Credit Cycles & the Rise of Inequality, Populism and Trade Protectionism
Where are we headed socially and economically
Economic cycles are inevitable..and we seem to be on the verge of a new one in the coming year or so (no one can really say), so it pays to understand the fundamental forces that drive a cycle and what has the world been suffering from in this past decade.
The Credit/Debt Cycle
A credit cycle describes the stages of credit availability to borrowers. Credit cycles first go through periods in which money is available and easy to borrow; these periods are identified by lower interest rates in the market (influence by the central bank) and less lending requirements, which stimulates a general expansion of economic activity.
These periods are followed by a contraction in the availability of funds as risks to the financial institutions start increasing prompting the central banks to start increasing interest rates. Also, lending rules become more strict, meaning that less credit is available for business loans, home loans, and other personal loans.
The contraction period continues until risks are reduced for the lending institutions, at which point the cycle bottoms out and then begins again with renewed credit.
Credit/Debt cycles occur on short term (7–10 years) and long term (70–100 years) scales.
When an economy is bloated with debt and faces a rescission, it’s time for the economy to pay-up/reduce the debt burden. There are mainly four ways for governments to take action:
Cut spending: people, businesses and government cut spending (2011 austerity measures in Greece, Italy, Spain, Ireland,..)
Reduce debt: through defaults and debt restructurings, the amount of debt in the economy decreases
Redistribute wealth: usually by increasing taxes on the rich to fund government spending for social security and projects. The first three measures are deflationary (i.e reducing economic activity) and create a lot of political unrest due to to the people feeling less well off (poorer).
Print Money: the central bank starts printing money to stimulate spending and maintain a healthy inflation to balance the first three deflationary tools
The Widening Wealth Gap
The problem here is, that most of the measures mentioned, benefited the holders of financial assets which are disproportionately the rich in the society. This has led to a rising wealth gap in most countries ever since.
These indicators may help us understand a few sociopolitical trends that have started rising ever since, mainly trade protectionism and populism/nationalism.
The Rise of Populism
In data released back in March 2019, the international network of academics have highlighted the extent of the rise in populism in the past two decades by analyzing speeches — through textual analysis — by key leaders in 40 countries during this period.
The research reveals that this latest wave of populism — fueled in part by the international financial crisis — has cast a bigger footprint than perhaps ever before. As a result the data indicates that some 2 billion people are today governed by a “somewhat/ moderately populist”, “populist” or “very populist” leaders, an increase from 120 million at the turn of the millennium.
Taking the US as an example, we can see the impact of the wealth gap on the rise of populism as it compares to the 1930s right after the great depression.
Trade Protectionism and the Decline of Globalization
The system of rules and regulations that has governed world trade for decades is under threat today.
US President Donald Trump has shaken the foundations of global trade, slapping steep tariffs on billions of dollars’ worth of goods from the EU, Canada, Mexico and China.
Many experts believe that the pace of globalization had accelerated so much in the period starting from 1990 to 2007 that the global economic crisis that happened in 2008 revealed the drawbacks of too much integration, interconnection, and interdependence. This is seen by many as the inevitable consequence of globalization going too far and hence, there are a need for greater autonomy in the countries affected and a need for local and less global structure of the economy.
This has naturally drawn a backlash from those affected by foreign competition and the sudden flight of capital in the aftermath of the crisis. Further, the fact local industries were dying as result of the skewed playing field that proved to be advantageous to foreign companies instead of local companies meant that the domestic industry and the workers employed in them were being hit. Naturally, the backlash against globalization was severe in most Asian countries except China.
Further, there were many who pointed to a select few benefiting at the expense of the many and hence called for greater protection to local companies and local industry and not for foreign companies alone.
From what it looks like, the world is getting more polarized and moving slowly and gradually towards closing the economy with trade protectionism, blaming minorities for economic troubles (Britain, USA,..) and populism and nationalism.
It pays to stay aware of these rising trends in the global economy in order for us to make more sane and rational investment decisions in the coming years.