On the other hand, today’s global megabanks are much larger than their 2008 versions were, and they are more interconnected. Most Americans – the 80% I’ve called the Unprotected – are still licking their wounds from the last battle. Many are in worse shape now than in 2008. Our crisis-fighting reserves are low.
European banks are still highly leveraged. The shadow banking system in China has grown to scary proportions.
Globalization has proceeded apace since 2008, and the world is even more interconnected now. Problems in faraway markets can quickly become problems close to home. And that’s without a global trade war.
I am concerned that another major crisis will ensue by the end of 2018 – though it is possible that a salutary combination of events, aided by complacency, could let us muddle through for another few years. But there is another recession in our future (there is always another recession), and it’s going to be at least as bad as the last one was, in terms of the global pain it causes. The recovery is going to take much longer than the current one has, because our massive debt build-up is a huge drag on growth. I hope I’m wrong. But I would rather write these words now and risk eating them in my 2020 year-end letter than leave you unwarned and unprepared.
Because I’m traveling this week, this letter will be just a few appetizers –black swan hot wings, black swan meatballs in orange sauce, teriyaki swan skewers, and the like – to whet your appetite and help you anticipate what’s coming.
Seriously speaking, could the three scenarios we discuss below turn out be fateful black swans? Yes. But remember this: A harmless white swan can look black in the right lighting conditions. Sometimes that’s all it takes to start a panic.
Black Swan #1: Yellen Overshoots
It is increasingly evident, at least to me, that the US economy is not taking off like the rocket some predicted after the election. President Trump and the Republicans haven’t been able to pass any of the fiscal stimulus measures we hoped to see. Banks and energy companies are getting some regulatory relief, and that helps; but it’s a far cry from the sweeping healthcare reform, tax cuts, and infrastructure spending we were promised. Though serious, major tax reform could postpone a US recession to well beyond 2020, what we are going to get instead is tinkering around the edges.
On the bright side, unemployment has fallen further, and discouraged workers are re-entering the labor force. But consumer spending is still weak, so people may be less confident than the sentiment surveys suggest. Inflation has perked up in certain segments like healthcare and housing, but otherwise it’s still low to nonexistent.
Is this, by any stretch of the imagination, the kind of economy in which the Federal Reserve should be tightening monetary policy? No – yet the Fed is doing so, partly because they waited too long to end QE and to begin reducing their balance sheet. FOMC members know they are behind the curve, and they want to pay lip service to doing something before their terms end. Moreover, Janet Yellen, Stanley Fischer, and the other FOMC members are religiously devoted to the Phillips curve. That theory says unemployment this low will create wage-inflation pressure. That no one can see this pressure mounting seems not to matter: It exists in theory and therefore must be countered.
The attitude among central bankers, who are basically all Keynesians, is that messy reality should not impinge on elegant theory. You just have to glance at the math to recognize the brilliance of the Phillips curve!