A decade on, the response to the 2007-8 crisis has created another bubble, and thus the conditions for another crashby Helen Thompson / July 14, 2017 / Leave a comment
Read more: The secret history of the banking crisis
Financial crises are an inexorable part of civilisational history and, since the Dutch “tulip mania” in the 17th century (yes, it really was about flowers), they have often been triggered by asset bubbles bursting. People (or firms) borrow to purchase the thing that’s surging in price, and there comes a certain point they can’t afford to service that debt. In the run-up to 2008, several debt-financed bubbles were in play—not tulips this time, but mortgage-backed securities and government bonds from southern European states. Eventually, as Adam Tooze explains, a vicious cycle set in—prices collapsed, and the credit markets which had financed the stampede of investments suddenly closed.
A decade on, the response to the 2007-8 crisis has created another bubble, and thus the conditions for another crash. In November 2008, the Federal Reserve began with Quantitative Easing (QE)—making up money, and pouring it into the system by purchasing assets. Now, thanks to QE, the Fed, the Bank of Japan, and the European Central Bank (ECB) collectively hold more than $13 trillion worth of assets, many of which are government bonds. This has created an unprecedented monetary order. You’d normally expect high levels of debt to make borrowing more expensive. But world debt has grown to more than 325 per cent of world GDP, while interest rates remain on the floor. Earlier this year even Argentina, a state that defaulted as recently as 2014, was able to sell 100-year bonds with a yield of only 8 per cent.
The logical corollary of extremely cheap money is extremely high bond prices. QE ensures a voracious demand for government bonds, and so drove prices up—so long as the authorities were buying on a mass scale, investors knew that if they piled into bonds, they’d be able to sell them on at rising prices. Thanks to all the easy money from QE, this could be done on virtually free credit. Now, however, the central banks want to draw back. They fear that if their extremely loose policies are not ended before the next recession hits, then even more extraordinary medicine could be required, with who knows what side-effects. The Fed terminated its QE purchases in 2014 and has since raised interest…