After 1987 and 2008, will 2023 be the next year of recession?
In 1987, the world financial market became a bloodbath. And thirteen years ago in 2008, the global banking system came close to collapsing. Economists are always searching for warning signs, but still, they’re often blind-sided by recessions. Now it’s on every economist’s mind – is another financial crisis looming in the year 2023?
Looking to the past
The 1987 crash was a huge shock. In hindsight, it is thought to have been caused by a mixture of computer trading models, a new insurance strategy and then investor panic. Most of the world markets were deeply affected by it, but New Zealand’s recession was notably long and deep. Our decline extended even after other markets had recovered and spilled over into other parts of our economy.
The sub-prime mortgage crisis in 2008 started with one bad decision by the US government. It deregulated the finance industry, which allowed banks to engage in hedge-fund trading without any underlying assets attached. Sub-prime mortgages (mortgages for people with low credit ratings), were then needed to support these trades, and with cheap sub-prime mortgages available, demand for houses skyrocketed and created a housing market bubble. The bubble popped in 2007 when the banks increased interest rates. Mortgage holders couldn’t afford repayments and with no more housing demand, they also couldn’t sell. The US government spent around $500 billion on bailouts for the big companies, but they still didn’t avoid a global recession.
What’s going on now?
After the turmoil of the past two years due to Covid. the world was hoping that 2022 would be calmer. However, in the past few months, many banks have started to worry that the risk of an economic downturn is rising, and that the economy could go into a recession in 2023.
First, the Bank of England, the US Federal Reserve and the European Central Bank were recently caught off-guard by a huge increase in inflation. This was predominantly caused by rising energy prices, labour shortages and supply chain inefficiencies. The Bank of England has predicted that the cost of living will increase by more than 5% by April.
Another major red flag was the recent 30% drop in the Turkish Lira. It has worried economists that there may be danger ahead for poorer countries. Many emerging markets have been borrowing a lot of money against the US dollar, and when the US Reserve decides to tighten policy, it may be more expensive for those countries to repay their debts. This could lead to a cooling of the global economy and the World Bank has already warned there will be an increase in debt concern, where a country is unable to pay back government debt.
Despite COVID-19, the worldwide economy has been steadily recovering, surpassing expectations. Households and businesses sustained a surprising amount of spending during lockdowns and other restrictions. Asset prices have risen throughout the pandemic because of lower interest rates and financial aid programmes from governments that have made it easier to borrow money to invest. However, in the past few months, economies around the world have finally started to slow after the initial catch-up. This weaker activity, coupled with high inflation rates, means central banks will need a more tight monetary policy and, just as in 2008, the crutch that has been supporting over-valued assets will be gone.
Russia and Ukraine war
officially started on 24th February 2022 and has since caused the stock markets a lot of turbulence. Russia is the second-largest exporter of crude oil and the largest natural gas exporter, and prices have already spiked. Without an easy supply of these fossil fuels, we could see life getting increasingly expensive. It is still unclear what the full consequences will be, but it is likely the war will lead to another rise in inflation.
On Thursday, 17th February 2022 the S&P500 banking index was down 3%, thought to be due to the Russia and Ukraine tension. Chief Financial Officer of Morgan Staley, Sharon Yeshaya said banks have seen “a lot of uncertainty in the marketplace over the past couple of weeks. At this point it doesn’t feel like the first quarter of 2022 is going to be the same as in 2021.”
Fear of recession is in the air
With all this market uncertainty, the economy could certainly be in danger of the next bad recession. However, we are still waiting to see where the interest rates go and what impact that will truly have. There are too many things at play to ever know for certain, and big decisions affecting the economy are made behind closed doors.
What could this mean for the New Zealand economy?
If a global financial crisis is inevitable, New Zealand is too small to prevent it, but it would be wise for our government to prepare by reducing public and private debt as much as we can. Arthur Grimes, former Reserve Bank of NZ chairman, fears that “central banks have placed New Zealand at greater risk of an asset price collapse with ensuing economic pain. The risk is heightened by unsustainable fiscal and monetary policies globally.”
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