How to predict the economic crisis? | R Blog RU


The history of the behavior of markets and the development of the world economy shows that when it comes to economic crisis, then it will obviously not be the last – another one will surely begin after it, which will not be similar to the previous one.

According to economists and politicians, this is a serious problem that poses a threat to all countries of the world. The financial crisis is taking its toll on the way people rely on financial institutions every day. Banks provide loans and credit cards so that customers can afford more and make the buying process as convenient as possible, insurance companies protect houses and cars from damage or theft, and in times of crisis, all this is paralyzed and collapses like a house of cards, including the stock markets …

In this article, we will look at the striking economic crises of the past and try to find signs that indicate the formation of another crisis in the future.

2008 economic crisis

After the end of the next financial crisis, its consequences are felt for decades. If we consider examples from history, then the economic costs of any crisis reach 80% of GDP; some estimate it at $ 25,000 per citizen.

If we take a close look at the 2008 crisis, which is rightfully considered one of the most difficult of all time, we will see that companies from the financial sector closed, and the rest were so damaged by it that private business could not receive the necessary funding to survive in these difficult conditions. Economists point out that this is the deepest recession in the economy since the Second World War.

Ultimately, such a collapse in the economic system provoked a serious drop in income and wages of the population, a decrease in jobs, and also completely blocked access to credit for people.

Why is there an economic crisis?

In the markets, we can constantly observe either a fall in the dollar, or a collapse in oil prices, and all this is associated with the emerging problems in the economies of individual countries. There are many reasons that can provoke another crash, and some of them seem completely absurd.

As an example, investors recall the Tulip Mania, which erupted in 1636 in the Netherlands. As the price of tulip bulbs rose, people spent all their savings and bought these bulbs. At some point, the price stopped growing and began to fall aggressively, which led to incredible losses and a general slowdown in the growth of the Dutch economy.

The 2020 crisis, also called the “Pandemic” crisis, was triggered by the appearance of a coronavirus infection. Everywhere there was a colossal decline in economic activity, a maximum increase in unemployment and a record decline in household income.

In the first case, we see the so-called “crowd effect”, when massive investment in one industry by private investors, fascinated by euphoria, inflates a bubble that bursts and damages the entire economy of the country. The phrase “when a shoe shiner starts buying stocks, it’s time to leave the market” comes in handy.

In the second case, a completely random cause led to a halt in economies around the world with oil futures falling below zero, which is a record decline in the history of commodities.

13 years after the crash Lehman brothers the global economic and financial system has become more secure and resilient. As you can see, the rise of the stock market in March 2020 became a record for the speed of recovery. Traders love to buy deep retracements, and the pandemic has forced unemployed people to look for new sources of income. Banks and the government made decisions as quickly as possible to deal with the economic crisis in a pandemic.

However, there are already new risks to financial stability, which will continue to emerge as it develops. Technology is having an incredible impact on financial services, and it must be the responsibility of banks and governments to monitor and influence the impact of new asset types and financial technologies on the global economy.

Today, more and more people who are willing to take risks in order to get maximum income are gaining access to financial markets. These investors unite in communities and are able to aggressively move stock prices, which is only worth the example of GameStopwhen a group of frequent traders was able to counter an entire hedge fund. Such actions can lead to the next “Tulipmania”.

How to predict the economic crisis?

There are several options for making such forecasts, some of which we have already described in our blog.

Time Cycles

A collapse in the stock market and a strong rise in the US dollar occurs every 10 years. After the collapse of the Dow Jones stock index in 2008, a similar fall occurred in early 2020.

Dow Jones Index Chart

Consequently, with a small time lag, we get another crisis, which is calculated according to the time cycle of formation. Based on this theory, the next crash can be expected in the period from 2028 to 2030. And the current rally in the stock market is probably only gaining momentum.

Leading Economic Development Index (LEI)

Composite economic indices act as a signal for identifying peaks and troughs in the business cycle. They are designed to generalize and identify common patterns, turning points in economic data, which can help determine the formation of a crisis. This index includes such indicators as the average working week, the average number of initial applications for unemployment insurance, new orders from manufacturers, as well as evaluating the behavior of shares, building permits, average consumer expectations from the business environment, interest rate spread, and so on. Further.

LEI Index

It is believed that this indicator was able to predict almost all crises in the United States in recent years. However, there were also false signals: the index may show the approach of the crisis in a few months at the moment when there is a reversal from growth to fall in values.

Fear and Greed Index (VIX)

This is the name of the Real-Time Volatility Index created by the Chicago Board Options Exchange (CBOE). It is calculated using the option prices of the S&P 500 Index and reflects expectations of volatility. If the value VIX is rising, there is a high probability that the stock market S&P 500 will fall, and if the VIX is declining, then the S&P 500 is likely to move up.

VIX Index

Essentially, the VIX helps gauge the sentiment of investors and the market in general. If the values ​​of the index fell below the level of 10, this indicates a high probability of an approaching crisis, and if its values ​​rose above the level of 40, then we can speak of the end of the crisis.

Difference in bond yield

Analyzing the yield on 2-year and 10-year US Treasury debt securities, one can also predict an economic crisis. Economists talk about the approaching crisis at a time when the interest on 2-year bonds begins to exceed the yield on 10-year bonds. This is defined on the chart as falling below 0.

US Treasury Bond Yield Chart

After such behavior, another crisis begins within a year or two. We see this at the moment the chart fell below 0 at the end of 2006, after which the crisis began in 2008. The next fall was already in the middle of 2019, and the next collapse of the markets occurred in early 2020.

Hyman Minsky’s theory

Hyman Minsky, an American economist who became especially popular during the 2008 financial crisis, identified three stages of lending, which ultimately give rise to an economic crisis. He called these stages:

  • Hedge
  • Speculation
  • Ponzi

In the Hedge phase, banks and borrowers are especially careful. Loans are issued in small amounts, and the borrower, in turn, has the opportunity to pay both the interest on the loans and the entire amount of the debt. As confidence grows, banks increase the size of loans on which the borrower can only afford to pay interest.

As a rule, the amount is issued for an asset, the value of which is growing, this will be the second stage, it is called “Speculation”. Banks and borrowers seek to earn as the value of an asset rises.

When the previous crisis remains a kind of distant memory, the next stage begins, called “Ponzi”. At this stage, banks are already issuing loans for which the borrower is unable to pay either interest, much less the principal amount of the debt. As the value of the asset rises strongly, both borrowers and lenders calm down. All this is supported by the belief in the endless growth of the asset in the future.

You can compare this phenomenon with a mortgage, when payments are not made for the first few years, and the borrower hopes that the cost of housing during this time will rise so much that the subsequent sale will pay both the missed interest and the entire amount of the debt. But as soon as the asset stops growing in value, banks and borrowers understand that there is debt in the system that will not be repaid. People in a panic sell assets, which provokes an even greater drop in the value of real estate, and this translates into another economic crisis.

Conclusion

Unfortunately, economic crises have been in the past and will continue to appear in the future. Most likely, each new such event will not be similar to the previous ones. However, there are some interesting signals that indicate a new economic crisis is approaching, which makes it possible for the experienced investor to exit the stock market and buy the US Dollar and Gold.

One of the easiest ways to identify a crisis in advance is to analyze bond yields: this chart accurately predicted the moment of the last two major crashes in the Dow Jones and the stock market. The method is simple and at the same time informative and working.

The theory of Hyman Minsky is also interesting with the stages of lending, when investors and borrowers lose their vigilance and fixate on the growth of the asset, which also leads to the next collapse of the world economy. But in this case, it is not enough to look at the curve of the graph, but you need to delve into economic processes and monitor the behavior of investors in the markets so that you do not accidentally find yourself in the place of a “Ponzi-investor” who buys up everything that grows with credit money.


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