What’s the next crisis?
Photo Alvimann. Source: Morguefile
It’s usually not the last crisis. People are ready for that. We’ve seen the challenges and dealt with them. The Euro crisis of 2011 was brought on by the perception that leaders and voters weren’t sufficiently committed to the common currency. It was dispelled by Mario Draghi’s “Whatever It Takes” speech, as well as popular votes around the Euro-zone. The Financial Crisis of 2008 was brought on by excessive lending to US homeowners, coupled with implicit leverage in our banking and money-market sectors. These were addressed by the Dodd-Frank financial reforms.
This is why lightning doesn’t strike twice: we see the problems and adapt our institutions to prevent their recurrence. That’s why generals are often accused of fighting the last war: they’re ready for the threats they’re aware of. Indeed, it would be foolish to ignore issues that you know about.
So what is the issue that no one thinks about, that no one is prepared for? It seems to me that the unrecognized threat is inflation. The last time we had an inflation crisis was in the early 1980’s, over 35 years ago. There are lots of reasons why inflation isn’t an issued now: automation and trade make labor inputs to inflation less important; financial innovations have disrupted monetary velocity; search technology makes it easier than ever for consumers to comparison shop. And all the folks who thought that the global monetary expansion implemented over the last ten years would lead to hyperinflation have been proven wrong — or at least, extremely early.
In addition, the current top policy-makers came of age during the inflationary ‘70s and ‘80s. They repeatedly say we “know how to deal with inflation”: strangle it with higher interest rates – and in the case of Zimbabwe or Venezuela-like hyper-inflation, turn off the government’s printing press. (Of course, these solutions may be technically effective but politically impossible.)
Dow Jones Industrial Average, log scale. Source: Bloomberg
But what if the next round of inflation isn’t caused by labor costs or monetary mischief? Economists and politicos will have to figure it out all over again. The solution to the next crisis won’t be found in file 265.83(a) in Ben Strong’s old office at the New York Fed. Solving the next crisis will require intellectual honesty, strategic ingenuity, and political courage to act when most people would rather hunker down. It will require leadership.
The time to buy straw hats is in February, and the time to get ready for a crisis is during the preceding boom. It may be many years before inflation shows up again, so you don’t want to over-insure. But economies always come unglued, eventually. “Man is born to trouble as the sparks fly upward.” (Job 5:7, and Peanuts)
Douglas R. Tengdin, CFA