In late 2008, at a meeting with academics at the London School of Economics, Queen Elizabeth II asked why no one seemed to have anticipated the world’s worst financial crisis in the postwar period. The so-called Great Economic Recession, which had begun in late 2008 and would run until mid-2009, was set off by the sudden collapse of sky-high prices for housing and other assets—something that is obvious in retrospect but that, nevertheless, no one seemed to see coming.
It would seem all too likely that now we are about to make the same mistake by being too sanguine about today’s asset and credit market bubbles.
Certainly, the U.S. and global economies have snapped back well from the depths of the coronavirus economic recession. It is also beyond doubt that effective vaccines have been developed and are now being distributed. However, as the Bank for International Settlements keeps warning us, global asset and credit market prices have once again risen well above their underlying value—in other words, they are in bubble territory. In addition, as our health experts keep warning us, we still have to get through a dark coronavirus winter before a sufficient part of the population has been vaccinated to allow a return to economic normality.
Considering the virtual silence among economists about the danger today’s bubbles pose and about the risk of another leg down in the global economy, one has to wonder whether in a year or two, when the bubbles eventually do burst, the queen will not be asking the same sort of question.
This silence is all the more surprising considering how much more pervasive bubbles are now and how much more indebted the world economy is today than it was twelve years ago. While in 2008, the bubbles were largely confined to the American housing and credit markets, they are now to be found in almost every corner of the world economy. Indeed, U.S. stock market valuations today are reminiscent of those preceding the 1929 market crash while countries with major solvency problems like Italy, Spain, and Portugal all find themselves able to borrow at zero interest rates.
Equally troubling has been the tremendous debt build-up around the world. Even before the pandemic struck, many years of cheap money had caused global debt levels to rise above their pre-September 2008 Lehman bankruptcy levels. After the pandemic, global debt levels have skyrocketed ever higher as budget deficits have ballooned and as corporations have been forced to go on a borrowing binge.
A particular area of concern has to be the emerging market economies, which now account for around half of the world economy and which have been hit by a perfect economic storm of pandemic related disruptions, low international commodity prices, and weak external demand for their exports. This has left those economies with record high debt levels and unusually high budget deficits. This is now prompting the World Bank to predict that it is only a matter of time before we see a wave of emerging market debt defaults and restructurings that could have important implications for the global financial system.
The very highly indebted and systemically important Southern European countries like Italy and Spain also have to be a source of concern. Those economies now have higher debt levels and very much higher budget deficits than they did at the time of the 2010 European sovereign debt crisis. As before, stuck within a Euro straitjacket, they will have the greatest of difficulties in reducing their budget deficits and restoring any semblance of public debt sustainability. This would seem to be setting us up for another European sovereign debt crisis.
Closer to home, New York University bankruptcy expert Ed Altman is warning of a looming spike in U.S. small and medium-sized bankruptcies in the wake of the pandemic. Meanwhile, Janet Yellen has long been warning of over-indebtedness in the highly leveraged debt market.
After the 2008 U.S. housing and credit market crisis, Chuck Prince, the former Citibank CEO, explained his bank’s speculative activity during the bubble by noting that when the music is playing you have to dance. Today, with the world’s major central banks continuing to supply the markets with ample liquidity, there can be little doubt that the music is blaring and the markets are dancing.
The question that nobody seems to be asking is what happens when the music stops playing? This is likely to leave a lot of explaining to Queen Elizabeth when the music does stop and nobody will have warned her of the crash that will almost surely follow the party’s end.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.