There will be another financial crisis. The only question is when?

Financial bubbles are inevitable as well as their pathologies virtually identical. The only variable is timing. This is why financial crises appear so obvious in hindsight yet remain frustratingly difficult to predict.

A couple of years ago, the hedge fund Winton Capital produced a handsome and richly-illustrated book known as the Pit and the Pendulum, chronicling many, but by no means all, from the financial crises throughout history.

Markets are human constructs. As such, they’re prey to every human foible

Winton makes its money by utilizing sophisticated mathematical models to detect when assets are mispriced. It shouldn’t work, based on the efficient market hypothesis, which posits that current prices fully and accurately reflect all available information. But David Harding, the founder and chief executive of Winton Capital, thinks the hypothesis is bunkum. He recently told a celebration that, if markets are efficient, he must be either “a lucky monkey or perhaps a fraudster”, adding that “neither of those characterizations appeals”.

Markets are, Harding argues, human constructs. As such, they are prey to each human foible. His comprehensive chronicle of speculative mania and panics was designed to hammer home the point.

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The book includes well-known bubbles, such as the tulip mania that gripped 17th century Holland, and also the boom in U.S. subprime lending which resulted in the 2008 financial crisis. On the way, it ventures from the wilds of Qajar Persia towards the bazaars of Constantinople, and highlights little-known bubbles like the Japanese rabbit mania of 1873, where fluffy bunnies imported from Europe could fetch as much as yen 600, at any given time once the average monthly salary was about yen 0.6. (Apparently those with yellow ears were particularly highly prized.)

The same thing happened with diving patents in the 17th century (that have been supposedly going to be accustomed to salvage sunken Spanish gold within the Caribbean); Brazilian rubber in the 18th century; and Spanish merino sheep, mulberry trees, and British railway securities within the 1800s. And so forth and so on: history stuck on repeat.



Such financial crises have a tendency to occur every two to three years on average, according to Danske Bank, which helpfully highlights that the last one, the ecu sovereign debt crisis, ended more than three years ago. The pattern is definitely the same. Cheap money floods the economic climate. In 1800s Japan it was compensation payments designed to samurai who have been disbanded in the wake of the Meiji Revolution. Since 2008, it has the been the 637 individual rate of interest cuts perpetrated by global central banks as well as their combined acquisition of over $12 trillion in assets, based on Bank of the usa Merrill Lynch.

That money flows in to the less risky assets and pushes their yield (which moves inversely to cost) down. Investors get greedy and begin looking at riskier assets. They also start borrowing money to create these investments. This drags in the banks. Leverage builds up. Bubbles start to inflate.



So where might this currently be happening? Where to begin? Emerging market debts are a great candidate, as are U.S. high-yield bonds. The Chinese construction bubble has arguably already burst and dragged global commodity prices down. But we have still got London house prices, government bonds, energy and commodity companies (especially U.S. shale producers) and extra Tier 1 securities from bank, to name just a few frothy assets.

At some point, money will become less cheap and the process goes into reverse. This is why the financial world is hanging on every word the chairman from the U.S. Federal Reserve, Janet Yellen, utters. It’s also the reason behind the present dependence on the efficacy of negative rates of interest in a few areas of the planet.

In Denmark and Switzerland, banks need to pay to place money on deposit with their central banks. Some are passing this onto customers by, for instance, increasing mortgage rates. And why is that important? It means that central bank monetary policy decisions which have been designed to stimulate the economy are actually resulting in a tightening of credit. This really is, needless to say, not even close to ideal. It may be among the first, faint signs that the world’s central banks are running out of room for manoeuvre.

Are we near to the crucial reason for every crisis – sometimes known because the Minsky moment – when overconfidence flips over into fear? This is exactly what causes markets to crash, banks to begin withdrawing credit and economies to plunge into recession.

Emotion plays a crucial role, because financial markets are not capable. Jeffrey Currie, the senior commodity analyst at Goldman Sachs, released a note on Monday which argued the markets had “absolutely nothing to fear but fear itself.” But that is not so reassuring, because fear appears to be establishing itself. Gold has risen by a lot more than 14 per cent this season; Bank of America’s latest fund manager survey discovered that investors possess a bigger part of their portfolios committed to cash than at any time since 2001.

Perhaps the admittedly benign economic fundamentals outweigh the financial dislocations. But add to the latter a palpable feeling of fear and the balance begins to tip.

That is the reason why all eyes are trained around the meeting of G20 finance minister and central bank governors, in Shanghai, appropriately enough, last month 26 and 27.

Bubbles always burst. However, many grow a little larger and float a touch longer on the breeze before they do. The question, therefore, isn’t “if” but “when.” One wrong step through the world’s central banks which could be at some point.