Economists are warning that the next financial crisis has already started. They believe history is repeating and that, once again, the world economy is in danger – perhaps even more so than the 2008 global meltdown. In 2008, the economic collapse started with the bankruptcy of the Lehman Brothers bank, ultimately affecting every country in the world. Today, with inflation, massive corporate debt, the COVID-19 pandemic, and the prospect of rising interest rates, many economists believe the global economy is in serious trouble.
The 5-year break-even inflation rate recently reached 3.11 percent, which is the highest reading since about 2003. It’s certainly higher than it was in 2011 when inflation caused a global food crises, and it’s higher than in 2005/06 when oil was ready to explode to a whopping $150 a barrel and the real estate bubble was at an all-time high.
Basically, the financial system is warning us that inflation is scaring investors and that something awful is on its way. What makes it worse is that it appears the Fed will find it really hard to stop this.
Consider this: It was back in 2005-06 that 5-year inflation break-evens were anywhere near this level, and at that time the financial system and economy were on the brink of the worst financial crisis and recession in more than 80 years. But the situation is a lot worse this time because back then the Fed had interest rates sitting at 5 percent and the economy was growing by 5-6 percent, meaning there was still room left to cushion the collapse.
Today, however, due to the 2020 lockdown and its after-effects, the Fed still has rates sitting at zero and the economy is structurally crippled. You may think we have a strong economy, but it should be considered that the Fed admits it will be at least the second quarter of 2022 until it can raise rates.
So, the question is this: What type of economy requires rates at zero to operate?
There’s yet another difference between today and the 2005-06 period and that is the Fed had not launched one single QE program back then. This means the impact of QE was still fairly strong.
Today we see the Fed already committed to a QE program worth $120 billion – and this is not tipped to finalize until midway through 2022. In simple terms, in 2005 and 2006 the Fed enjoyed a much stronger position, allowing it to fight against a financial crisis or a collapsing economy. However, the situation is much different this time. The Fed has already made use of every device available to it – and this includes some devices that it should not be permitted to use, such as buying municipal and corporate debt.
The big question remains: What will the Fed do next? Will they send the monthly QE as high as $500 billion? Will they even consider cutting rates so low that they move into the negative? What happens when the bubble bursts once again? Only time will tell.