelled by decades of debt-financed consumption and investments and low cost of funds, now face their most rigorous examination.

Equity valuations based on finding a greater fool to pay you more than you did may prove unsustainable. Some sectors, mainly new-age businesses which have dominated the last decades, are particularly exposed.

High-flying new enterprises prospered in an unhealthy cycle where investors backed those with strong sales growth, which then used the cash to attract more unprofitable customers to boost revenues to attract further capital etc. That game is over.

Even the more established of these firms -- some of them heavily dependent on advertising revenues and facing regulatory scrutiny -- may struggle. Lacking radical new products, most large players, now near monopolies, are losing momentum.

Borrowings are high. Personal, business and government balance sheets are stretched. Everyone has, in the words of Bruce Springsteen, debts that no honest man can pay.

Slower economic growth and lower asset values may result in rising bad debts.

While better capitalised than before, banks are still highly leveraged and vulnerable to financial shocks. This is compounded by the still large shadow banking system to which it is connected by financial dealings. Ultimately, a problem in one place will work its way through the hyper-linked global financial system.

Already weakened by the pandemic, many emerging market borrowers may need to restructure debt. Sri Lanka's problems -– political failures, misguided policies, pandemic and domestic insecurity induced falls in tourism revenues, unsustainable borrowings, lack of foreign currency, corruption -- are far from unique.

The combination of an economic slowdown (growth in developing economies is forecast to fall from 6.8 percent in 2021 to 3.6 percent in 2022), rising borrowing costs, high levels of debt and a strong US dollar will expose vulnerabilities. Food, energy and raw material importers face extra challenges. The 1980s Latin American and 1997/98 Asian crises were triggered, in part, by rising rates.

The unresolved European debt crisis is re-emerging. The European Central Bank acted as buyer of last resort for almost-bankrupt members to cover up the problem. Rising rates will pressure highly-indebted countries: France (government debt at 113 percent of GDP), Greece (193 percent), Italy (151 percent), Portugal (127 percent) and Spain (118 percent).

Fault lines between inflation-phobic Germany and debtor nations will increase. The indebted eurozone member's lack of independent monetary policy, fiscal capacity, currency flexibility and ability to monetise away debt will again become problematic.

Currency instability is a visible manifestation of the rising dysfunction. The Euro, the Yen and many emerging market currencies have fallen sharply against the US dollar. The sharp moves affect domestic inflation and trade competitiveness as well as foreign capital flows. Desperate chatter about a new Plaza accord highlights the problems.

Serial Crises

The reckoning may not be immediate. The Great Depression, 2000/2001 tech bubble and 2008 mortgage problems took years to develop. As economist Rudiger Dornbusch noted: "the crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought."

Authorities will resort to the old rule book to extend-and-pretend and kick-the-can down the road for a little longer. But the narrowing path out of the problems means it will be difficult to contain the ultimate dislocation.

Governments have high debt levels, central bank balance sheets are bloated and real (inflation adjusted) interest rates already negative. While inflation will ease over time, rates are unlikely to retrace as central banks will be cautious about elevated absolute prices and wary of reigniting inflationary expectations.

The paucity of policy tools is evidenced by the European Central Bank announcing its Transmission Protection Instrument to prevent financial fragmentation. Designed to lower the borrowing costs of vulnerable members (whose rates are rising relative to Germany), it conflicts directly with announced increases in official Euro interest rates.

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Rather than economic considerations, social and political matters are increasingly likely to dominate.

Populations exhausted by the sequential problems are unlikely to remain quiescent. For wealthier spoilt citizens, for whom a late online delivery or a slowdown in internet speed is an existential emergency, their unmet lofty expectations are the source of restlessness. For the less fortunate, real privations and lack of bare essentials are driving disquiet.

Globally, resentment of governments, unable to deliver on promises, and elites, emblematic of wealth inequality, underlies social unrest. In China, in an unusual sign of disharmony, a growing number of home buyers stopped paying mortgages on incomplete and stalled projects, forcing the government to act.

Infantile politics adds to the problems. The US, now 'Somalia with nukes', is in permanent deadlock, probably ungovernable and on the verge of civil war. In the UK and Europe, a revolving cast of leaders and unstable alliances held together only by distrust engender paralysis. Many nations now pay lip service to democracy and look to charismatic authoritarian figures for salvation.

The political impasses are related to the electorate’s unwillingness to acknowledge conflicting priorities. Additional investment in public services and cost of living assistance is incompatible with lower taxes and sound public finances. Deregulation and interventionism on pet issues are inconsistent. Sacrifices and lower living standards are firmly rejected.

The ultimate result of these interlocking crises may be the impoverishment of large sections of the population, creating conditions for social and political upheavals. French political scientist Alexis de Tocqueville held that such events occur when a period of objective economic and social development is followed by a sharp reversal. People's mood and attitude shifts when they fear that the gains acquired with great effort may be lost. He wrote: "Evils which are patiently endured when they seem inevitable become intolerable once the idea of escape from them is suggested."

Having ignored or deluded ourselves about essential issues and avoided hard decisions, it is inevitable that, in the words attributed to Robert Louis Stevenson, we will all have to sit down to a banquet of consequences.

Satyajit Das is a former banker and author of numerous works on derivatives and several general titles: Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006 and 2010), Extreme Money: The Masters of the Universe and the Cult of Risk (2011), A Banquet of Consequences RELOADED (2021) and Fortune'ss Fool: Australia’s Choices (2022). His columns have appeared in the Financial Times, Bloomberg,WSJ Marketwatch, The Guardian, The Independent,Nikkei Asia and other publications. This is part of the web-only series of columns on


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