On Tuesday, the American Enterprise Institute (AEI) convened a panel of financial experts to discuss what might cause the next economic collapse.
Moderator Paul Kupiec, a resident scholar at AEI, began by pointing out perceived flaws in existing analyses of global markets. While more than 60 countries and multinational organizations compile reports on financial vulnerabilities, Kupiec argued that those reports are inevitably filtered through a political lens and tend to exclude threats that “could be traced to a policy or an institution controlled by the reporting agency.” He suggested that the empaneled speakers were better equipped to examine threats to global markets given their freedom from bureaucratic constraints.
“While their conjectures are as speculative as any vulnerability identified in an official financial stability report, unlike official financial stability reports, they have the freedom to identify government policies and regulatory shortcomings as vulnerabilities,” Kupiec said.
The first panelist to speak was Alex Pollock, distinguished senior fellow at R Street Institute, a free market think tank in Washington, DC. Pollock mentioned several possible causes of the next financial crisis, including errors in judgment by the world’s central banks, a housing-market collapse, a future pandemic, or war. He cautioned that a crisis could be caused by a factor that “nobody sees coming,” which would inevitably hamper state response.
“If the next crisis is again triggered by what we don’t see, the government reaction will again be flying by the seat of their pants, making it up as they go along,” Pollock said.
R. Christopher Whalen, the chairman of Whalen Global Advisors, spoke next. He identified runaway inflation as the key threat to the American financial system, a system that he claimed “is based on inflation.” Whalen argued that there is a tendency in modern American politics to assume that there are no “limits” or trade-offs associated with pursuing inflationary fiscal and monetary policies.
“In peacetime, since the end of World War II and the Korean War, the United States has taken on the same hubris and arrogance as Rome and other great states that have come in the past, thinking that we can do anything, and that we have no limits on our actions, that there will always be a market for treasury bonds, and there will always be demand for dollars as the global means of exchange,” he said.
Whalen also identified another round of potential COVID-19 lockdowns as a looming threat to the American economy.
Ehud Ronn, a professor of finance at the University of Texas at Austin, was the third panelist to speak. He delivered a presentation on oil-market volatility and the possibility that a future oil-supply crisis could precipitate a financial collapse. Ronn used government data on American oil production and strategic reserves to argue that the United States could be thrown into a financial crisis if geopolitical tensions in the Middle East impede America’s ability to import oil.
Jerry Dwyer, professor of economics at Clemson University, spoke next. He echoed Whalen’s argument that inflation posed the preeminent threat to American financial markets. He identified exorbitant federal spending and Federal Reserve policy as potential catalysts for runaway inflation.
“The [effect of the] increase in the nominal quantity of money, which the Fed can’t take back without changing monetary policy’s structure very, very substantially in a way that is probably not politically feasible, is prices are going to rise, like, 20 to 30 percent over the next few years. We’re just seeing the start of it,” Dwyer said.
He then argued that price levels are lower than they would be if firms and individuals were accurately assessing the threat of inflation.
“One of the things that’s going on right now is people aren’t raising prices, firms aren’t raising prices, because they think inflation will return to two percent. They are mistaken,” Dwyer said.
Dwyer also argued that inflation will affect the value of debt and therefore cause distortions in the housing and credit markets. Those distortions could portend a recession, he said.
“[Inflation] is going to lower real GDP as it did in the Seventies. How are you going to get out of it? Well, you’re going to have a big recession, possibly much worse than the Great Inflation of the 1970s,” Dwyer said.
The fifth speaker was noted author and economist Ed Kane, who claimed that rise of “ultra-nationalis[m]” poses a significant threat to international markets. He called the system ofinternational financial institutions “fragile” and argued that the failure of one big bank could spell trouble for them all.
“This is a recipe for disaster if the U.S. decides they are not going to help the foreign banks,” Kane said, referencing the possibility of a future nationalist president.
The final speaker was Rebel Cole, a finance professor at Florida Atlantic University. Cole set forth a disaster scenario in which inflation causes so-called “bond-market vigilantes” to end the “era of zero-interest-rate policies” and thereby sparks a financial crisis. He argued that President Biden’s proposed infrastructure plan could be the first step toward an economic downturn.
“In my scenario, a financial crisis is precipitated by the passage of the proposed six-trillion dollar infrastructure package currently being debated on the Hill. This is at a time when inflation is running at more than six percent. Just earlier this month we learned the May 2021 PPI – Producer Price Index – rose by 6.6 [percent] year over year, the largest increase in record since the statistic was created in 2010,” Cole said.
The panelists closed the event with a discussion of the state of the American economy. While most agreed that inflation was a leading threat to domestic financial markets, Jerry Dwyer insisted that analysts should be wary of the unknown.
“It’s what you don’t see that’s going to hit you,” he said.