The financial cycle refers to a co-movement between asset prices and bank lending. While asset bubbles can definitely emerge themselves (just look at the recent Gamestop and Bitcoin stories), thanks to positive feedback loops that are inherent to these markets, when the banks join in … you better hide because that’s when they can get truly dangerous.
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5 BOOKS THAT INSPIRED THIS CHANNEL
The Narrow Corridor: States, Societies, and the Fate of Liberty: https://amzn.to/3gr6pSV
Money Changes Everything: How Finance Made Civilization Possible: https://amzn.to/3mt3xbY
Adaptive Markets: Financial Evolution at the Speed of Thought: https://amzn.to/3sCkS3a
House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again: https://amzn.to/3gqXNeZ
The Third Pillar: How Markets and the State Leave the Community Behind: https://amzn.to/382Agwo
There are two elements to the financial cycle story:
1) The first is that of rising asset prices, primarily houses, but also stocks.
2) And the second is that of rising debt to GDP. Or increased bank lending.
The biggest and most recent episode of a financial cycle happened in the United States and it started … right around 1996. In this year both the level of debt compared to the size of the economy (also known as credit to GDP) and inflation adjusted house prices started to pick up. And up and up they went. And as they went up… the people were happy, the sky seemed the limit. If you want to get rich, just buy a house.
And the banks? They were more than willing to lend. After all, if a borrower could not repay the loan, he or she could sell the house. Since the price could only go up, the house sale would always yield enough money to repay the loan….
Now at the same time, it so happened that the economy was doing really well. Even a big stock market crash in 2001 could not stop the party. After that stock prices also started to pick up until….. in 2006 house prices started dropping. Then in 2007 stock prices followed, and in 2008 everything came crashing down and the world faced its biggest banking crisis in a hundred years.
Currently banks are far better regulated and are less likely to have pumped up asset prices such as those of stocks like Tesla, and Nvidia, but also about crypto assets like Bitcoin and Ethereum.
This video has been inspired by work from economists at the Bank for International Settlements such as Claudio Borio. I’m also using it in a course that I am teaching at the University of Groningen called International Financial Markets that I teach with prof. Dirk Bezemer.
Want to know more? Watch the video, or read it all in the script here: https://www.moneymacro.rocks/2021-01-27-domestic-financial-cycle/
Narrated and produced by Dr. Joeri Schasfoort (University of Cape Town)