After the dot com bubble burst — and after the post-9/11 U.S. military escalation — Washington engaged in fiscal and monetary activism that would culminate in the 2008 failure of the global financial system. Instead of changing tactics, Washington raised the stakes, taking on a lot more debt and printing a lot more money.
Since then, cycles of easy money policies have created a series of dollar liquidity summers and winters. Summers, or periods of abundant liquidity, are associated with greater risk-taking and higher asset prices, but they also foster excessive debt, bubbles and instability. Winters, on the other hand, are periods of less liquidity characterized by lower appetite for risk, bubble deflation and recession, but also by corrections of excess, repairs of balance sheets and restoration of confidence. Near the end of the third quarter of 2014, a winter set in, bringing with it falling commodity prices, cracking currency pegs, fearful corporate bond markets and volatility on Wall Street.
The recent convulsions in Chinese financial markets have only made things worse. Beijing appears wholly amenable to keep pumping more credit into the system without regard for the consequences, although this time its citizens and the markets are unconvinced that such aggressive policy stimulus will work. The veneer of Beijing's efficient, competent and formidable autocracy is cracking, chipping away at China's strategic ambitions and the integrity of its currency in the process.
And problems for the United States and China mean problems for the stability of the international currency system. When reserve currency control became a matter of privilege rather than responsibility, it sparked a chaotic battle in the global financial system. This struggle has now become a morass of inflationary monetary expansion and geopolitical clashes as nations pursue incompatible currency objectives. Those clashes, in turn, have yielded widespread financial instability, weakening the state-centric currency model that has dominated decentralized market-centric monetary innovation for around 100 years. Digital currency technology is now making a subversive assault on nationalized currency that could radically change the monetary landscape, the politics of monetary control and state power itself.
Threats for Some
Winter has not ended, and the investors, markets and economies that became complacent during the previous summer cycle are likely to find themselves more exposed to tighter liquidity conditions. In the United States, threats to financial stability have manifested in many sectors: student loans, corporate leveraged loans, vehicle markets and mergers and acquisitions as well as biotechnology and social media. Each of these sectors boomed in times of easy financing but are now more vulnerable to tightening liquidity. For example, since the recession ended in 2009, the amount of student debt has nearly doubled and now stands at about $1.3 trillion. Meanwhile, college tuition has soared. The higher costs, combined with bleak job prospects for graduates, have made conditions ripe for a high rate of default. The entire college economy may be vulnerable, from credit and business risk to the universities themselves and the industries that support college towns.
Elsewhere, mergers and acquisitions in the global biotech industry surged by 270 percent in 2014 and rose by another $500 billion in 2015, increasing their share of total mergers and acquisitions from 6 to 13 percent. This current biotech bubble resembles those in the telecommunications sector in the late 1990s and in the retail and banking sectors at the end of the 2000s. All of these sectors experienced surges in mergers and acquisitions as global liquidity became scarcer. In another risk-laden sector, U.S. sales in lightweight vehicles have returned to historic highs of around 17.5 million units per year, thanks to a 21 percent increase in automobile debt per capita since 2007 and the growing portion of sales funded by subprime automobile loans. Though perhaps not posing the systemic risk of subprime mortgages, subprime automobile delinquencies are becoming more common, posing a growing threat to the United States' trillion-dollar auto loan portfolio and the market for new vehicles, which turns over about half a trillion dollars each year.
In the meantime, contagion from crashing oil and natural gas prices has yet to run its course. Junk energy bonds continue to hurt the total junk and leveraged loan markets. At the same time, the economy is still feeling the effects of credit contagion on upstream and downstream energy service industries and government finances that rely on energy revenue. The collapse of oil prices has exposed the poor economic management of many oil-producing countries, where currency pegs are at risk of breaking or, in some cases, have already broken. Nigeria has been forced to devalue the naira, and Saudi Arabia might have to follow suit with the riyal before long. Africa, in particular, has been hit hard by the steep dive in energy prices, and exploration for new oil and natural gas reserves has dropped off precipitously. Latin America has not fared much better; the latest winter cycle and low oil prices have hastened the slide of the Venezuelan economy to the brink of a hyperinflationary catastrophe.
Of course, what hurts the energy sector and deepens sovereign debt also damages the financial sector, too. In Europe, banking risks are rising, a situation worsened by negative interest rate policies and a flattening term interest rate structure. Then again, the drastic suppression of interest rates might be the only thing keeping investors from lumping debt-laden France in with the rest of the eurozone's peripheral members.
Real estate could face some serious problems as well. Easy money policies and the flight of Chinese capital into desirable property around the world have made the real estate market a potential flashpoint for financial crisis worldwide. Residential and commercial property sectors in Canada, the United Kingdom, Scandinavia and Australia are arguably in the midst of mega-bubbles that any number of events could burst. If these countries' central banks attempt to counter the bubbles' deflation and prop up their markets with extremely loose monetary policies, their currencies might bear the brunt of the resulting pain and depreciate even further.
Opportunities for Others
Still, this is not to say that the effects of the winter cycle will be all bad. Latin America might look fragile at the moment, but it is well-positioned to bounce back from its current troubles. Structurally, the region's largest economies have either made great strides in becoming more liberal or are on the cusp of shifting away from the leftist tide that swept Latin America in the late 1990s. And because the markets have already adjusted to account for poor regional performance, spurring currency and stock sales in the process, rising interest rates are generating returns at a time when much of the developed world's yields are plunging. Latin America also has geopolitical stability to offer, something that is being increasingly factored into economic risk calculations of late.
Other types of currency, including gold and cryptocurrencies, also stand to do well. These kinds of assets can capitalize on messy currency skirmishes among nations, skirmishes that take their toll on the current monetary order. The gold mining sector, which has been beaten down in recent years, is already starting to recover and could see impressive returns in the years ahead. Meanwhile, private investors are pumping money into blockchain technology, and though a financial crisis could stem these funding flows somewhat, cryptocurrencies and blockchain technology seem likely to experience high levels of growth over the next decade.
In health care, new niche technologies will continue to outperform their competitors in today's graying society, especially those that aim to extend lifespans and combat diseases related to old age. Robotics is also an exciting opportunity for growth, as are technological advances in transportation and infrastructure, which will be aided so long as commodity prices remain low.
Finally, after a prolonged retreat in emerging markets, this year may prove to be a turning point, featuring fresh opportunities for investors looking to borrow money at low interest rates to invest in assets with high returns. For that to happen, though, the developed world's core economies — especially that of the United States — will have to first loosen their monetary policies considerably.
If the United States' grand gamble fails, the international monetary system should brace itself for significant and destabilizing change. Moreover, as the effects of this winter cycle's tightening liquidity spread, it is unlikely that commodities and emerging markets will be the only bubbles to pop. Beijing's debt, for one, remains a threat to both China and the rest of the world, particularly as the Asian giant becomes more integrated with international markets than ever. The uncertain future of the U.S. dollar adds to global financial instability and enhances the prospects of an ugly transition, the effects of which could create as many risks as opportunities. The next decade is poised to be every bit as remarkable as the last.