The crux of timing

Crises have their own timetables

From Tuomas Malinen’s Forecasting Newsletter.

The crisis takes a much longer time coming than you think and then it happens much faster than you would have thought. - Rudiger Dornbusch

Issues contributed:

• The timelines of the 2007-2008 financial crisis and the ongoing one seem to coincide in a perplexing manner.

• Only a very limited means exists to quell the crisis in its upcoming, third ‘act’.

• Credit crunch, the economic cycle and response time of authorities to its next escalation will determine the future path of the ongoing crisis.

Economist Dr. Rudiger Dornbusch was a renowned international macroeconomist, a demanding teacher, intimidating public speaker (to some) and one of the leading experts on crisis management, who passed away on July 25, 2002. I am not an expert of his work, but I know him and his research by reputation. One of his most famous quotes, in addition to the above, considers handling of the economic crisis in Brazil in 1998. It goes:

When they [Brazil] call 1-800-BAILOUT, just let it ring. Say our operators are busy.

Dr. Dornbusch was an unyielding opponent of governments meddling with the economy, but he did support creation of supranational entities to handle crises. I have to say that I have grown rather critical towards those of late, because of the actions and comments by the leaderships of International Monetary Fund, the World Health Organization and the United Nations. Yet, we can safely assert that the modern national political leaders and central bankers have taken a completely opposing road of that of Dr. Dornbusch. Bailout, of everything, has become the norm.

After we had understood, in early 2017, that 1) the world economy had never really recovered from the global financial crisis of 2007-2008 and 2) that the whole “charade” (the world economy) had been kept standing only through utterly unsustainable fiscal and monetary stimulus, our small forecasting team at GnS Economics conducted a lively debate on the timing of the crisis.

I can admit that back then I thought that the crisis, which has now started, would have appeared way earlier. My thinking was that the economy and markets will be allowed to correct themselves, i.e., that the economy would be allowed to drift into a recession and markets even crash. My two colleagues, who have unfortunately been forced to leave our company, were adamant that authorities will do their utmost to postpone the collapse of the global economy.

And, they were right.

Our conclusion was revealed in our December 2017 Special Issue, ominously entitled as The Approaching Perfect Storm. Two excepts.

Forecasting the crash and the onset of the crisis has been extremely difficult because of the centrally controlled nature of the current expansion. The central authorities of China have thus far run to the rescue each time some corner of its highly levered capital market that seemed to catch fire. How long they want and are able to continue doing this, remains unknown.

As mentioned above, both the global central banks and China are planning to diminish their support for the global economy and the markets around the same time (H1 2018). This would start what can only be a long and painful road towards returning to the market economy. If the central banks and China really go through with their plans, noting that China can also just run out of options, 2018 is likely to be the year, when the first signals of the crisis will appear. These include serious market turbulence, bank failures and possible panicky responses from the central authorities. In 2019, the crisis would get to the full swing when the last efforts of the central authorities to uphold the global asset bubble would become exhausted.

By December 2017 we had understood that everything in the world economy hinges on the willingness and ability of central bankers and politicians to keep supporting it. I am rather proud of this, I have to admit, because the following years showed it to be true. 2019 was also the year, when financial markets started to become ‘unhinged’, with the near-explosion of the repo-markets, forcing the Federal Reserve back to quantitative easing. Albeit the crisis did not get to “full swing”, it proved our point. The world economy was unable to stand without constant support.

Now we face a question, when does the crisis escalate, again?

Financial crises are ‘cunning beasts’ in the sense that they develop for long under the surface of normally functioning economy, and then surface in a series of consecutive and escalating events, which may be weeks or months apart. The global financial crisis 1.0 (2007-2008) progressed in waves.

There were several bank failures, merges and bailouts induced by government and central banks starting from 2007 before the crisis emerged for everyone to see in the failure of investment bank Lehman Brothers on 14 September, 2008. We seem to be on a similar path now, which I will detail next.