In 2009, the International Monetary Fund (IMF), along with most other economic forecasters, was caught flatfooted by the global economic and financial market meltdown that occurred in the wake of the Sept. 2008 Lehman bankruptcy. The IMF’s main mistake was to ignore the likely world financial market consequences of the bursting of the U.S. housing and credit market bubbles.
Today, the IMF seems to be setting itself up to make the same forecasting mistake. It is doing so by downplaying the global financial market fallout that must be expected from the likely bursting of a global “everything” asset and credit market bubble that is much larger than it was during the earlier U.S. housing market bubble.
The IMF’s rosy world economic outlook is all the more surprising considering how very much more indebted the world is today than it was in 2008. It is also all the more surprising considering how very likely it is that an overly expansive U.S. fiscal policy will cause bubbles to burst soon by driving up U.S. interest rates.
To its credit, the IMF is now sounding the alarm about the likelihood of an imminent debt crisis in the emerging market economies, which now constitute around one half of the world economy. Indeed, IMF Managing Director Kristalina Georgieva is warning that a tightening of global financial conditions being led by rising U.S. interest rates could trigger a significant emerging market capital outflow. That, in turn, could pose major challenges, especially to large middle-income countries such as Brazil, South Africa and Turkey with large external financing needs and elevated debt levels.
The IMF is also to be complimented for highlighting other major world financial market vulnerabilities at a time of rising U.S. interest rates. Not only is it warning of the dangers of excessive worldwide corporate and household leverage in the wake of the pandemic. It is also pointing to the fact that global equity valuations are very stretched and that serious financial market problems could result from a badly damaged real commercial sector as a result of a more digitized world.
Despite seemingly being aware of the global “everything” asset and credit market bubble as well as of the financial market vulnerabilities that these bubbles entail, the IMF is choosing now of all times to upgrade its world economic forecast. Never mind that since the start of this year, U.S. Treasury bond yields have been rising at as fast a pace as they did during the 2013 Bernanke taper tantrum. Never mind too that the excessive Biden budget stimulus and unusually large pent-up household demand risks inviting the bond market vigilantes to drive U.S. Treasury bond yields ever higher.
The main failing of the IMF economic forecast is that it is overly focused on the boost that the Biden budget stimulus might provide to the U.S. economy rather than on the risk that the Biden stimulus might drive up U.S. interest rates. This blinds it to the likelihood that global liquidity could tighten soon in a manner that would burst the global “everything” bubble.
The IMF would also seem to be failing to ask a very basic question. If the bursting of the U.S. housing bubble triggered the Great Recession of 2008-2009, why will the bursting of today’s very much larger “everything-bubble” not do something similar as global liquidity conditions tighten? This question is especially pertinent at a time of record-high global debt.
All of this must make one wonder whether by being overly optimistic precisely at the moment that the world economy could go pear shaped, the IMF is not running the real risk of seriously damaging its credibility. Similarly, one must wonder whether the IMF might not better serve the international community by refraining from making world economic forecasts and by sticking instead to identifying the many risks that confront the global economy.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.