By George Hoguet
This year marks the 100th anniversary of the onset of World War I, a conflict from which, scholars argue, Europe never fully recovered. A century later, historians still debate the causes and legacy of the “war to end all wars”. No doubt 100 years from now future historians will still argue over the causes and consequences of the Global Financial Crisis of 2007–2009.
While there may be disagreement on the causes and consequences, the fact remains that world output fell 0.4% in 2009, the first contraction in global output since 1973. In some countries the impact was much more severe. For example, output in Japan fell 9.2%, 11% in Russia and 7.2% in the UK. Britain nationalised two banks and still owns more than 50% of the Royal Bank of Scotland. Iceland went bankrupt and imposed capital controls. Government intervention was massive. By some estimates, globally it entailed more than $40trn in emergency loans, capital injections, and credit support and liquidity facilities.
One important legacy of the Global Financial Crisis is reduced policy flexibility for governments in the event of another shock to the world economy. In a future crisis, governments will be less able to effect favourable outcomes because of high debt levels and, in some cases, legal restrictions. Quantitative easing (QE) notwithstanding, uncertainty and volatility cannot be done away with, only transferred somewhere else. Or it can be postponed to a later date.
A further legacy of the Great Recession is large: the still unresolved eurozone crisis; 26.7 million people unemployed in the European Union (EU), and over 55% youth unemployment in Spain and Greece; on-going QE programmes in the US, UK and Japan and core inflation in the US and the eurozone that is uncomfortably low. The global financial system has dramatically restructured; the largest banks in Europe and the US, quite apart from write-downs, have allotted roughly $200bn for legal fees, litigation and settlements. Not to mention Basel III and Dodd Frank.
Moreover, sovereign debt/GDP ratios have ballooned over the past five years. A world in which a country’s debt-to-GDP can increase roughly fivefold (Ireland) in six years is clearly a world hard to forecast. And a world in which one country (Germany) consistently runs a current account surplus of roughly 6% of GDP is not a world in which the painful costs of adjustment are borne symmetrically.
A full understanding of the Global Financial Crisis therefore requires a perspective broader than macro or financial economics. Political Economy might be a start. As economist Ben Friedman argues, “One inescapable principle highlighted in the current financial crisis is that a democracy gets the regulation it chooses.” Investors must be ready for regulatory and political risks to gain further prominence.
Additionally, the relentless pace of technological innovation also creates networks which are difficult to analyse. Precisely because of the terrifying events of the post-Lehman panic, investors need to explore the most sophisticated techniques available.
Each investor may, of course, have a different interpretation of the causes of the Global Financial Crisis and draw different conclusions but, in light of the above, investors should consider:
1. More robust and detailed risk analytics.
2. More liability hedges.
3. A larger allocation to tactical asset allocation strategies.
4. Advanced beta techniques that reduce downside volatility.
5. Maintaining sufficiently liquid assets in the portfolio to meet cash calls and contingencies.
Ben Bernanke remarked in 2012, “We came very, very close to a financial meltdown.” As global investors assess prospective returns and risks over the next five years, they may wish to reflect on the events of five years ago. The best investors, consultant George Russell once remarked, have the right admixture of “arrogance and humility.”
George Hoguet is global investment strategist at State Street Global Advisors
Comments