Looking Ahead: Another Financial Crisis?

AMA12-8-14As the US economy regains its feet after the massive financial collapse of 2008, economists are turning their gaze to the future: what will trigger the next major economic crisis – not just for the US, but also for the global economy as a whole? And a bigger question: can it be prevented?

To answer these questions, financial and economic experts are looking at repeating patterns in lending, borrowing and global banking. As a recent article from Business Insider points out, while those patterns suggest that circumstances are very different today than in i2008, that doesn’t necessarily mean that a crisis of a different kind won’t happen.

As Business Insider reports, economists from the Bank for International Settlements have identified key global trends that are likely to affect the world economy, for better or worse, in the coming years. Leading the list: a shift from bank lending to bond markets, and the growing effect of the stability of the dollar on the behavior of world markets.

The Bank for International Settlements has been called the “central bank of central banks.” Based in Basel, Switzerland, it acts as the center for central banks around the world. Its job is to ensure stability in the world’s banking systems, and it does this by managing a variety of transactions including distributing war reparations, making loans to struggling countries and managing gold and foreign currency exchanges.

The financial crash of 2008, which was caused largely by speculative lending without enough underlying capital, is still fresh in the memory of these regulators. And while lessons were learned from that catastrophe, other risks are emerging in today’s volatile marketplace.

One major change has to do with a gradual shift in credit growth from bank lending to capital markets. That wasn’t true in 2008 or the years leading up to it, when US banks both large and small extended credit to borrowers of all income levels, regardless of creditworthiness. As a result of that unbridled lending, millions of loans went bad, largely in the housing sector, leaving banks facing major losses.

Now, on the other hand, the corporate bond market is booming even as traditional bank lending retreats. In this new lending landscape, asset managers may hold the key to financial stability. Those assets include pension funds and other kinds of investments in bonds and other securities, so a credit crisis in that arena could spell trouble for small investors and retirees hoping for money to fund their golden years.

But more significant and far reaching is the role of the dollar in the overall stability of world currencies. Dollar denominated debt has vastly increased over the last few decades, and that means that fluctuations in global exchange rates could send ripples through markets around the world.

Dollar denominated debt is any debt measured in dollars. Even as values fluctuate in global trading, the dollar still reigns as the medium of international exchange thanks to its stability and high profile. That means that many countries, especially those with unstable monies, have to take out loans in foreign currencies.

Borrowing in foreign currencies has its own risks, if there aren’t sufficient reserves to back up the debt in case of a default. If a government can’t trade its own currency for the foreign currency it needs, it can face a collapse. So keeping a reserve of a stable foreign currency such as the dollar is a way to keep from falling into a severe debt default and domestic financial crisis.

When local currencies appreciate, countries are in a stronger position. When they fail, those countries are at risk for financial collapse, which sends ripples throughout the global markets. But when the dollar appreciates, institutions lending exclusively in local currencies feel a pinch and financial structures topple. That scenario played out in Latin America and Asia over the past few decades.

In the end, the perennial stability of the dollar is a key ingredient of world financial balance. That means that factors that affect the stability of the dollar market could play a major role in the global financial balance – and disruptions in that market could pitch not just the US but also the world economy into chaos.

For now, those considerations are merely speculation, based on observed trends. But economists warn that in a tightly connected world, events in one place can have an impact on events half a world or more away. And another financial collapse could come from completely unexpected events. But examining past and present trends makes it possible to speculate on the impact of the dollar on the world markets – and on pocketbooks at home. (Top image:Flickr/SqueakyMarmot)


“Bank for International Settlements.” Investing Anwers. investinganswers.com. 8 Dec 2014

“Dollar Denominaed.” Muddy Water Macro. muddywatermacro.wustl..edu. 8 Dec 2014
Ferro, Shane. “This is What the Next Financial Crisis Might Look Like.” Business Insider. Businessinsider.com 5 Dec 2014

Read more from The American Monetary Association:

AMA 100: Manage Your Expectations with Christine Hassler

Shady Trading Bilk Small Investors

The Amerucab Monetary Association



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