3 signs to spot the next global crash - Economist Linda Yueh
Key context
Linda is a British-American economist and broadcaster who we love - and this episode was recorded in early July 2024 btw.
She says you can’t stop crashes, but you can stop them from spreading and turning into global crashes.
Not all crashes become great crashes. But every great crash starts with exuberance, or a bubble, like the DotCom bubble which was irrational exuberance.
At times like this, people feel FOMO and pile in, creating a bubble which isn’t supported by fundamental value and ultimately bursts.
There are three phases of every great crash for Linda: exuberance, resolution, and aftermath.
We’ve had a lot of crashes since the 1980s, and half the great crashes have happened this century. This is because financial markets have become international - and information and loss of confidence can travel much faster than before.
Regulation comes as a response to the last crash, so the next great crash will come from something new.
Financial markets are separate to the economy. That’s why the stock market was able to boom after 2008 even though the people suffered hugely.
History doesn’t repeat itself, but it does rhyme.
Banking crashes
A banking crash is amongst the worst of financial crises.
They affect the real economy, e.g. in the DotCom bubble, companies were ahead of their time and didn’t have much substance. But the money invested in those companies didn’t come from banks, it came from VCs (Venture Capitalists), so when the bubble burst it didn’t infect the banking system.
The Nasdaq didn’t recover for 15 years (the world’s leading tech index) but other markets performed well.
Contrast that with the credit crunch in 2008. Because this was a banking crisis, people and institutions couldn’t access money which affected the real economy - e.g. loans being recalled and good businesses going bust.
The extent of the damage in the aftermath of a crash is defined by its cause (e.g. too much debt) and the behaviour and credibility of policy makers in the wake of the crash.
When there's a lot of investing from debt, that often causes big problems - and great crashes.
The IMF says what you do in the first 10 months after a crash is key.
After the great crash in Japan in the early 1990s, it took them 8 years to support the banks which made the crash so much worse. The government didn’t support the banks enough initially because they didn’t think there was enough public and political support - because the banks had been instrumental in causing the crash in the first place. There was so much anger with the banks, but not supporting the banks made the aftermath so much worse.
The leads to big moral debates around ‘too big to fail’. Basically, banks can get away with being failing businesses which is unfair - but if you don’t support them when they fail, it makes the country’s recovery much longer and harder.
The failure of Silicon Valley Bank (SVB) was a digital run on the bank. It happened incredibly quickly, and mid-sized banks were at risk of contagion from SVB falling so the US Treasury had to step in to prevent a domino effect.
Mid-sized banks falling could’ve triggered a systemic crisis.
It was the second biggest banking failure in US history.
How to recover well
The credibility and quality of policymakers is key in recovery. The market needs confidence in leaders.
Mario Draghi delivered his famous “whatever it takes” speech to save the Euro, which bolstered market confidence. Yes, it can be as simple as a leader delivering a few words well.
When there is a banking crisis, central banks need to support banks to support viable businesses, and one way to do that is offering banks favourable lending terms with specific criteria, e.g. this money has to be lent to viable SMEs.
Linda’s worried about China
Linda predicts the next great crash will come from China (but she doesn’t say when).
Shadow banking is a big fear. This means any kind of lending from private entities, e.g. private equity firms lending money, or insurance companies or whatever. This is lending from entities that aren’t regulated like banks.
Half of the lending in the world comes from shadow banks!
Take one province in China, where half the companies borrow from shadow banks. If the shadow banks fail, it could crash the economy - and that could have devastating effects on the world. A lot of fragile countries rely on Chinese credit.
China have been trying to deal with shadow banks for years but they’ve dealt with it quite slowly.
China does more lending than the World Bank to developing countries. If China has big issues, it will probably trigger a massive domino effect.
But she also says that lots of things could trigger the next great crash, including the environment, e.g. there might be mass flooding in a global city which insurance balance sheets can’t support.
Linda worries the current conflict (or conflicts) in the Middle East could trigger a global economic crash just like the 1973 Yom Kippur War triggered the world’s first global supply shock because of its impact on the oil industry.
Are we in an AI bubble?
Linda says it’s important to ask if something like AI is a bubble or fundamentally rising in value.
The AI moment we’re in has a lot of parallels with the DotCom era. There are parts of the tech (Al today or the internet 25 years ago) that could change the world.
There will be a lot of losers amongst today’s AI’s companies but there will be some winners, like Amazon coming out of the DotCom bubble.
The question is, can you pick the winners?
It’s really difficult. Jeff Bezos was the 50% owner of Pets.com - the poster child of the failings of the DotCom era.
A VC told Linda recently they wouldn’t look at a proposal if it didn’t have AI in the title - sounds quite crashy!
