Fifteen years ago this week, French bank BNP Paribas announced it was closing three of its hedge funds heavily exposed to the U.S. subprime mortgage market.
Little attention was paid to the news on the day, but it quickly became clear that not only BNP Paribas but almost every major financial institution was neck-deep in underperforming US home loan securities. In early August 2007, BNP was simply the pebble that marked the oncoming avalanche.
Another August, another crisis. Memories of 2007 were rekindled by Andrew Bailey last week when the Governor of the Bank of England announced that interest rates were being raised just as the UK economy is expected to hit the wall.
Pandemic-induced collapse of activity aside, the last “proper” global recession was the global financial crisis of 2007-09, a period in which only massive government bailouts prevented the system from collapsing banking collapsed.
The Bank of England believes the recession it expects will last as long (five quarters) as the 2008-09 recession, but will be less severe. Output, as measured by gross domestic product, is expected to fall by just over 2% compared with the nearly 6% decline in the late 2000s.
The other good news is that, as far as you can tell, the global banking system is better placed to withstand losses than it was 15 years ago. The regulations are tighter, the capital cushions bigger. That said, banks were also thought to be in good shape in mid-2007.
However, there are other ways in which the two crises differ that should be cause for concern.
For starters, the previous crisis followed a prolonged 15-year upswing in the global economy. Growth was strong and living standards rose steadily. Cheap imported goods from China and other emerging market economies kept inflation low.
Since then, growth has been anemic, living standards have flattened and inflation is nearing its highest level in four decades. Warning signs of trouble ahead have been flashing for some time.
In terms of the ability to deal with a crisis, finance ministries and central banks were much better placed in 2007. Public debt levels were low, official interest rates hovered around 4- 5%, quantitative easing was a thing of the future. Governments felt they had room to spend more and tax less, while central banks had room to cut borrowing costs aggressively and embark on massive bond-buying QE programs.
Today the US Federal Reserve, the European Central Bank and the Bank of England are raising interest rates even though the US economy has contracted over the past two quarters and both the economy of the area euro like the UK are headed for recession. If it weren’t for high inflation rates, all three central banks would cut rates without raising them. The central bank’s goal is to act countercyclically: raise rates during a boom and cut them in a bust. Far from mitigating recessionary pressures, the Fed, the ECB and the Bank of England are adding to it.
With central banks determined to reassert their anti-inflation credentials, finance ministries face a choice: stick to their deficit-reduction plans or try to ease the pain of the recession by spending more or taxing less. If they make sense, they will prefer the latter option.
A second notable difference between 2009 and today is the breakdown of international cooperation. When Gordon Brown hosted a summit of G20 leaders in London in April of that year, it seemed that a new era was beginning in which developed economies – such as the US, Germany and Japan – and major emerging countries, such as the China, Brazil and India. and Russia: they will act together to reactivate the global economy.
G20 unity frayed as the world economy stabilised, but is now gone altogether. Russia’s invasion of Ukraine has prompted economic sanctions from the West, and the Kremlin has responded in kind by cutting off gas supplies and raising energy costs. Vladimir Putin will have seen the Bank of England’s decision to raise interest rates despite the UK’s looming recession as a small victory in the economic war.
If Ukraine is an example of deglobalization in the world, Taiwan is another. Already poor relations between Washington and Beijing have further deteriorated following US House Speaker Nancy Pelosi’s visit to Taiwan and the economic, military and diplomatic measures China has announced in response.
In 2009, China was seen more as an economic partner than a geopolitical threat. It was admitted to the World Trade Organization in 2001 and G7 central bankers, such as then Bank of England Governor Mervyn King, said there would be no real solution to major global problems without Beijing at the table.
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The mood is different now. The supply chain chaos caused by Covid-19 created demands for greater self-sufficiency; China’s threat to Taiwan, the world’s largest semiconductor producer, will accelerate this trend. No country will want to run the risk of being cut off from the supply of components that are vital to so many products.
Deglobalization may not be bad for the planet if it means shorter, lower-carbon supply chains. But not if that means breaking global agreements to reduce carbon emissions. Worryingly, one area where China says it will stop cooperating with the US as a result of Pelosi’s visit is climate change.
The 2007-09 crisis briefly brought the countries together. The crisis of 2020-22 has sown division and exposed some painful truths. The real recovery of 2009 never happened and the world has no rudder at a time when it’s hotter, poorer and angrier.