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Warning: The Next Crash is Taking Shape

 By Shlomo Maital

     In the children’s fable, a boy cried “Wolf! Wolf!” in jest – until, when there really was a wolf, nobody came to help. Economists seem to be like that boy. We are always crying “wolf!”.   Problem is, sometimes, not always, the wolf does come.

     Writing in the New York Times, Ruchir Sharma, chief global strategist of Morgan Stanley Investment Management (a Wall Street insider for sure) sounds a thousand warning bells. When an insider cries Wolf!, we should listen.

       Here is why.

      “Central banks adopted zero to negative interest rates and provided huge amounts of cash” after the 2008 crisis. Result: “global financial assets are worth over $250 trillion, up from $12 trillion in 1980, or more than 3 times global GDP.” …”The ocean of money in financial markets is so large, it’s possible that ripples on its surface could trigger the next big downturn.”

       Suppose, just suppose, as North Korea and the US square off, global financial markets fall by 10%. That implies paper losses of $25 trillion, or half again as large as the United States’ annual GDP. That could trigger widespread panic.

         Why have asset prices risen so dramatically? Because when you get to borrow free money, you are tempted to do something, anything, with it —   even when returns are low. At long last, central banks are beginning to worry about what they’ve done – create a new bubble. As Sharma notes, “asset prices from stocks to real estate have never been this expensive simultaneously.” Clue that it’s a bubble? Of course.

         Since WWII, there have been 88 recessions – and 62 of them followed a stock or housing bubble or both. So a financial crash will inevitably bring an economic crisis.

       Does anyone else agree that the wolf is on the way?   Philip Inman, The Guardian, does. He notes that the US Federal Reserve is now starting to sell its $4 trillion in bonds, bought in order to pump money into the system. In other words – soak up some of the mountain of money it created. This will require the US Treasury to raise more in tax, Inman notes. Why? If the Treasury can’t sell bonds, it has to raise taxes.  But baby boomers everywhere, those who have grown wealthy, simply refuse to pay the taxes needed to keep their governments afloat. And the Trump administration is hell-bent on lowering taxes, not raising them.   The baby boomers are “offloading the problem to younger lower-income groups, who now must borrow excessively just to make ends meet”.  

     It’s a recipe for big trouble, which now includes a war between the generations – when once, we old fellows used to try to make things better for the younger kids, and now we seem to be working hard to make them worse. And I haven’t even mentioned climate change.  

     “There is growing evidence of a slide into outright deflation even ahead of the next recession…”, notes a financial analyst, Albert Edwards. He thinks the US will soon slide into recession. And Trump is about to appoint five new Fed governors, all of whom want less regulation and less government.  

       I know a fairly wealthy investor, highly savvy, who is pulling his investments out of the US and putting them into Europe, of all places. Problem is, in a global crisis, there is no safe haven.

       These are dangerous times.   Everyone should set aside a bit extra for rainy days, and prepare at least mentally for a new global crisis.

 

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Euro Nations: Benchmark Estonia

By Shlomo Maital     

 Estonia

  With all eyes focused on Greece,  it is easy to forget about little Estonia.  Bloomberg Business Week reports that this tiny nation, squeezed between Latvia and Russia, joined the Euro zone only four years ago.  Many countries leaped at the Euro capital markets opportunity and their governments sold bonds like drunken sailors. 

    Not Estonia.  Government debt is less than 10 per cent of GDP.  That is one – tenth the average debt burden in Europe, and about 1/20th the debt burden of Greece (170 per cent of GDP).

    How come?

    Estonia has refrained from issuing government bonds, since 2002.  Instead, the Estonian government took loans from the European Development Bank, which lends ONLY for infrastructure and investment, not to finance current government spending.  Maris Lauri says, “we can’t afford to borrow to finance current spending; such borrowing becomes a habit and we saw where that landed Greece and Russia, in 1997/8”. 

      Some Estonian economists are opposed. They think Estonia should leap at the low interest rates and borrow.  But it won’t happen. 

       “Estonia is a strange bird in the Euro zone,” says Frederick Erickson, who heads the European Institute for Political Economy in Brussels. “No other country has such a stronge instinct for understanding the way macroeconomic problems are rooted in the real economy.” 

       Estonia’s Prime Minister says Estonia has to save its borrowing and access to Euro capital markets, for the time when Estonia’s GDP reaches 75 % of the Euro average (it is now 73%), at which time European aid money dries up. 

        Strong wise leadership can keep a small country like Estonia out of hot water.  Greece, in deep hot water, has to be rescued.  Estonia will not.  As the Hebrew saying goes, wise leaders avoid crises that smart leaders know how to escape from. 

Explaining (again) the Euro/Greece Crisis to Grade 5

By Shlomo Maital

Grade 5

  Hello Grade 5’ers!  Thanks for inviting me.  I know my subject, money and economics, is BOOOOOring.   But believe me, it is important for you to know what is going on, because when you are just a few years older, what happens in Europe will affect you. Because Europe is the world’s biggest, or next-to-biggest, economy, depending on how you add the numbers. 

   So here’s the deal.  Europe has had lots and lots of terrible wars, with France, Germany England and others fighting each other. Someone (in France) had a great idea.  What if we stopped fighting and made money together, by buying each other’s stuff?  If you buy my stuff, I’m not likely to want to fight you.   So they called it the European Single Market.  And it worked beautifully.  No-one thinks Europe will have a big fight any time soon (though, Russia may be an exception – that’s another scary story).

     If you sell and buy, you use money.  But there are 28 countries that belong to this European club.  What a mess if you have to start finding escudos, guilders, lira, pounds, francs, and all kinds of weird money.   So 19 of the countries decided they would use the same new currency, which they called the “euro”.  Kind of like America, where the 50 states all use the same money, the dollar.  Some 332 million Europeans use the euro. 

     But there is a problem.  If you have the same money, you have to have the same rules for making the money.  That means, you have to get all those 19 countries to agree on the “rules of the game”.  You can’t play baseball or football if neither team agrees what the rules are, right?  And here is where things broke down.  

  Some countries want there to be lots and lots and lots of euros.  Some countries want just a little bit of money.   Some countries (like, a little country called Greece, only 11 million people) broke the rules, spent too much money, and got into trouble, just like we do when we spend too much.   Because they had to borrow and now they have trouble paying back what they owe.  Other countries, like Germany, who had lots of money, helped Greece but sent Greece kind of to the penalty box. No more spending.   Less treats, less goodies.  And Greece didn’t like it.  I wouldn’t either. 

      So Greece has had elections and its new leaders are making a big fuss about the punishments other countries have given it.   Some think Greece might even leave the ‘club’ (the euro).  That might be terrible, because then some other countries might do the same, and the whole club would collapse.  So, the 27 countries want Greece to stay in the club but they do not agree how to make that happen.  It’s like, do you punish the Greek people for overspending (they didn’t do it, their leaders did)?  Do you forgive them, and then others might do the same?   Why should other countries give money to Greece? But if they don’t, they will lose too, because the whole Euro club might come apart.

    And you know, Grade 5’ers,  I guess you could see this coming.  If you start a game, and you have not all agreed clearly on the rules, including for things that are really strange (like, what if two guys are on second base – who’s out?  What if one player’s mother comes on the ice and drags him (the goalie) off to Hebrew School?  (yup, happened to me) – you’re going to get into trouble.  Those Europeans, they started a club without a clear set of rules, and worse, without any way of leaving it without causing REAL trouble. 

    I’m pretty sure they will muddle through and keep that weird euro club going.  They all have too much to lose. But boy, kids, I think you Grade 5’ers could have done a far better job.  Those Europeans, they couldn’t see their fingers even if they were right in front of their nose.   So, when you go to play a game, or start a club, make sure everyone knows the rules.  Kids usually do. It’s the grownups who are dumb about that sometime. 

Blog entries written by Prof. Shlomo Maital

Shlomo Maital
June 2019
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