Peter Brown: This economic crisis is very different to 2008, but more complex

Russia, China, energy, interest rates, work force shortages, supply chain shortages, and climate targets are all contributing to a complex soup of economic influences.

From an Irish perspective, it is not that easy to see we are in a deep global economic crisis. We are experiencing the effects of inflation, but outside of that, growth is strong, tax receipts are stellar, and we have full employment. Globally, the crisis is far more complex and extremely worrying.

Back in 2008 the crash was due to too much debt. Banks crashed and asset prices fell hard. Many experienced extreme hardships but the markets bottomed out in March 2009, a short correction.

From there, stocks rocketed up until to December 2021. Central banks printed massive amounts of cash and lowered rates to enable the recovery. It was easy for an investment manager to advise clients on buying stocks and bonds.

Fast forward to the present crisis and it is very different. Debt levels are much higher than in 2008 but this is not a debt crisis as interest rates are still low, which makes borrowings manageable.

The core of this problem is inflation. High inflation caused by central banks' excessively loose monetary policies, Covid shutdowns leading to global supply chain issues, war in Ukraine, and energy and food prices soaring.

Inflation has caught everyone by surprise. For more than a decade the ECB tried to raise the rate of inflation from 0.5% to 2% unsuccessfully. Now the genie is out of the bottle and anyone who was around in the '70s knows inflation is a devil to control.

Cure to inflation

The cure to inflation is to raise rates to slow consumer demand. This has the risk of causing a recession and, worse, another debt crisis.

Current interest-rate levels are not enough to subdue 10% inflation, but 3% or 5% rates would be more appropriate. 

In the US rates, have risen this year to 2.5% and are expected to rise further, maybe up to 4% by year-end. The big debate over there is whether the Federal Reserve will continue to raise rates with a firm eye on the inflationary fight and ignore the possibility of causing a deep recession.

In Europe the ECB is slow to raise rates due to the energy crisis so, in the meantime, inflation roars. However, we saw the first rate rise of 0.5% in July and can expect further increases by year-end.

The current extreme debt levels are corporate and sovereign; personal debt and mortgage debt are not concerning. We are not facing a 2008 banking crisis this time. 

The ECB is already supporting Italian bonds, which is a worry, and the Irish Government’s borrowing cost are up nearly 2% so far this year. The cheap money is running out.

With interest rates on the rise, we expect to see further losses to US stocks, despite the recovery from the heavy losses in the second quarter. 

US companies have serious debt levels and are expected to struggle as rates rise. It is not the stocks that have fallen that will recover but the ones with low debt that will prosper.

Reeling from inflation

In Ireland we are reeling from the effects of inflation. In truth, there is massive price gouging taking place — just look at the profits of the energy companies. Other goods that have no real reason to rise in price are showing increases of more than 10%.

We are in an environment where nobody is questioning price increases, so everybody is doing it. Inflation is the great excuse to increase profit margins. That will result in wage demands, which, when conceded, imbed inflation into the economy.

Where we go from here is a much more complex analysis than 2008. Russia, China, energy, interest rates, workforce shortages, supply chain shortages, and climate targets are all contributing to a complex soup of economic influences.

What is certain is that inflation will stay stubborn for some time, interest rates will rise, and markets will stay volatile.

Peter Brown is managing director of Baggot Investment Partners