How do you predict international financial crises?

There are two different types of crisis: the crisis derived from economic, fiscal and debt imbalances, these may be anticipated with some degree of strategic thinking; the ones originated by exogenous shocks are unpredictable, as it was for the Covid crisis and its inflationary effects. Roberto Albisetti, banker, economist, business consultant

Based on the economic and financial literature, a crisis that can be contagious widely in all economic countries and widely has some important features including: 1️⃣ It will start from financial crisis and came from important economic such as U.S or other important economic. 2️⃣ the interdependencies between financial markets are so important, The greater the correlation of the financial markets of that country, the greater the possibility of its expansion and spread at the international level. 3️⃣ Turning the crisis into a liquidity risk and then a systemic risk.

1. checking the typical features of a financial bubbles (new era thinking, overvaluation in more than one asset class, easy monetary policy, strong credit growth, boom of new financial instruments, financial deregulation, overtrading, swindles). 2. identifying peaks in the financial cycle, based on the joint dynamics of real house prices and private non-fin. sector leverage.

A financial crisis need not be when a country faces many of the above at once. It can be one of the above such as a banking crisis which then leads to another if correct policies are not put in place to correct that one problem.

I think international financial crisis can be defined as lack of trust between parties/countries and those involved in the financial transactions. Trust is the most important thing in the finance whenever the finance is used in other than financial gain then the global trust goes out. Politicizing the banking and financial sector always reduce the trust between parties. Never mix politics with finance. Because finance is based on the reality and require more trustworthiness while the politicians always not realistic on some issues and matters. Thus, lack of trustworthiness and righteousness trigger the lack of trust in between people and parties.

[While theoretically possible, I’m going to suggest that we have no historic examples of international financial crises caused by “large and unsustainable” surpluses in fiscal or external accounts.]

When an economy is not in an equilibrium due to certain macroeconomic shock. Financial fragility is when enacted policies are not robust enough and a periodic check is not in place to the key variables exposing the economy to various shocks. External shocks also include geopolitics , and as rightly mentioned other key changes such as demand downturn / natural disasters which then have a ripple effect on the economy.

A country’s integration to the rest of the world is largely due to the movement of goods and services, financial and capital flows. Whenever, there arises an international financial crisis leading to a situation where a country or a group of countries face a severe problems in their financial or banking system, or may face a currency turmoil. This may impact debt crisis of any country. The global spread of this crisis - generally called as contagion effect, may lead to impact the economic system of many other countries, which may jeopardize the real as well as financial health of these countries. The consequences of the negative externalities could be in the form of impacts on growth and employment in many other countries.

Causes and triggers is just different terminology for underlying and proximate causes. Ultimately, going back to the Tulip Mania and South Seas Bubble, the ultimate cause was grossly inflated financial asset prices brought about by hugely mismatched supply and demand that then self-corrected, rapidly and brutally. the proximate cause usually occurs when the last buyer turns into a seller and panic ensues.

The primary causes of an international financial crisis are complex and multifaceted Asset bubbles: Asset bubbles occur when the prices of assets, such as stocks, bonds, or real estate, become inflated and unsustainable. Systemic risk: Systemic risk is the risk that the failure of one financial institution or sector will have a cascading effect on the rest of the financial system. Regulatory failure: Regulatory failure occurs when financial regulations are inadequate or ineffective. Moral hazard: Moral hazard is the tendency to take on more risk when the potential losses are borne by others. Global imbalances: Global imbalances occur when there is a large trade surplus or deficit between countries.

My favourite indicator is the level of foreign currency reserves a country holds. For example, if the USD reserves are rapidly diminishing then the local Country faces a high Probability of currency devaluation and a collapse of its currency. Another indicator is the level of debt to GDP. If spending Is happening uncontrollably and this ratio rises to a level where interest payments are too high, then the probability of a financial crisis materially increases.

Indicators can be broadly classified into three categories - leading, coincident and lagging. Since the goal is to predict the international financial crisis, leading indicators are the ones that you got to be looking at. Likewise for models, it should be built using mostly leading indicators for both higher predictive power and lead time.

Beware that no specific playbook exists as the source of a crisis might be exogenous, unpredictable and the timing could be much different from similar situations already occurred in the past.

Gross mispricing of asset classes can be indicators as it was in past global financial crises: Before the 2008 financial crisis - stock prices were overvalued, house prices elevated, credit spreads between corporate and government bonds widened. Leading up to the Asian financial crisis of 1997, a number of Asian countries saw grossly inflated stock prices, and currency valuations pegged at unrealistic levels. However, bloated asset prices don't always point to a global financial crisis. Presently, we are witnessing rapidly rising government bond yields which can be a sign of stress or rapid repricing of central bank actions (higher interest rates for longer). Neither outcome is favourable

Indicators such as political instability, banking sector vulnerabilities which then leads to bank run , balance of payments problems such as current account defecit/surplus needs to be mentioned. Models such as first generation model (looking into monetary and fiscal policies) , second generation models which emphasies on financial markets, third generation models which like contagion , liquidity crisis models etc

Should include from latter question the indicators and models which have been mentioned such as balance of payments problems check , Reserves depletion , forex, banking sector vulnerabilities and these should be monitored periodically using models which can be then optimized and made efficient by adding more variables

When investors sentiment starts to materially deviate on a consistent basis from roaring red economic indicators such as massive indebtedness versus more humble GDP growth, massive printing of currency and cheap credit, high prices coupled with risk taking appetite on all asset classes on the expectation that growth is forever, then prepare for a crisis sometime soon. Macro Economics, debt and GDP is a zero sum game overtime. Excess liquidity that does not translate into meaningful GDP growth sets the grounds for a massive write off of businesses i.e. Crisis.

Sometimes human behaviour in putting the right policies in place at the right time limits in enacting and fixing the problem. We have a classic example pf feds delaying raising interest rates on time assuming it will cool off as it was assumed to be a demand rebound on selective sectors post covid resulted in high inflation. Historical trends needs to be visualized better to understand how the events resulted in fincancial crisis although in some instances certain variables are false alarms

Typically, analysis and signals used to predict any crisis are only as good as the underlying economic model. When the prevailing theoretical model cannot sufficiently explain the crisis, there needs to be a paradigm shift according to the data to provide policy makers with the right tools. The 20th century has multiple examples of this, e.g. the failure of the Philips curve to predict inflation in the 1970s and the subsequent adoption of expectation augmented Philips curve.

One thing I’ve learned is the importance of considering disruptions (its causes and consequences) to understand the complexity of the current financial environment. The changes that the pandemic caused in the development of new conditions in the world order, and in the balance of power show how relevant is to create new patterns of behaviour of capitals, markets and interactions.

One of the more common causes of international financial crises is failure to recognize the impossible trinity: control of exchange rates, monetary policy (interest rates), and capital mobility.

Geopolitical events like the Ukraine-Russia conflict can serve as catalysts for financial crises by causing political instability and trade disruptions. In our interconnected world, shifts in trade, exchange rates, and monetary policy can impact multiple economies. Behavioral aspects such as investor sentiment and public confidence offer valuable qualitative insights often missed by quantitative data. The 2008 crisis underscored the need to monitor the health of the global banking system closely. Metrics like debt-to-equity ratios, non-performing loans, and liquidity reserves are vital indicators.

By observing debt/leverage and complacency. The level of central bank interest rates is also very important. Above 4 % Federal Funds Rate usually indicates a financial crisis is not far away.

History has taught us a lot about what to look for. Which policies may leave economies more at risk and how to maintain stability. The world economy has changed a lot over the last century and with it we have many lessons.

Mr Posledovich, Fed funds over 4% is no indicator of crisis; indeed, it is normal. Over the past 70 years, the Fed funds rate was over 4% more than half the time, including for a period of 27 years (1965-92) when it dipped below 4% for just 11 months.