Financial and Monetary Systems

Are we at risk of a financial crisis? Our new report takes a look

Debt is a concern – but the slide towards recession is a concern, too. We need to create a more sustainable growth environment. Image: Pepi Stojanovski/Unsplash

Guy Miller
Chief Market Strategist and Head of Macroeconomics, Zurich Insurance Group
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Financial and Monetary Systems

Economic risks remain high, with the risk of a fiscal crisis taking top spot among executives, finds the latest Regional Risks for Doing Business Report from the World Economic Forum in partnership with Zurich Insurance Group.

Certainly, the level of global indebtedness should be a concern to us all, with corporate, household and government debt at extreme levels despite economic growth over the past few years.

But high levels of government debt begs the question of whether fiscal support – government spending – will be deployed as it was in the past to help avoid or at least mitigate the next recession.

At a time when government indebtedness is so high and confidence in governments so low – note the continued rise in populism – investors are falling over themselves to lend money to governments. More remarkable still, they are prepared to be charged negative interest rates for the privilege. Around 30% of all fixed-income investments, or ~$16 trillion of government bonds and credit, now have negative yields – including a few companies in the high-yield indices, a misnomer if ever there was one.

One reason for this: with global growth again weakening, interest rates set by central banks have dropped even lower. This year has seen more than half of global central banks cut rates. However, balance sheet recessions are strange beasts, and as we have seen over the past 10 years, monetary policy is less and less effective in stimulating growth.

In such an uncertain world, with a trade war between the two economic goliaths affecting everyone, financial engineering is the name of the game. Rather than growing the economic pie and improving trend growth through investment and greater productivity, companies are encouraged to use cheap debt to buy back and retire their costly equity capital, leading to asset price reflation rather than stimulating economic growth.

Indeed, while business investment has increased by around 50% in the United States over the last decade, stock repurchases and dividend increases are up 300%. Of course, this makes economic sense in the short term. An immediate financial gain today is worth more than the hopes of achieving one through investment in the future. Something has to change.

To reduce the risk of fiscal crisis, we need to think about government spending differently. Spending for investment should not be considered the same as spending on consumption. But governments need to take advantage of cheap borrowing to “invest” and should not be prohibited from doing so due to the application of rigid rules.

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Yes, debt levels are a very real concern, but so, too, is a slide towards recession. Governments need to work alongside central banks to create a more robust and sustainable growth environment – something that has failed to be achieved over the past decade. Rather than incentivising asset price reflation through monetary policy alone, incentives and fiscal initiatives need to encourage real engineering of the global economy rather than the financial engineering of recent times.

Developed economies need to push forward and become “developing” economies to increase their growth potential and developed companies need to become “developing” companies to improve productivity and profitability over the longer term. This will require tax incentives to effect the change, and government investment to create a multiplier effect on growth to embrace – rather than crowd out – the private sector.

If this doesn’t happen soon, we may see a fiscal crisis – potentially hastening and deepening the next global recession.

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