10 Years after Lehman – Is an Economic Crisis on the Horizon? (Part 2)

In the last blog I showed what the basic pattern of serious economic crises looks like. In the past, such economic slumps were often triggered by a burst of speculative bubbles. In this post you get insights on the prerequisites of speculative bubbles.

An important prerequisite for a speculative bubble – high liquidity – is undoubtedly there. Worldwide, central banks have dramatically increased the global money supply. One indicator of this is the development of the balance sheet total of the central banks: between 2002 and 2016, the global balance sheet total of the central banks increased by a factor of 5.6, with the value of global GDP increasing only slightly more than twice in this period (see Figure 1).

Triggering an Economic Crisis: Speculative Bubbles

If the money supply grows faster than the quantity of goods and services, this should actually raise inflation. In fact, however, we see only slight increases in consumer prices in the major industrial nations. The money made available by the central banks did not flow into the commodity markets but into the markets for assets (shares, securities, real estate, etc.). That’s where speculative bubbles build up.

At the same time, debt is increasing worldwide: in 2001 (the year in which the dotcom bubble burst) the debts of private and public economic actors corresponded to around 184 percent of global GDP. In 2016, these debts rose to 217 percent of the world’s GDP (see Figure 2). This is not surprising either: With their money increase, central banks want private households and companies to get into debt. The purchases of goods financed by loans increase the demand for goods and services and thus stimulate the economy.

Is an economic crisis building up?

All in all, there are many indications that speculative and credit bubbles are building up worldwide.

• If a larger number of investors fear that prices will fall, this triggers the sale of assets.
• High sales cause an excess supply, which causes a decline in prices.
• This would bring about the associated speculative bubble to burst.  If the assets were used as collateral for loans, the credit bubble would also burst.
• Both developments would rapidly spread to the real economy with the described negative consequences for GDP and employment.

Governments and central banks should therefore take precautions to be prepared for a possible bursting of a speculative bubble.

Read the first part of our analysis on a potential economic crisis here.
If you enjoyed reading this post you might also like our post on the Greek Economy.

Recommended reading:

Samba Mbaye, Marialuz Moreno Badia, and Kyungla Chae: Global Debt Database: Methodology and Sources, IMF Working Paper (WP/18/111), Washington DC (https://www.imf.org/en/Publications/WP/Issues/2018/05/14/Global-Debt-Database-Methodology-and-Sources-45838).