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Abu Dhabi, UAEWednesday 20 June 2018

Forecasts of economic doom are likely wide of the mark

Pundits that missed the 2008/9 financial crisis are getting their predictions of woe in early

A Lehman Brothers employee leaving the office in September 2008 in New York following the firm's collapse. Pundits worry about another crash on the horizon. Getty Images
A Lehman Brothers employee leaving the office in September 2008 in New York following the firm's collapse. Pundits worry about another crash on the horizon. Getty Images

It is a well-known fact that almost no one forecast the global financial crash of 2008/9. In the summer of 2008, when the banking crisis was looming and a recession was clearly (in retrospect at least) on the horizon, economic forecasters and pundits hung on to their conviction that any upcoming downturn would be shallow and short, and that normal life — which meant a resumption of the longest bull market in history — would soon get going again.

The Bank of England (BoE) at the time monitored 27 economic forecasts, from the UK’s Treasury, the IMF, and the OECD (plus of course the BoE’s own forecasts), and came up with a consensus forecast of 1.2 per cent growth for the UK’s economy in 2008, followed by a 1.5 per cent growth in 2009.

The reality was somewhat different, of course. The UK’s GDP dropped 7.5 per cent in the four quarters following October 2008, the indicator’s biggest fall in almost 100 years, larger even than in the depths of the Great Depression.

The trigger for the financial crash was the sub-prime mortgage crisis in the US, which brought down Lehman Brothers and a multitude of others. In the aftermath, a few brave souls were credited with a bit of foresight: Yale economist Robert Shiller, author of the 2000 best-seller Irrational Exuberance, told Barron’s in 2005: “The home-price bubble feels like the stock market mania in 1999.” The Sage of Omaha, Warren Buffett, testified before a US congressional committee that he too had feared “the greatest bubble I’ve ever seen in my life” where the entire American population was caught up in a “belief that house prices could not fall dramatically.”

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There were precious few others though. Even the great Alan Greenspan, in his day possibly the most revered chairman the US Federal Reserve has ever had, was still brushing aside warnings in 2007, arguing that a crash in house prices, the underlying cause of the crisis, was “most unlikely”. In fact, US house prices would go on to plunge by a quarter between 2006 and 2012.

These same economists and pundits — or their successors — are determined they are not going to be caught out again, and are busily getting their prognostications of gloom about the global economy in early. In recent weeks, I have read at least half a dozen forecasts that another financial crash, maybe even bigger than the last one, is just around the corner. The reasons vary: another oil crisis triggered by conflict between Iran and Saudi Arabia, and the closure of the Straits of Hormuz; a debt bubble in many western economies; a crash in China; another house price bubble in the US (New York condo prices are now 19 per cent above their pre-crisis highs); a stock market crash simply caused by prices getting too high; and the reversal of quantitative easing leading to much higher interest rates. The Bank for International Settlements recently published “early warning indicators for stress in domestic banking systems”. Two big economies which came up red were China and Canada. A banking crisis in either would spread to the rest of the world in a matter of hours.

It is also widely argued that stock markets are too high by any historic standards. The shares in the so-called “Fang” tech stocks — Facebook, Amazon, Netflix and Google — are up between 30 and 60 per cent this year. In China, the market values of Alibaba and Tencent have passed the $500bn mark in the past week. Bitcoin, for reasons no one can explain, is up seven-fold. Such rises can’t go on forever.

The latest pundit to forecast that the end is nigh is Professor Niall Ferguson, a widely respected economic historian, who now reminds us that a month before the Lehman crash he anticipated a “global tempest,” for which the term “credit crunch” would be an absurd understatement. To be fair to him, Ferguson had been warning from 2007 onwards of a “man-made disaster” as the sub-prime crisis worked its way through financial institutions. No one wanted to know.

Now, he says, we are in for another dose of bad medicine, this one maybe even nastier than the last one. His reasoning covers several of the above factors, but also includes the ominous prediction that the 35-year bull market in bonds is coming to an end. “Bonds will sell off; long-term rates will rise”, he predicts, with serious implications for highly-indebted entities.

Yet Professor Ferguson, and other forecasters of doom, miss a key point: financial crashes by their nature take markets by surprise. If investors, bankers and regulators were as convinced of the upcoming crash as Professor Ferguson is, then they would be taking action now, and there would be no crash. There may be a correction or even a recession perhaps, but that's part and parcel of the natural economic cycle, and very different from a crash or depression.

The crisis of 2008/9 was a once-in-100 years event, as opposed to the once every ten year recession of 1991/2, or the abnormal once every 25 years recession of 1982/3. Such shocks to the system were far better-signposted than the events of nearly 10 years ago.

By contrast, the Great Crash of 1929 caught everyone by surprise as did the crash of 1987. But not many people anticipated the abrupt end of the dot.com bubble in 2000. And 2008/9 was a whopper which only Ferguson and very few others thought was on the way.

Sure, we will certainly arrive at another financial crisis sooner or later, and, as always, it will come from a direction that most forecasters never thought about. But I don’t think it’s nigh, mainly because so many people are telling us that it is.