On the surface, August 2007 was a good month for the US and global economy. Unemployment was low. The stock market had a bumpy few days, but nothing too dramatic.
Why it matters: Many see it as the beginning of what we now call the global financial crisis. And there are some ominous parallels to what the world is experiencing right now.
- To be clear, we are not predicting another crisis as severe as the one that rocked the world in 2008. Rather, we argue that large (and acceleration) underlying shifts are ongoing and will likely linger for years to come.
- How severe the pain will be is difficult to predict. It can vary significantly by country and industry. It is plausible that the economic damage will be minor in most sectors of the US economy.
In this parallel The turmoil in the UK – where currencies and government bonds are falling – is the equivalent of French bank BNP Paribas’ funding problems over mortgage losses.
- The bank requested a liquidity lifeline from the European Central Bank on August 9, 2007, which many date as the start of the global financial crisis.
- As it was then, the US economy remains strong and the financial disruptions across the Atlantic seem a long way off. But in this episode they were actually early manifestations of profound adjustments that were just beginning and would eventually impact economies around the world.
Game Status: After the 2008 crisis, the world was stuck in a low interest rate, inflation and growth rut for more than a decade.
- Central banks looked for new ways to ease monetary policy to stimulate demand, including negative interest rates and quantitative easing.
- They concluded that the “neutral rate” had gotten much lower due to seismic forces like demographics and globalization.
- The widespread view — reflected in bond prices and official comment — was that after the disruptions of the pandemic, this low-interest-rate normal would return. At least until recently.
What happened In recent months – and at a dizzying pace in recent days – markets are bracing themselves for the possibility that the era of ultra-low interest rates and liquidity is over and that the 2020s will be very different from the 2010s.
- Consider that a 30-year US Treasury note returned 1.92% at the start of the year. That’s up to 3.62% this morning as of 10:45 am EDT.
- The effects of this re-evaluation are only just beginning to permeate the economy. This is most evident in housing right now, but could ultimately affect everything from the sustainability of large budget deficits to the profitability of any business that relies on large leverage.
Flashback: Donald Kohn, who played a key role in combating the global financial crisis as the Fed’s No. 2, made a forward-looking statement last year.
- “It is possible that [the natural rate of interest] is higher than backward-looking models now suggest,” he said at the 2021 Jackson Hole Symposium, pointing to loose fiscal policy and pent-up savings.
- “But the transition to a higher interest rate environment could be quite bumpy given that many assets and debt sustainability assessments have been based on very low interest rates for a very long time.”
What you say: In a note this morning, Joseph Brusuelas, chief economist at RSM, said dollar funding markets have shown some of the strains they have seen in past crises (though not as severe).
- He writes that economies that “have been characterized by insufficient aggregate demand and low inflation for the last two decades are likely to now be characterized by insufficient aggregate supply, negative supply shocks, geopolitical tensions and higher inflation” that other monetary and fiscal policies.
- “Fixed income markets are signaling a shift in perceptions of financial stability and are cautioning investors,” he added.
The bottom line: We are just beginning to see how a tighter money world will affect sovereign nations, real estate, the corporate sector and more.