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Global Affairs

How to Predict and Prevent a Financial Crisis

 7 min read / 

After the 2008 financial crisis, the Queen famously asked academics at the LSE “Why did nobody notice it?” Indeed this is a very good question. However, she should have elaborated and asked: why have economists failed to predict every crisis in the past 150 years? Surely with their use of complex mathematics and some of the best brains, they should be doing better than this. Andy Haldane, Chief Economist at the Bank of England, put it rather nicely in saying that the economics profession is “to some degree in crisis”.

In order to stand a chance at forecasting an upcoming recession, it is vital for economists to have a true understanding of the macroeconomic system one lives in. Fair enough, up until 2007 New Keynesian economic models seemed to accurately represent the real world. Economic bodies like the OECD were forecasting a rosy future. Seemingly the recipe for economic stability had been found. Then the biggest financial crisis since the Great Depression erupted with disastrous effects on the global economy. Andy Haldane made a good comparison between the financial crisis and the infamous 1987 “Michael Fish” moment, where everyone was assured that a devastating hurricane would not hit – before it did.

The Wrong Models?

Clearly, something is wrong with DSGE economic models. In order to forecast financial crises, one first needs an economic model that can actually generate real-world crises. There is a central feature of the real world that is not considered by mainstream economists and their models – the level and acceleration of private debt. Debt is regularly referenced when discussing people’s own economic difficulties, yet it is surprising that it is not seen at all in macroeconomic models. Bernanke said that changes in debt “should have no significant macroeconomic affect.” Lending is simply portrayed as the transfer of spending power. This belief has recently been debunked by the Bank of England which confirmed that lending is actually additional spending power being created and destroyed. Aggregate (total) demand in an economy – a key determinant of economic growth – is, therefore, the sum of GDP and credit (growth of private debt), as opposed to simply GDP.

With debt now factored in as part of the macroeconomy, its danger can be realised. During good times, banks, firms and individuals take on more debt to purchase goods and in pursuit of profits. Private debt in an economy cannot increase indefinitely, and inevitably at some point, it falls. When this happens there is a subtraction from aggregate demand and fall in economic growth – possibly even enough for there to be a recession! So what seems like periods of ‘economic stability’, are in fact the planting of seeds for yet another financial crisis.

This all sounds good, but where is the proof? Thanks to economist Steve Keen’s research, there is remarkably supportive empirical evidence. Prior to the financial crisis, private debt in the US and the UK was growing at an unprecedented rate. In 2008, credit turned negative for the first time since the Great Depression, causing the recession.

Source: Open Democracy

Source: Open Democracy

As expected, credit is also tied to employment:

Source: Open Democracy

Familiar dynamics even took place in Japan’s ‘Lost Decade’. Banks were providing finance for technology and industry, as well as for speculation in assets and property in what was called a ‘Bubble Economy’. When the credit growth that fuelled this halted, Japan’s crisis was triggered. Another crisis could be cited, but that is not necessary thanks to Richard Vague who identified a regularity in every economic crisis over the last 150 years: A private debt to GDP ratio of 150%+, and a 17%+ increase in credit to GDP over the five years prior to a crisis. This profound connection confirms that credit is a major cause of booms and slumps in economies around the world. Even more significantly, it provides a baseline for which future financial crises can be predicted.

What to Look at

From Richard Vague’s research, it can be deduced that to successfully predict an upcoming recession, the level of private debt in an economy and its rate of increase must be inspected. A good rule of thumb would be to look at countries that have a private-debt to GDP ratio in the range of 120% – 150%, along with a 10% – 17% increase in credit to GDP over the last five years. If an economy’s values exceed both of these ranges, it is an imminent danger zone. One particularly influential country that is currently at risk is China. In response to the 2008 financial crises, its government instructed banks to lend heavily to property developers. However this came at a price; private debt has risen from 120% of GDP in 2008 to over 200% in 2017. With China accounting for 16% of global GDP, its crisis will have significant impacts on the global economy.

Source: Credit Suisse

It is all good knowing that a crisis will hit, but how could this be prevented? Given that a government has actually identified the issue, there are a few things they could do. An increase in government spending could be utilised to indirectly bring down the level of private debt. However, this may be insufficient. This can be seen in Japan where government spending to GDP had increased from 150% in 2008 to 220% in 2016, and yet, private debt to GDP has remained at around 165%. Another way to reduce private debt is through debt forgiveness.

However, this is unfair to savers and would surely face negative reactions. A more acceptable method would be an increase in the money supply which indirectly reduces the debt burden. But to sufficiently dilute the effect of private debt to an appropriate level, the amount of money that would need to be injected is huge. The best solution is a combination of the above two. There could be a direct injection of money into all bank accounts, however, it is mandatory that the first use of it is to pay off debt. With this, private debt is directly reduced in a practical manner.

The Solution

The solution proposed would merely reset the clock for another bubble. In order to prevent excessive private debt creation in first place, banks must stop financing asset speculation, and instead, lend more to businesses. This would be difficult to achieve as a bank’s business model discourages it from funding risky entrepreneurs. Furthermore, in this system, people are encouraged to undertake greater leverage (e.g. when competing to purchase a house).

Current forecasting is so poor primarily due to the delusional vision of the macroeconomy that is widely accepted. The consequence of credit-fuelled growth is clear, yet it is still at odds with mainstream economic thought. It is simple to identify countries that could fall victim to a crisis and there are measures that could be taken to escape this trap. Nonetheless, in order to truly prevent the possibility of crises of this nature, there is much to be done. Having political leaders and their economic advisers understand credit bubbles is the first step. Then, banking reforms and sensible policy can finally be discussed.

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Global Affairs

BP and Iraq Sign Development Deal for Kirkuk Oil Fields

 2 min read / 

BP Kirkuk deal

Iraqi Government and British energy giant BP have signed an agreement for the future development of the Kirkuk oil fields in Northern Iraq.

A statement on the Iraqi Oil Ministry’s website said the “memorandum of understanding” between the government and the London-based oil company would enable further development of the oil fields as well as “to open a new page of work” for the North Oil Company, a subsidiary of the Oil Ministry, on “solid foundations”.

BP Director, Michael Townsend, said the company would conduct the necessary surveys and prepare the required statistics.  He claims the company will increase production by 750,000 barrels of oil a day.

The Kirkuk Oil Field, discovered in 1927, is one of the largest oil fields in the world, producing half of Iraq’s oil exports, a reported million barrels a day. However, it has also been a wellspring for local instability: the fields had been seized in 2014 by the Kurdistan Regional Government, who piped oil across the Turkish border, a few hundred kilometres to the north. The fields were only retaken by government forces in October 2017.

Baghdad is attempting to reassert its authority throughout its provinces and according to Iraq’s Minister for Oil, Jahbar Ali al-Allaibi, Thursday’s announcement will “speed up the rehabilitation process”.

During the Saddam Hussein era, the fields suffered irrecoverable damage due to poor management. Excess production was reinjected back into the ground making Kirkuk’s oil thicker and therefore harder to extract.

On Wednesday al-Allaibi met with Britain’s ambassador, John Wilkes, where according to the ministry’s website, they talked about joint cooperation between the two countries in the oil and gas industry.

Keep reading |  2 min read

America

Trump’s Presidency and Russian Relationship: The Future

 4 min read / 

Trump Russia

Much has been said about Donald J. Trump’s love affair with Russia. Questions deserve a thorough and honest investigation. As distasteful and risky it may be, the best outcome of the enquiry is accusations continue to swirl, Trump limps through three more years, and in 2020, he is crushed at the ballot box. The world moves on. If removed from office, odds are Trump whips his base into a frenzy. Only the height and duration of civil unrest is in question. A worse case is that Trump emerges emboldened, eager to settle Putin’s longstanding challenge.

Putin Mocks Trump

The competition is real. Putin’s economic and political dominance gnaws Trump. Putin knows this. So, he taunts the President and dares Trump to employ the same ruthless tactics he exploited to consolidate power and possibly become the world’s richest man. Since Trump only sees green, he took the bait. The race is on to be the world’s first trillionaire.

Russia’s population is 142 million. Its $3.86trn translates into a measly $26,900 per capita GDP. In contrast, the 326 million people of the United States generate $18.62trn in GDP, nearly five times Russia’s total. The US per capita GDP of $57,600 more than doubles Russia’s. Despite Russia’s meek economy and reports  that Putin has embezzled up to $200bn in assets, Putin remains incredibly popular in Russia.

The apathy regarding this unparalleled heist makes Trump and Putin salivate over what they could jointly pilfer from the world economy. To advance their contest, the pair will identify a common threat. US-Russia relations will warm. Under the guise of “Peace through strength,” Russian sanctions will be lifted, and the Magnitsky Act repealed.

The administrative state in retreat, animal spirits will run wild. Trump’s name will be emblazoned across the globe. Countries desperate for jobs will be compelled to forge deals sponsored by Putin and Trump. Ethics be damned, the race to the bottom of the $120trn global economy will prompt a wave of corruption never seen before. Every facet of human decency will be compromised: environmental regulations, free and fair-trade by-laws, intellectual property, and human rights protections. The collusion is real.

In time, complicity will turn to double-crossing. It’s the Trump-Putin way. Makeshift “me-first” trade deals will collapse. Boycotts, divestitures and sanctions will be commonplace. Cooperation will evaporate. New political boundaries will be drawn with little world condemnation.

It doesn’t have to happen this way. Patience is a virtue. The checks and balances of the three branches of government are powerful mechanisms to thwart overt corruption.

Yet, for the impatient who seek Trump’s impeachment or removal via the 25th Amendment, be careful what you wish for. Only Trump can tame his army. To assume Trump will plead mercy at the feet of the administrative state contradicts Trump’s lifelong persona. He will relentlessly counterpunch and encourage his followers to do likewise. The short and long-term political and social risks are astronomical.

If Trump stems the tide, consolidates power and aggressively partakes in Putin’s race for two terms, the risks outstrip his forced removal. The consequences will be multi-generational.

Rope-a-Dope Is the Key to Containing Trump

The only path that possibly prevents extensive collateral damage is to check Trump into policy oblivion. Legislators must play rope-a-dope for as long as it takes, even three years if necessary. If Democrats take back both houses in 2018, the tactic will not set up Trump and his base for a final knock-out punch in 2020. For that to occur, numerous members of the GOP must join the effort. They too must throw periodic jabs at Trump then absorb a barrage Trump’s counterpunches.

With foes in every corner, even Trump – the self-proclaimed greatest counterpuncher in history—and his base will wear themselves out well before 2020. Then the decisive knockout punch can be delivered at the ballot box—without collateral damage.

Trump is severely wounded. If he gracefully and peacefully surrenders the Presidency, great. But don’t expect it. Rope-a-dope deployed by both parties is the countries best hope for a peaceful end to the Trump Presidency. Any other scenario risks the once unthinkable; an ‘American Spring’.

Keep reading |  4 min read

Europe

May Meets Macron

May Macron

The UK prime minister agreed to pay £44.5m towards tighter border security at Calais.

Editor’s Remarks: The French president arrived in the UK for the Anglo-French summit amid widespread complaints from the Tory party about just why Britain is paying another £44.5m for tighter security in France. One Tory MP pointed out that this addition brings the total figure the UK has paid to France in recent years up to £170m. France, meanwhile, says that the amount is necessary because the migrants in Calais are trying to get to the UK, who must, therefore, contribute towards their costs. The talks were also consumed by the imminent task of reaching consensus over the UK’s trade deal with the UK after Brexit goes through.

Read more on Europe:

Keep reading |  1 min read

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