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10 Years After Lehman’s Collapse, Economies Are Sowing the Seeds of the Next Crisis

Picture by Mark Lennihan/Associated Press 

by Brunello Rosa

17 September 2018


September 15th, 2008: financial services firm Lehman Brothers files for Chapter 11 bankruptcy protection. This is the largest default in U.S. history, and marks the beginning of the Global Financial Crisis (GFC), the most severe episode of financial instability and economic contraction since the Great Depressions of the 1930s. From late 2006/early 2007, when the first elements of the crisis start to emerge, until September 2008, the crisis is mostly confined to the financial sector, having little impact on real economic activity. After Lehman’s collapse, however, the crisis becomes truly global. A number of economies enter a severe recession in 2009; they will emerge from this recession only a number of years later, profoundly transformed. 

September 15th, 2018: ten years after Lehman’s collapse, it is evident how the consequences of the 2008 GFC have gone far beyond the financial industry and the real economy. New political movements have emerged, and a world-wide retreat of globalization has begun, in a process that is still ongoing. The eventual outcome of this process has not yet become clear. In a Special Paper published by the Systemic Risk Centre of the London School of Economics(derived from a video interview by Angela Antetomaso with Nouriel Roubini and myself, which is available on a page dedicated to the 10th anniversary of the GFC of our website), we analyse what went wrong in 2008, and what lessons have been learnt to prevent another crisis of similar proportions from emerging again. We discuss the perverse relationships that often exist between academics, regulators, market participants and politicians, and why the institutions that were supposed to look after the economic and financial stability of countries failed to prevent the excesses of finance from occurring. 




We analyse the effectiveness of the instruments of fiscal and monetary policy adopted to counter the effects of the crisis, and we highlight the insufficient use of fiscal policies, which at least in Europe would have helped alleviate the effects of the economic downturn. The link between financial crisis, economic contraction and the rise of populist parties, which led to Brexit and the election of Donald Trump, can clearly be seen. In this context, rising geopolitical tensions occurring within a deteriorating macro environment, as well as increased financial fragility, might trigger a new crisis that could be worse than the GFC. 

In recent articles published by the Financial Times and Project Syndicate, we explain how economies today have already sowed the seeds of the next global recession and financial crisis. We expect such a crisis to materialise by 2020, for the following ten reasons: 1) the fiscal drag on the US economy in 2020, as Trump’s fiscal stimulus expires; 2) the continuation of monetary policy tightening by the Fed and the beginning of interest rate normalisation by the ECB and BOJ, as inflation rates return toward central banks’ target levels; 3) the effects of trade wars and protectionism; 4) the restrictions to FDI and immigration, both reducing economic growth potential; 5) economic burdens deriving from the increase in public and private debt; 6) economic, financial and political fragilities in the Eurozone, China, and other EMs; 7) the potential for bubbles to burst in many over-priced markets; 8) the potential for fire-sales to take place in increasingly illiquid markets; 9) a “wag-the-dog” political risk in the US; e.g. Trump embarking on foreign policy adventures in the lead-up to the 2020 general election; and, 10) the constraints, deriving from the rise of populist parties, that policy makers will face in using policy tools to counter a crisis.  

Latest research

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by Brunello Rosa and Nouriel Roubini

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by Brunello Rosa

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The Geopolitical Corner by John Hulsman

Why A Real Russia-China Axis Will Never Happen

19 September 2018 

Introduction: What Mao Understood

During the height of the Cold War, it was taken as gospel that the communist alliance of Mao’s China and Stalin’s Russia would last forever. United in a common ideological hatred of the United States, these rising powers aspired to jointly knock America from its preeminent perch. There was only one thing wrong with this conventional wisdom; it entirely ignored the strategic rationale for alliances in the first place: The securing of its members’ primary interests, as an alliance must enhance a country’s power, and not diminish it.

Simply put, the great majority of western analysts vastly overestimated the power of what was then called ‘Monolithic Communism,’ having forgotten that China and Russia (whatever the ideological trappings) were first and foremost states, with very different interests. While western analysts went on for quite a time—somehow believing that the obvious rift between Mao and Khrushchev were merely part of a cunning, Dr. No-style plot to fool the US—the strategic reality was far more prosaic, and timeless. For Mao had begun to chafe in his role as Robin to the USSR’s Batman.

Being second-banana in the Sino-Soviet alliance (which given China’s anaemic GDP and primitive (if numerous) army it was bound to be) no longer served China’s basic interests. That is because a major reason for the Chinese Communist Party’s (CCP’s) success in its long, murderous war with the Chiang Kai-shek was that it had managed to better appropriate organic Chinese anti-colonial, nationalist sentiment.

Chinese communism, after humiliating western colonialism and the Opium Wars, would at last see the country stand tall again, able to repel foreign invaders and enjoy its genuine sovereignty. This message can best be thought of as an early version of Donald Trump’s ‘Make America Great Again.’ By credibly promising to ‘Make China Great Again,’ Mao secured the vital backing of his country’s peasantry, and went on to hold absolute power. But, in hastening the Sino-Soviet split, he never forgot the underlying nationalist reason he came to power in the first place.

For Mao, it mattered little whether China was dominated by westerners or by the Russians. To be constantly made aware of his secondary (if important) status, forced to take reams of Soviet technical ‘advisers’ into his country, forced to accept the city-dominated form of communism which had precious little relevance in a country based on its peasantry, the Russians came to be viewed by the Chairman as much as a hindrance to his goals for genuine independence as the hated westerners were.

The final straw came when Khrushchev refused to help Mao develop an atomic weapon, the totemic symbol of Great Power status. Khrushchev, perhaps rightly fearing that Mao would actually use the thing, recoiled from aiding his ally. For Mao, the alliance had become just the latest form of servitude; unsurprisingly he abruptly ended it, a decade later even siding with the hated capitalists against the Kremlin. As ever, (Chinese) national interests had determined both the Sino-Soviet alliance, and its eventual breakdown.

The forces that bind

Fast forward to today, and Russian President Vladimir Putin’s eye-catching Vostok (it means ‘East’) 18 war games, set to take place in Siberia, the Bering and Okhotsk seas, and the Sea of Japan. The war game is massive, with headline (if overstated) numbers of 300,000 Russians, 1000 aircraft, and 36,000 tanks taking part. But these gargantuan numbers (it is easily the Kremlin’s largest war game since the end of the Cold War) are not the reason it has caught the fancy of the commentariat.




Rather, a war game usually aimed at countering a possible Chinese invasion of Siberia has now instead included a small number of the Chinese army troops (perhaps 3,000) in the game itself. The diplomatic signalling is seemingly crystal clear here: Russia is no longer strategically worried about Beijing, but instead wants to work with China to counter the United States, still the closest thing the world has to a global ordering power. 

If this admittedly low-level military cooperation is the start of something much bigger, than it is the most important geopolitical story out there. For in the near- to medium-term, only a Sino-Russian alliance has the economic and military heft to seriously challenge the US as the most important power in the world. Surely, in his usual, cagy chess-playing fashion, that is the message that Vladimir Putin would like to send to the world, which this week got a serious case of the strategic jitters.

And as was true with the Cold War alliance, on the surface, there is seemingly a lot to bind the two powers together. Both resent continued American pre-eminence, and lecturing about their respective human rights records. Both seem baffled, confused by, and alarmed by the chaotic presidency of Donald Trump, who is just not behaving as the leader of an ordering power historically should (that is conservatively, cautiously, and carefully). Both clearly see that the US is in relative decline, even as it remains by a long way the dominant single power in the world, and both want to capitalise on this newfound weakness. Isn’t this enough to bind the two together in a coherent anti-American alliance?

The forces that repel

Well, no. For President Putin now finds himself uncomfortably in the position that Chairman Mao did during the Cold War: Very much the junior partner of an alliance that humiliates as much as it helps. For Putin, like Mao, rose to tremendous power pledging to make his country great again.

It is because of Putin’s uncanny ability (much like De Gaulle) to personally embody his country’s nationalism (and less accurately its way back to Great Power status) that explains why now—even after the recent pensions controversy—the Russian president remains broadly popular, with over a 60% approval rating, a number the present undistinguished crop of western politicians would kill for. But for the embodiment of Peter the Great to accept stooge-like status in alliance with China fits neither Putin’s temperament, nor does it serve his interests.

And there is no doubt Russia is second banana to China. Beijing, thanks to the transcendental reforms of Deng Xiaoping, is well on its way to becoming an economic superpower; Russia has a GDP smaller than the state of Texas. China has a diversified, modern economy; Russia is a one-trick pony, dependent every day on the spot price of oil and natural gas. China is seen over time as a possible peer competitor to the US; Russia is at best a declining regional power. No, the only way for such an alliance to work is for Russia to meekly accept its status as Ringo Starr, with China playing the starring role of Lennon-McCartney.

Conclusion: Don’t hold your breath

So for President Putin to achieve an anti-American axis with Beijing (something he may indeed very much want) he would have to also accept permanent second-banana status (something he would very much hate). Don’t hold your breath, as for Putin to do so he would make a lie of the very Great Russian nationalist ideology that is the basis to his power in the first place. As was true in the Cold War, a Sino-Russian alliance doesn’t make sense now as it does not truly serve the national interests of the junior partner. And alliances that don’t serve a country’s primary national interests are unlikely to endure. 

This article was originally published on the Author's LinkedIn Page. John Hulsman's new book, To Dare More Boldly: The Audacious Story of Political Risk, was published by Princeton University Press in April 2018. 

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Looking Ahead

The Week Ahead

Week  17 - 23 September 2018


In the Eurozone, inflation is expected to remain unchanged, both headline (CPI Aug y-o-y, c: 2.0%; p: 2.0%) and core (Aug y-o-y, c: 1.0%; p: 1.0%). 

In Europe, the Swiss National Bank and Norges Bank will hold policy meetings. Norges Bank is expected to increase its policy rate by 25bps to 0.75% (the first rate rise since May 2011), and to indicate 2-3 additional rate hikes over the forecast horizon, with an up-lifted rate path.

In Japan, the BoJ is unlikely to change its policy rate (c: -0.1%; p: -0.1) given low growth and inflation prospects: CPI Aug (c: 0.9% y-o-y; p: 0.9%) is expected to remain unchanged, below 1%. 

The Quarter Ahead


The US will continue to normalize policy ... Market expectations about “at least 2 additional hikes in 2018” remained high, at 79.3% (pw: 79.8%), while the likelihood of “at least 4 additional hikes by September 2019” increased to 50.1% (pw: 37.6%), given that: a) US job openings hit 6.9m—a record level—in July (c: 6.7; p: 6.8); and b) inflation softened, but remained above the Fed’s target (CPI Aug y-o-y, a: 2.7%; c: 2.7%; p: 2.9%: Fed’s target: 2.0%). As a result, short positions on UST 10y futures reached a record high of 683k contracts 

… while other DMs will remain on hold. In Europe, the ECB and the BoE—both facing weakening economies—left policy rates unchanged (ECB, a: 0.0%; c: 0.0%; p: 0.0%; BoE, a: 0.75%; c: 0.75%; p: 0.75%). In Q4, the ECB will reduce its monthly asset purchases to EUR 15bn; if the EZ economy remains resilient, ECB’s QE will end in December 2018. Next week, the EZ’s September composite PMI is expected to remain unchanged at 54.5. 

In the UK, a no-deal Brexit could hurt real estate prices. Mark Carney, BoE’s governor reportedly told cabinet ministers that a no-deal Brexit would see house prices fall by a third within three years.  

EM weakness is likely to continue. The divergence between stable DMs and volatile EMs will persist, triggering bouts of volatility: last week, a) the ARS weakened a further 7.6% against the USD (to USD/ARS 39.736); and b) the BRL depreciated by 2.8% (to USD/BRL 4.174). 

Saudi Arabia will increasingly rely on bank financing. Saudi Arabia needs funding to meet its diversification and investment plans, following the postponement of Saudi Aramco’s IPO. Last week, the country’s SWF borrowed USD 11bn from a consortium of banks. The loan was reportedly priced at LIBOR +75bps.  


In Turkey, the economy will weaken … The government announced measures (i.e.: postponement of new investment projects, reductions of public sector hiring) to reduce the fiscal deficit. Q2 GDP growth fell to 5.3% y-o-y (c: 5.3%; p: 7.4%) and is likely to decline to between 0 and 1% in Q3. Lower growth will reduce the C/A deficit—which already fell to 6.6% of GDP (July 12m rolling avg., p: 7.0%).  

… but the TRY will be supported by: a) a more proactive CBT—last week, the CBT raised the one-week repo rate by 625bps to 24.0%, above markets’ expectations (300-400bps); and b) new regulation banning the use of FX in real estate and motor vehicle transactions (sale, purchase, lease or rent). 

In Egypt, the C/A deficit will decrease. A presidential decree signed last week: a) increased customs tariffs on 5,791 imported products; and b) reduced tariffs on materials used as inputs in local assembly lines. The move aims at encouraging local production and raising fiscal revenues.

In Bahrain, the CBB sold USD 254m of debt: six-month Islamic bonds were sold at 4.35% (up from 4.19% in the previous issue), and three-month Treasury bills at 4.13% (p: 4.09%). 

Brent oil price will likely remain above 70 USD/b. In Q4, the US will keep expanding production: in August, average output reached 10.9 mb/d—making the US the world’s leading producer—up from an average of 9.4 mb/d in 2017. However, oil prices rose by 1.6% w-o-w to 78.1 USD/b due to: a) in the short term, concerns about the impact of Hurricane Florence in the US: and b) in the medium term, the impact of sanctions on Iran. 

Last week's Summary (10 - 16 September 2018)

Global stocks (MSCI AWCI) Rose by 1% on a Weekly Basis

In DMs, positive developments on global trade lifted equities (S&P500 +1.2%; Eurostoxx 50 +1.6%; Nikkei 225 +3.5%), shrugging off reports that US President Trump could impose further tariffs on USD200bn of Chinese goods. Volatility declined (VIX, -2.8 points to 12.1; 52w avg.: 13.6; 10y avg.: 19.5). Driven by positive data in the US labor-market, the 10-y UST yield rose by 5bps w-o-w to 2.99%. The USD weakened w-o-w against: a) a currency basket (DXY -0.4%); and b) the EUR (EUR/USD 1.163, +0.7%).   

In EMs, as Turkey’s CB delivered an above-consensus rate hike (by 625bps to 24%) and the Russian central bank rose its policy rate by 25bps to 7.50%, EM stocks (DJEM -0.1% w-o-w) and currencies (MSCI EM Currency index, +0.2% w-o-w) stabilized.

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