By IMD Professor Arturo Bris
We are now in a post-crisis period. Yet, looking back to between
1945 and 2008, we see that the frequency of financial crises and
recessions is quite high: on average, there is one crisis every 58
months (using data from the US National Bureau of Economic
Research). In other words, statistically speaking we should expect
the beginning of the next crisis in April 2015, which would end by
March 2016. So are we in a post- or a pre-crisis period?
I do not want to be the bearer of ill tidings, but I think we
should always wonder what the cause of the next crisis will be.
There is no single episode of financial panic in the last 50 years
that could not have been prevented. This time, let us look ahead,
not react after the crisis.
The world economy is now more interconnected than ever.
Financial markets are heavily regulated while capital markets are
expanding in Asia, Africa and Latin America. The banking sector is
going through a concentration process with fewer and fewer players
left. Mexico, Indonesia, Nigeria and Turkey (the MINT countries)
are coming into focus after Brazil, Russia, India, China and South
Africa (the BRICS) have disappointed. Europe seems to be back in
the game, with Germany leading the recovery of the continent. The
US is still the world's most competitive economy,
according to the IMD World Competitiveness
. The process of deleveraging the balance sheets of governments and
companies is under way. Interest rates and government bond yields
are at historical lows and stock markets have recovered to
So what is there to worry about? There are eight possible
scenarios that could cause the next crisis, none more important or
likely than the others. For some, prevention is straightforward.
For others, I am not sure there is much we can do. Some of them
represent imminent threats. A few are more long-term, less dramatic
sources of instability.
Stock market bubble
Between June 2013 and June 2014, world stock markets returned 18
per cent on average. Of course, performance was uneven, not unlike
a "normal" year: the market return was 30 per cent in India, and a
meager 8 per cent in China. However, most companies that announced
results during 2014 disappointed markets, and for most large
corporations, stock markets have reacted negatively to annual
earnings. The reason is that, driven by excess liquidity and a lack
of alternative opportunities, a lot of money has flown in to equity
markets. The Yale University economist and Nobel Prize winner
Robert Shiller has shown that the gap between stock prices and
corporate earnings is now larger than it was in the previous
pre-crisis periods: 2000 and 2007. If markets were to return to
their normal earning levels, the average stock market in the world
should fall by about 30 per cent.
Chinese banking system
Shadow banking (lending by anything other than a bank or outside
the control of financial regulators) now represents more than 100
per cent of GDP in the US, and about 70 per cent in China. This is
more of a problem in China than in the US, for two reasons. First,
in China the banking sector is protected from foreign competition -
only local banks are allowed to operate independently in the
country. As a result, without any threat in a huge market, the
biggest banks in the world are now Chinese. They are truly too big
The second reason is that a big part of Chinese shadow lending
goes to central government and provincial governments. Banking
regulation in China is considered to be very stringent, but we know
what happens when regulators become self-interested. Without a
doubt, the next banking crisis will be triggered by a Chinese
An energy crisis now would not be caused by the scarcity of
energy sources - quite the opposite. The development of fracking
techniques and growing supply of gas in the US have turned shale
gas into a potent geopolitical weapon. If the US Congress were to
allow energy exports, energy prices in the world would fall
significantly. This would be great for companies, but would trigger
geopolitical problems in Russia and West Asia. These countries rely
on energy demand from western Europe and China, where energy costs
are currently hurting competitiveness and where a cheaper
alternative would be welcomed with open arms.
New real estate bubble
The conditions in 2005-07 that led to a real estate bubble are
back: low interest rates, growing demand, and increasing real
estate prices in some markets. With respect to the demand factor,
in current market conditions, the only attractive investments for
institutional investors are real estate and equities. As a result,
prices are increasing.
The Bank for International Settlements has recently released
data on real estate prices in several markets from 2013. Between
the end of 2007 and the end of 2013, residential property prices
increased by more than 80 per cent in Brazil, 60 per cent in China,
and 15 per cent in Canada.
There are also fears of a bubble in other countries such as
Switzerland and the United Arab Emirates. Like any other bubble, it
will only become one once it bursts. What is different in 2014 is
that now central banks have a great tool to prevent real estate
bubbles: Basel III and its countercyclical capital buffer.
The norm for companies is now to be BBB-rated. In the US, there
are only three firms that still are AAA-rated: Johnson &
Johnson, Exxon Mobil and Microsoft. There were 61 in 1982. Since
interest rates are low, companies see the benefits in debt
financing. But this means that firms are also more sensitive to
changes in interest rates. Typically a BBB rating is associated
with a probability of default of about 4 per cent in five years.
Therefore, we should expect that in the next five years, about 16
companies in the S&P500 index will go bankrupt. One of them
could be the new Enron.
From Nigeria to Ukraine, and from Syria to Venezuela, the world
risk map shows too many hot areas where geopolitical events could
trigger a world crisis. Why should anyone care about Ukraine or
Syria? Because financial markets tend to overreact to political
events. And because, given the financial linkages among countries,
negative sentiment in China will trigger a market collapse in the
US and vice versa. Let us not forget the lessons of the Great War
(we are now commemorating the 100-year anniversary): the butterfly
effect can be deadly in politics.
Over the last few decades the world has become richer and more
prosperous. While the percentage of the population in absolute
poverty is today at its lowest level ever, the absolute number of
poor people continues to grow. In this context income inequality is
one of the social battles that we need to fight. But the problem
with fighting income inequality is that the usual solutions
(typically taxes) hinder the competitiveness of nations. This is
one of the long-term crises that will require smart leadership to
avoid inefficient solutions.
There is too much money out there. It is the result of
quantitative easing policies that central banks have followed. The
excess liquidity in the system is concentrated among financial and
non-financial firms. Citigroup has more than $487 billion in cash;
Apple about $150 billion. It is paradoxical that, in some cases,
banks and firms are so rich that they could buy entire countries
(if one takes into account the total GDP minus government debt). If
the corporate sector were to unload such massive financial
resources (as is their moral obligation) on to society, they would
create hyperinflation and hence financial crisis. But otherwise we
are in a situation in which central banks print money that they
will have to take out of the system later. We know how quantitative
easing works, but we do not know how to exit from it.
While we can already see these eight sources of a new coming
crisis, the problem is that many obvious solutions that governments
can implement would be detrimental to world competitiveness and
could hinder local economies. More taxes, more regulation and more
protectionism all create a more hostile environment to economic
growth and competitiveness.
Politicians and corporate executives should now look to
diversify, to seek varied geographical presence, to be flexible,
resilient and to manage risk. They should cultivate and reward
talent and improve their credibility in society. To boost their
nations' competitiveness and their chances of inclusive economic
success, leaders need to invest internationally and make
acquisitions in order to make their countries attractive to foreign
capital. In order to avert the next crisis and others after that,
global leaders should be making employment, sustainability and
social cohesion the top priorities of their nations.
is a professor of finance at IMD and directs the
. He will present on the fundamentals of finance and on
competitiveness at IMD's
program in Singapore from November 17-22.
Real Estate Shorts Are In Play