President Trump's recent nomination of a number of senior Treasury officials including David Malpass and Adam Lerrick, who are known for their antipathy towards the International Monetary Fund, suggests that he might wish to clip the wings of that organization. Before he yields to any such temptation, he might want to reflect on the fact that there is a high probability that during his administration he will be confronted with a global economic and financial market crisis that will require a large and proactive IMF for its early resolution.
Heightening the chances of a full-blown global economic and financial crisis within the next three years is an unusual confluence of adverse factors. These include the fact that the world economy is now drowning in debt, which is being grossly mispriced by the markets in the sense that investors are not nearly being adequately rewarded for default risk. At the same time, there appears to be no shortage of fault lines in the global economy, with several of these fault lines concentrated in countries of systemic importance. If the past is prologue to the present, the Trump administration would ignore the present confluence of these risks to the global financial system at its peril.
ANOTHER MINSKY MOMENT?
Barely nine years after the 2008-2009 global economic and financial crisis, market participants appear to have forgotten economist Hyman Minsky's basic message. This is all the more surprising considering their near-death experience during that crisis. Minsky taught that when markets become overly complacent about future economic growth prospects, they take on too much risk. When they do so, they set up the very conditions for the next economic and financial market meltdown.
Had Minsky been alive today, he would no doubt have noticed the extraordinarily easy global monetary conditions of the past several years. Indeed, he could not have failed to be struck by the massive balance sheet expansions of the Federal Reserve, the European Central Bank, the Bank of England, and the Bank of Japan. Since 2009, the combined balance sheets of these banks increased by more than US$10 trillion as they engaged in highly unorthodox monetary policies to prop up their faltering economies.
Minsky would also almost certainly have noted that years of extraordinarily low policy interest rates had pushed investors to stretch for yield around the globe. They did so as interest rates on long-dated government bonds were reduced to...