More thoughts on which countries will be having the next financial crises

by on January 15, 2014 at 7:50 am in Economics | Permalink

Many loyal MR readers have been asking me, since my post from yesterday, whether all those countries listed are likely to have financial crises in the next few years.

I say that most of these countries are quite unlikely to have major financial crises anytime soon.  Let us return to the distinction between a recession and a financial crisis.  When the U.S. real estate bubble burst in the late 1980s, there was a downturn in output and employment but no financial crisis.  No capital markets froze up for instance and risk premia never deviated much from normal in the first place.  And if that late 1980s-like path is what someone is predicting for the Nordics, Canada, or Singapore, well maybe so.  I’m not predicting it myself but I certainly can see that within the realm of the plausible.  (In any case, here is the Singaporean defense of their own economic prospects.)

Why then was the American carnage of 2007-2009 so much worse?  Well, for at least two reasons.  First, after the relative prosperity and stability of most of the 1990s, so many people thought “the great moderation” had arrived, so investors were much more overextended that time around.

More importantly, the bursting of the real estate bubble overlapped with previously unrecognized, massive systemic risk in the shadow banking system.  All of a sudden people realized that U.S. financial institutions, far from being the world’s finest, were in some serious trouble.  Risk premia shot up and in some ways they have stayed stubbornly high.  Our whole theory of the financial system behind the world’s premier “riskless” asset required a radical and rapid revision.

There were other differences too, but those will suffice for now.

Now let us ask, do any comparable phenomena — in terms of very significant and deeply frightening systemic risk at the global level — exist when it comes to Singapore, Canada, and the Nordics?  I don’t see it, so I think if those economies have troubles they will be a relatively moderate set of recessions, a bit like America in the late 1980s.  You could make the “China is going to blow and take everyone else down with it” argument.  I still see a very good chance of that blow-up happening, but not as soon as 2014, and furthermore its fallout would take a while to travel too.  Note also that event probably would not devastate the Nordics, though it would hurt Singapore and Canada more.

You also could try the “the taper will kill us all and reveal the emerging economies to have been bigger bubbles than we thought” line of reasoning.  Maybe so, but again that won’t crush Singapore, Canada, or the Nordics.  Furthermore the taper already is expected, already has done some of its damage, and the emerging economies already have begun to adjust.  Or not.

I do see the global implications of the taper as a real issue.  I also see current account deficits for badly run indebted governments as a real issue.  I see political instability as a real issue, in part because it may prevent economies from adjusting to the taper and loss of liquidity as they ought to.  And when you put those pieces together, you come to the view that Turkey and Thailand and Indonesia are the most vulnerable potential victims for the financial crises to come.

I don’t in general believe that countries with bad institutions are always the best picks for pending financial crises, but I see the current constellation of forces — namely a lot of advance time to adjust and prepare, on the heels of a global great recession and a well-signaled taper– as pushing us toward that view right now.

Or so I think today.

dearieme January 15, 2014 at 8:15 am

“Our whole theory of the financial system behind the world’s premier “riskless” asset required a radical and rapid revision.” Allow me to translate that into British English: a large chunk of macroeconomics proved to be bollocks.

Mike January 15, 2014 at 9:30 am

Actually, that would be the Capital Asset Pricing Model that’s proved to be bollocks, not macro.

dearieme January 15, 2014 at 3:31 pm

I stand corrected. So the bollocksiness of macroeconomics is demonstrated by different evidence presumably?

Barclay January 15, 2014 at 9:12 am

Are you placing any bets?

Or perhaps it would be easier to bet on which countries are unlikely to have a financial crisis in the next year.

rayward January 15, 2014 at 9:26 am

Turkey has the highest level of income inequality of all the European Union countries; Thailand has the highest level of income inequality in the world; and Indonesia, whose gini index was relatively flat for almost 40 years, now has one of the highest rates of growth in the level of income inequality. I mention this since Cowen identifies these countries as being the most vulnerable to financial crisis. Of course, correlation doesn’t imply causation (assuming Cowen is correct in his prognosis), as economists like to remind us; and I am neither suggesting causation nor am I an economist.

Das January 15, 2014 at 9:58 am

Turkey is not a member of the European Union. Therefore another country must have the highest level of income inequality of all the European Union.

Bill January 15, 2014 at 9:31 am

Turkey, Thailand and Texas. Turkey and Thailand for reasons mentioned. Texas for decline in oil prices and mental instability

TMC January 15, 2014 at 9:42 am

Re:Texas

Mental stability, financially, seems to be pretty sound, as the only state to produce jobs throughout the recession. I would think the new natural gas wells would offset oil price issues.

I’d look for for California’s continued decline, and NY’s peak, then decline coming soon.

JWatts January 15, 2014 at 10:26 am

“I’d look for for California’s continued decline, and NY’s peak, then decline coming soon.”

I think if you look at the fundamentals, then Illinois is the state with the worst outlook. Particularly with regards to a high unfunded debt with little room to raise taxes.

JWatts January 15, 2014 at 10:24 am

“Texas for decline in oil prices and mental instability

That looks like an example of projection.

Bill January 15, 2014 at 1:49 pm

No, close observation of Cruz and Perry.

JWatts January 15, 2014 at 3:02 pm

Claiming that Senator Cruz and Governor Perry are mentally unstable is about as truthful as making the claim that President Obama is a Communist.

Do you think that people who go around claiming that Obama is a Communist are making a sophisticated observation or do you think they are basically ignorant ideologues?

Bill January 15, 2014 at 5:41 pm

Cmon, that was by no means insulting and meant to be humorous If it was insulting to you, I apologize.

Bill January 15, 2014 at 5:56 pm

JW, Let me explain the joke to you.

3 T’s. Tyler predicated Turkeys and Thailands problems on economic and political instability. Take the economic instability of declining oil prices (the economic instability portion) and search for another candidate word that goes with “instability” for the political instability portion.

JWatts January 15, 2014 at 6:15 pm

Hmm, well I didn’t read it as a joke, so maybe I’m being a tad too serious today. :)

KSZX January 15, 2014 at 11:02 am

I tend to agree, but I would add Taiwan, Tajikistan, Togo and Tuvalu to the list. Maybe also Tanzania and Tunisia due to political instability.

msgkings January 15, 2014 at 3:16 pm

Don’t forget Tennessee

Turkey Vulture January 15, 2014 at 9:32 am

The risks were supposedly previously unrecognized in the U.S., so might there similarly be unrecognized risks in many other countries – or risks that are willingly unrecognized?

This is all mental masturbation, of course, as economists have enough trouble agreeing on what is happening right now or what happened in the past. Their ability to prognosticate seems little better than that of the poor unwashed masses. Perhaps, like many people who know more than a little about a field, they tend to be overzealous in predicting crises. But predict enough things and eventually you’ll hit on a couple. Hit on more than a couple and you can make a lot of money from people paying a premium for your lucky past performance.

Farts Galore January 15, 2014 at 12:24 pm

I agree.

Greg Torr January 15, 2014 at 9:52 am

Tyler, I’m surprised you didnt mention South Africa as a crisis candidate. It seems to tick a lot of your boxes:
- high current account and budget deficits (the sum of these is highest in the world I believe, for countries of a certain minimum size)
- taper sensitivity (South African rand is very liquid & interest rates are on the high side, so often used as a carry trade currency; therefore vulnerable to quick unwind)
- possible political instability (you previously cited “Political Collapse in South Africa” as one of your top stories to watch for in 2013, and things have gotten worse, not better since, then)

Seems pretty bad. Is it plausible that these negatives are offset by:
- floating currency & very little foreign currency debt
- well run and well-capitalised banking systems
- strong private sector institutions, accounting standards, corporate governance?

JWatts January 15, 2014 at 10:29 am

“Is it plausible that these negatives are offset by….”

I would add a strong mining sector as another offset.

8 January 15, 2014 at 9:53 am

The systematic risk is the U.S. dollar and the global financial system which rests upon increasing debt. The debt crisis is fractal. It exists at the individual level, the firm level, the industry/sector level, the state level and at a global level. Everything was repriced in 2008 and everything will be repriced again when states go through the crisis.

Every single developed nation is on the verge of a financial crisis, as are nearly all emerging markets. Timing is a matter of social mood, economic cycles, luck, whatever you want to call it. Like a man smoking a cigarette while standing in a pool of gasoline, the world is awash in debt and the trigger will be whatever it will be. Maybe someone will push the man and he will drop his cigarette, then all will say the pusher is to blame. Not the guy standing in a pool of gasoline with a lit cigarette.

Chinese economic satellites are the most likely to experience a crisis. Brazil has already been hit by the slower demand growth from China. If China really weakens, even Australia and NZ will see their currencies torched, let alone Indonesia and others. Which exporter will be able to survive the currency repricing? The crisis may already be underway because China appears to have entered a permanent state of “liquidity crisis” aka solvency crisis. Since June, there has been a “cash crunch” at every quarter end and the banks are under pressure again due to the upcoming New Year which always sees heavy cash demand. Even if China “solves” the crisis through financial repression, that ultimately means slower growth for emerging markets. Cue Charlton Heston.

charlie January 15, 2014 at 10:37 am

I’m puzzled why people think the impact of a Chinese financial collapse will take a while to show up in the US.

Joe Smith January 15, 2014 at 6:52 pm

Because China runs a trade surplus with the United States

Yancey Ward January 15, 2014 at 11:16 am

When the U.S. real estate bubble burst in the late 1980s, there was a downturn in output and employment but no financial crisis

You sure about that? I remember a fairly significant one that appears to have vanished down the memory hole.

prior_approval January 15, 2014 at 12:25 pm

What’s a few S&Ls here and there, and who didn’t enjoy have a family member getting a couple of summer jobs through the RTC, anyways?

‘The Resolution Trust Corporation (RTC) was a U.S. government-owned asset management company run by Lewis William Seidman and charged with liquidating assets, primarily real estate-related assets such as mortgage loans, that had been assets of savings and loan associations (S&Ls) declared insolvent by the Office of Thrift Supervision (OTS) as a consequence of the savings and loan crisis of the 1980s. It also took over the insurance functions of the former Federal Home Loan Bank Board.

Between 1989 and mid-1995, the Resolution Trust Corporation closed or otherwise resolved 747 thrifts with total assets of $394 billion.[1] Its funding was provided by the Resolution Funding Corporation (REFCORP) which still exists to support the debt obligations it created for these functions.’ http://en.wikipedia.org/wiki/Resolution_Trust_Corporation

msgkings January 15, 2014 at 2:56 pm

Exactly, 2008 would have been a lot closer in scope to the S&L ‘crisis’ than the debacle it was with the mark-to-market rules from that era still in place. They were changed in 2007 from rules that had been in place for 70+ years and worked perfectly well.

meo fio January 15, 2014 at 12:37 pm

Singapore can crash because it is not a self-contained economy, it mainly dependents on influx of China and southeast asia money.

Eric Falkenstein January 15, 2014 at 1:05 pm

“most of these countries are quite unlikely to have major financial crises anytime soon”

Is there any state of the world that could falsify this statement in principle? If no, why say it?

msgkings January 15, 2014 at 2:55 pm

A third factor why 2008 was so much worse than the late 80s was the reimposition of draconian mark to market rules in 2007 where banks had to value their loans in current markets, many of which had ceased to function, so perfectly good loans looked worthless and so did perfectly good banks. They scrapped the rule early March 2009…check what happened then.

carolospln January 15, 2014 at 3:30 pm

“Why then was the American carnage of 2007-2009 so much worse? Well, for at least two reasons. First, after the relative prosperity and stability of most of the 1990s, so many people thought “the great moderation” had arrived, so investors were much more overextended that time around.
More importantly, the bursting of the real estate bubble overlapped with previously unrecognized, massive systemic risk in the shadow banking system. All of a sudden people realized that U.S. financial institutions, far from being the world’s finest, were in some serious trouble. Risk premia shot up and in some ways they have stayed stubbornly high. Our whole theory of the financial system behind the world’s premier “riskless” asset required a radical and rapid revision.” (snip)

BS.

‘Subprime’ was a US$1.4T problem. Yet the losses from the GFC in the USA were $14T. Why?

Leverage.

Floccina January 15, 2014 at 4:25 pm

Would competitive currency/money save us from these financial crisies?

Anthony Alfidi January 15, 2014 at 4:45 pm

Credit default swaps on sovereign debt are the first indicator of trouble when they start blowing out. Notice the Baltic Dry Index’s recent decline, and how it will hurt shipping revenue. Hmm, which nations have economies dependent on shipping? Greece, anyone? LOL, I love this game.

ChrisA January 15, 2014 at 7:00 pm

The whole of South East Asia and Australia economies are a big bet on China growth continuing. So if we see China for some reason start to stall, there will be huge over capacity in commodities in ANZ leading to massive deflation there, Indonesia is also in the same boat (if they don’t kill themselves earlier by their silly nationalism, such as the recent ban on raw ore exports). Fortunately I doubt very much that China will falter for at least the next ten years, the leadership there is terrified of the instability that would result and they will do literally anything to keep growth going and currently they have the ammunition to do so. For nothing else but expectation reasons this suggests the growth will continue. But there is a bit of a peso problem there in South East Asia as a result.

Joe Smith January 15, 2014 at 7:02 pm

“Now let us ask, do any comparable phenomena — in terms of very significant and deeply frightening systemic risk at the global level — exist”

They do, but not in the countries you identify as dangerous. The global derivatives markets is at about $700 Trillion – say ten times the size of the world economy. We know that many, and possibly most, players in that market do not understand it. Jamie Dimon has admitted that JP Morgan, which would be at the high end of sophistication, did not understand the comparatively small derivative positions involved in the “London Whale” Derivatives created by Goldman Sachs may have masked and ultimately exacerbated Greece’s debt problems. . We know that the auditing profession is incapable of identifying off balance sheet risk.

A meltdown in the derivatives market has the potential to take out major banks in the United States and Europe. That would be the systemic risk I would worry about. A credit crisis in Turkey would be trivial event by comparison.

BC January 15, 2014 at 10:53 pm

To predict which country will be next to have a full blown crisis, as opposed to a moderate recession, wouldn’t we need to consider which central bank is most likely to keep money too tight, i.e., to let NGDP expectations collapse? I thought that was the lesson of both the Great Depression and the Great Recession.

Bill January 15, 2014 at 11:51 pm

I worry more about Saudi Arabia, not because Turkey or Thailand are more probable, but because a problem with Saudi Arabia has more consequences. Germany and England worry about nationals fighting in Syria, returning home after being trained, but that is nothing compared to those who will be returning from Syria to Saudi Arabia. Not now, but in just a few years. Ad to that a decline in oil prices and political stability paid for by a welfare state that may not be able to give as much welfare to appease the citizens….

Turkey has an entrepreneurial middle class, which prospers only with political stability. Their fortunes are grounded in stability. But, ask how the fortunes of Saudi Arabia which are concentrated in a hereditary class of privilege will react to succession problems or internal conflict, and whether those governed by the hereditary and privileged class, if a conflict were to break out, would have more to gain and less lose. Probably not much to lose. And, the leadership that would likely emerge would be religious.

John Galt III January 17, 2014 at 12:37 pm

Venezuela and Argentina are messes – total messes – they both have already blown up and they are ongoing collapses – just check their currencies. Both countries are run by people like Obama – economically brain dead.

The BIG KAHUNA is Japan. Read Kyle Bass on Japan. He is early but Japan’s economic policies are extremely dangerous.

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