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

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.


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