We’re facing a very different global economic crisis


Leo Tolstoy famously wrote that “Happy families are all alike; every unhappy family is unhappy in its own way.” It would appear that the same might be said of different global economic crises. For instance, the 2008 global economic crisis differed fundamentally from that of 1998. Now it would seem that the global economic crisis that is presently brewing in 2016 has its own special characteristics. That will almost certainly make this crisis very different, though possibly no less severe, from both those in 1998 and 2008.

For all of today’s vulnerabilities in the world economy, unlike in 2008, they are not centered in the United States. In particular, the main threat to today’s global economy is not a major bubble in the U.S. housing market, nor is it one of very high leverage and the excessive use of derivatives in the U.S. financial sector. Indeed, if anything, the U.S. economy is one of the few sources of strength in today’s very troubled global economy.

Similarly for all of today’s weaknesses in the emerging market economies, unlike in the 1998 crisis, fixed exchange rates of the sort that prevailed throughout Asia and Latin America in 1998 are not one of them. For the most part, having learned from the 1998 crisis of the dangers of overly rigid exchange rate policies and of currency crisis contagion, practically all of the major emerging market economies have moved to very much more flexible exchange rate policies. They are also generally now going into the brewing economic crisis with much lower public debt levels and more balanced public finances than before.

One of the major distinctions between the global economy today from 1998 and 2008 is that its center of gravity has shifted dramatically away from the world’s industrialized economies to the emerging market economies. As a result of many years of very rapid growth in the emerging markets and of sclerotic performance in the industrialized economies, China has now become the world’s second largest economy, while the emerging market economies, including China, now account for over 40 percent of the world economy. This makes developments in those countries today much more important for the global economy than was the case in either 1998 or 2008.

Yet another fundamental distinction between today’s global economy and those of 1998 and 2008 is that the world’s central banks are now running out of room for policy maneuver. Unlike in 1998 and 2008, when at the outset of the economic crisis, interest rates in the world’s major economies were far from the zero-bound interest rate, today we find that they have been stuck at that rate for many years. Similarly, we now find that the world’s major central banks have already gone well down the road of unorthodox monetary policies with apparently diminishing returns. This has to raise basic questions as to how effective might those central banks be in moderating a renewed global economic downturn through additional monetary policy action.

Perhaps the most fundamental distinction between today’s global economy and those of 1998 and 2008 are the many more sources of vulnerability today than in the previous crises. Sadly, unlike in both 1998 and 2008, when the global economic crisis emanated from a confined geographical area, today’s crisis has the potential of being driven by events not only in China and the emerging market economies but also by events in the European economic periphery, the United Kingdom and Japan.

The multiplicity of serious trouble spots in today’s global economy might be underlined by considering three major fault lines. First, China, which earlier was the main engine of global economic growth, is now undergoing a major transition away from its earlier investment and export-led model that is almost certain to result in a major slowing in that economy. This is all the more so the case considering that it is occurring at a time when the country is experiencing a major outflow of capital as Chinese residents lose confidence in their economy. That has the potential to cause China to further depreciate its currency, which could very well result in a global currency war.

Second, the major emerging market economies like Brazil, Russia and South Africa are being hit by a major commodity bust that shows little sign of ending anytime soon. This has to be of systemic concern not simply because of the increased relative importance of these countries to the global economy, but rather because the corporate sectors of these economies could soon start defaulting on the major debt mountains that they have built up during the boom years.

Third, economic and political developments in Europe suggest that any slowing in the global economy could reignite the European sovereign debt crisis. Economies in the European economic periphery are still drowning in debt. Meanwhile, they have generally now elected governments that are opposed to the budget austerity and structural economic reform that might have held out the prospect that those countries might eventually grow their way out of their debt problems. To compound matters, the European banks are holding an excessive amount of troubled sovereign debt, while it does not help that fears about a “Brexit” ahead of a likely referendum on this question in June 2016 will heighten European economic uncertainty.

All the evidence cited above would strongly suggest that the global economic crisis of 2016 will not resemble either 1998 or 2008. However, that is not to say that it will be any less painful or deep given the multiplicity of vulnerabilities. That would especially seem to be the case should global policymakers continue to underestimate the likely severity of the forthcoming global economic crisis.

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