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2020: year of new financial crisis in review

By Mikhail Karkhalev

If we look closely at the evolution of the world monetary system and the main technological breakthroughs, we should notice that they recur in regular cycles.

If we look closely at the evolution of the world monetary system and the main technological breakthroughs, we should notice that they recur in regular cycles. Each crisis comes as the world realises that the current financial model is no longer able to meet all our needs.

The development and growth of the world economy are also cyclical. The cycle consists of four main components:

  • Growth: the gradual recovery from the previous decline;
  • Peak: the peak of business activity, when the highest point of economic recovery is reached;
  • Decline, or recession: a decrease in economic growth and business activity;
  • The bottom: the lowest point of manufacturing and employment, normally accompanied by social crisis.

The global economy went through 11 complete cycles between 1945 and 2019 with intervals of seven to 11 years. The last two crises occurred following the collapse of the dotcom bubble in 2000 and the collapse of the US mortgage market in 2007. The two recent crises had eight years in between them and now we are 11 years away from the latest one, which indicates that the world is going to pass through a cycle quite soon.

Experts expected the global financial crisis to break out since the end of 2017. Some analysts predicted a decline in 2018 and 2019 but currently all the indications are that the year of the crisis is 2020 and that 2021 is less likely.

To back up this reaffirmation with supporting evidence, let's look at the evidence that indicates the forthcoming crisis. It is worth noting that we are primarily considering the situation within the United States, as the country is still considered to be at the centre of the world economic system. All events in the US economy affect the rest of the world.

How do we know that the crisis is on the way? The theory states that the recession is characterised by a decrease in manufacturing volumes, as well as business and investment activity. As a result, the rate of unemployment is increasing. The recession is typically registered when a decrease in business activity lasts for more than six consecutive months.

Unemployment rate in the US

Let's start with the unemployment rate. In the US it is currently at its lowest level since the 1970s – at 3.5 per cent. It is good, on the one hand, as people are working and getting their wages while the Treasury receives taxes. However, we should note that shortly before a crisis the unemployment rate is normally at a low level, while the drastic increase of this indicator coincides with the first months of the crisis. Let’s see how it was during the previous crises:

2000: the collapse of the dotcom bubble led to a quick surge in unemployment rate which earlier was at its record low.

2007: the collapse of the mortgage market, which led to a liquidity crisis in the banking system, was followed by the bankruptcy of the world's largest investment banks (Lehman Brothers, Merrill Lynch). The unemployment rate initially was at its lowest since the previous crisis.

2019: the US enjoys the lowest unemployment rate since 1970. It is possible that the indicator will soon decline in the wake of the crisis.

Reduction of industrial output

The next indicator that directly impacts the unemployment rate and plays a significant role in the context of the crisis, is a decrease in industrial output. This is perhaps the main indicator: its decline sets off a chain reaction.

The main outcome of such a reduction is the withdrawal of investments from business and states. The capital starts flowing to the more stable, safe or profitable markets. But what is happening with the manufacturing output these days?

The industrial output in the US has been falling since October 2018 at an incredibly fast pace: from 5.6 per cent to -1.3 per cent in just a year.

The EU has faced a similar situation. Between February 2018 and February 2019, the industrial output fell from 5.2 per cent to -4.2 per cent. At press time, the situation has slightly improved but is still critical. Currently, the output is at -2.2 per cent.

Purchasing managers' index (PMI)

As mentioned in previous articles, the recession is preceded by a decline in business activity that lasts for more than six months. Let's see what the PMI was like in the EU manufacturing sector.

In the recent two years, the index has been decreasing. Since January 2018 the PMI fell from 60.6 to 46.3.

As for the PMI in the US manufacturing sector, the situation is slightly better, but the overall trend is also downward.

Between 2018 and 2019, the PMI fell from 56.6 to 49.9. Later it recovered slightly and got up to 52.4 by the end of the year. Despite the fact that it could be a simple rebound, other indicators also sent warning signs.

Inverted yield curve

Inverted yield curve for bonds is a rare situation in which short-term debt instruments have higher yields than long-term instruments, although the long-term bonds normally have higher yields than the short-term bonds.

If 10-year bonds have a yield higher than the two-year ones, everything in the economy is running its course, and the yield curve is normal or upward.

But when long-term securities have a yield lower than short-term ones, the economy falls on hard times. The inverted yield curve is considered to be a precursor of recession in the US.

Let's turn to the official data of the US reserve banks. The yield curve has reached 0. As historical data shows, in 2000 and 2007, the financial crisis arrived as soon as the yield curve reached zero or fell below it.

This indicator is closely related to inflation and the collapse of the current market system. In 2000, it ruined the dotcom bubble and, in 2007, the mortgage market fell down. Currently we might see the age of unsecured fiat money on the market crashing down. US president Donald Trump seeks to reduce lending rates in every possible way, same as the EU, Japan and Switzerland have previously done.

When the market enjoys cheap money in excess, they are frequently invested in risky assets with high profitability, more precisely in businesses and stock markets. In such periods, investments in long-term government bonds are far from interesting, as traders are trying to get their profit here and now. As a result, prior to the crisis the stock market and the yield of short-term bonds are growing.

Critical situation at stock markets

Stock markets, not only the United States, have been constantly growing since 2009. The S&P 500 index gained more than 450 per cent, the NASDAQ Composite more than 730 per cent, and the Dow Jones – 380 per cent. The short period between 2018 and 2019, when the US-China trade war broke out, was the only exception. During that time, the stock markets were trading sideways, failing to overcome historical highs. However, they did not decline strong enough to cause a collapse.

As US and China declared a truce, agreed on certain concessions and partially cancelled or froze severe trading tariffs, the stock markets went up again and finally on the offensive and finally reached their historical highs.

As we can see, the risky assets are constantly growing, investors are pouring cash into the markets, the companies are developing and people are getting richer day by day. However, the scheme is not that simple. Who would invest in risky assets when they are trading at their historical highs, while all the crucial market indicators show that the global economy is in stagnation?

By lowering interest rates and introducing quantitative easing programmes (QE), leading states are stimulating their economies with cheap money in an attempt to accelerate inflation. As long as prices are not rising, the economy is not developing and companies are not making profits. In this case it is worth asking where the stock market growth comes from.

The answer is quite simple. If you see the chart below, it clearly demonstrates that the vast amount of trading on stock markets refers to the world's largest corporations that are repurchasing their own shares from the market. The so-called buybacks are performed for a range of purposes, but the main one is to maintain the value of shares at an important level for the company.

In conclusion, for the first time since the crisis broke out in 2007, the 500 largest US companies by market cap are now spending record amounts of funds to buy their own shares back from the market. At the same time, they pay less in dividends and capital expenditures. So basically, nowadays companies mostly spend their funds on buybacks instead of funding development or paying profits.

In 2018, more than $820bn was spent on buybacks. According to the results of the third quarter of 2019, only within this period the total amount of repurchases comprised $546bn. There is a small chance that the buybacks will reach $300bn for the fourth quarter. However, normally the buyback expenses are higher than the year’s average for this particular period. In 2019, the fourth quarter is likely to close well above $200bn, with the total amount of buybacks sent to $750bn. The difference is quite small if we compare it to 2018. However, it would be drastic in comparison with 2017 and earlier.

Where are the investors?

Investors are mostly keeping quiet awaiting new highly profitable assets. Traditionally, in troubled times like these, investors store their funds in safe haven assets, such as gold, Japanese yen and the Swiss franc, which are typically strengthening against the US dollar.

At the same time, the cryptocurrency market is recovering. In the first half of 2019, all major coins went up three to five times higher and then went for a correction prior to some important events. Those included the launch of Bakkt, the regulated trading platform for trading Bitcoin futures and some regulatory decisions from major stats that were expected to help industry to recover from the 2018’s crypto winter. Moreover, upcoming Bitcoin halving is set to send the world’s major cryptocurrency to new heights.

It is crucial that the majority of experts believe in the further growth of cryptocurrencies. During the financial crisis, the stock markets collapse and investors are interested in profits. In addition, the recovery period for the stock market could take years, which is why it is likely that cryptocurrencies can become a new safe haven asset for the period of the financial crisis. It has been 10 years since Bitcoin was launched amid the crisis of 2008. During the reported period, one dollar invested in the stock market (for example in NASDAQ) would have brought nine dollars to the investor. Meanwhile, one dollar invested in Bitcoin, which was equal to 1310 BTC at the very beginning, would have brought more than $26m up to date.

But let's go back to safe havens and take a look at the charts.

Gold has been steadily growing since mid-2018, moving from $1,180 per Troy ounce to $1,550. The latter is an important historical resistance. Once gold breaks through it, it could rush to its historical high of $1,900 reached in 2011.

The USD/JPY currency pair is in a long-term downtrend. The dollar is gradually weakening against the Japanese yen.

The situation is similar in the USD/CHF pair, where the US dollar is lowering less drastically than in the USD/JPY pair but still very noticeable.

How major investors act

The behaviour of some major institutional investors also indicates their expectations regarding the forthcoming crisis.

One of the largest US hedge funds, Bridgewater Associates, together with one of the world's largest investment banks Goldman Sachs, have put $1bn on the collapse of the S&P500 and Euro Stoxx 50 indices by March 2020. At the moment, this is the largest short position in the market.

Summary

1. We are on the verge of a global change in the monetary system, which had already ripened in 2008 amid the global financial crisis and the G20 summit that discussed the fate of the Jamaican currency system. In 2009, the launch of Bitcoin gave rise to a wholly digital and decentralised financial system, which is gradually replacing the traditional fiat money. The major example is the Chinese project of digital yuan.

2. The new technological breakthrough is about to come, driven by the development of a fully fledged quantum computer. It will have a revolutionary impact on the global financial system, medicine and other technologies, including the development of AI.

3. A global financial crisis is quite near, according to the most-known indicators that had previously predicted it in the past. At the same time, the new crisis is not likely to be similar to the previous ones, as the collapse of the current monetary system is combined with a new technological breakthrough. It is possible that we will find ourselves in a new world after a series of these events.

How soon will the crisis happen? Some believe that 2020 is the year, while others move the deadline a little bit later. However, previous crises have shown that most of the changes are in fact benefitting humanity and providing new opportunities for further development.

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