Nobel-winning economist Paul Krugman warns of a 'real amnesia' around the last financial crisis - and breaks down why we're poorly prepared to handle the next shock
- There's a "real amnesia going on in the political sphere" that threatens the global economy ahead of the next financial crisis, according to the Nobel Prize-winning economist Paul Krugman.
- In an exclusive interview with Business Insider, Krugman laid out what's being overlooked, and explained how those factors could come back to bite us in the next crisis.
Paul Krugman does not know what exactly will cause the next financial crisis.
When the professor and Nobel Prize-winning economist surveys the global economy, nothing looks quite as compelling as the housing bubble that helped jump-start the Great Recession about a decade ago.
What does raise red flags, however, is an apparent forgetfulness of why the crisis struck in the first place. Krugman specifically pointed to the rise of shadow banking - or institutions that look like banks and function like them, but are not regulated with the same scrutiny.
Following the last financial crisis, other economists pinpointed the loosely regulated market for repurchase agreements (short-term loans offered to institutional investors) as one of the main triggers.
The topic arose again earlier this year when, before the 10-year anniversary of the crisis, the Financial Stability Board - a regulatory watchdog for G20 countries - said its measure of shadow-banking activities rose 8% to $99 trillion. That made up about 30% of global financial assets and was the highest level since 2002.
"The case for basically revitalizing the system of bank regulation to cover this broader financial universe is really strong," Krugman told Business Insider in an exclusive interview.
"That's important because a lot of people are pushing really hard to take away the limited financial regulations that were in fact put in place ... it's this real amnesia going on in the political sphere."
This is one of the lessons Krugman hopes to impart - especially to people who aren't economists - in a recently launched online course on economics for Masterclass.
Another thing Krugman wants people to bear in mind is how certain swaths of the public reacted to the crisis. In his view, there were unfounded concerns that swirled around the stimulus measures that monetary authorities put in place to revive the economy, including the Federal Reserve's unprecedented bond purchases to suppress borrowing costs. This expansion is now the second-longest ever, and will break the previous record if it continues through July 2019.
"I hope we'll have less harassment of the Fed and other players when they try to deal with the [next] crisis," Krugman said. "We had an amazing amount of trying to stop them from doing what they could, which was limited by all these years of totally unwarranted fears of inflation."
While the fear of inflation did not materialize, there are others that now make the economy more vulnerable to the next crisis.
"We are poorly prepared to deal with the next shock," Krugman said. "Interest rates are still close to zero in the US, and in most of the rest of the advanced world. The fiscal policy we did was badly handled in the aftermath of the 2008 crisis, and there's no particular reason to think it will be better. In fact, there's good reason to think it will be worse."
That's not all. The trade war between the US and China persists, with investors eagerly awaiting the outcome of talks at the G20 meeting this week between presidents Donald Trump and Xi Jinping.
Krugman, who won the Nobel Prize for his work on international trade, said both countries are in danger of throwing away frameworks that successfully governed exchanges between countries for years.
"'If I sell to you I win and if I buy from you I lose' is a really wrong way to look at things," he said.
Still, Krugman declined to pin the cause of the next crisis on trade disruptions, Fed policy, deregulation, or any other specific catalyst. He said that while most people - even those of his pedigree - are bad short-term forecasters, it shouldn't stop them from trying to understand and mitigate the inevitable next shock.
"The tragedy of all this is that we actually had the knowledge and we had the tools to make this a much less severe crisis than it actually turned out being," Krugman said.