‘Perfect storm’ alert for global risk
SWITZERLAND: The world financial system is as dangerously stretched today as it was at the peak of the last bubble, but this time authorities are caught in a ‘‘policy trap’’ with few defences left, a veteran central banker has warned.
Nine years of emergency money has had a string of perverse effects and lured emerging markets into debt dependency, without addressing the structural causes of the global disorder, says Professor William White, the Swiss-based head of the OECD’s review board and former chief economist for the Bank for International Settlements (BIS).
‘‘All the market indicators right now look very similar to what we saw before the Lehman crisis, but the lesson has somehow been forgotten,’’ said White, speaking before the World Economic Forum in Davos, Switzerland.
White said there was an intoxicating optimism at the top of every unstable boom, when people convinced themselves that risk was fading, but this was when the worst mistakes were made. Stress indicators were equally depressed in 2007 just before the storm broke.
This time, central banks are holding a particularly ferocious tiger by the tail. Global debt ratios have surged by a further 51 percentage points of GDP since the Lehman crisis, reaching a record 327 per cent.
This is a new phenomenon in economic history, and can be tracked to QE liquidity leakage from the West, which flooded East Asia, Latin America, and other emerging markets, with a huge push from China pursuing its own ventures.
‘‘Central banks have been pouring more fuel on the fire,’’ White said.
‘‘Should regulators really be congratulating themselves that the system is now safer? Nobody knows what is going to happen when they unwind QE. The markets had better be very careful, because there are a lot of fracture points out there.
‘‘Pharmaceutical are subject to laws forcing them to test for unintended consequences before they launch a drug, but central banks launched the huge social experiment of QE with carelessly little thought about the side effects,’’ he said.
The United States Federal Reserve is already reversing bond purchases – ignoring warnings by former Fed chair Ben Bernanke – and will ratchet up the pace to US$50 billion a month this year. This will lead to a surge in supply of US Treasury bonds just as the Trump Administration’s tax and spending blitz pushes the US budget deficit towards US$1 trillion, and China and Japan trim their Treasury holdings.
It has the makings of a perfect storm. At best, the implication is that yields on 10-year Treasury bonds – the world’s benchmark price of money – will spike enough to send tremors through credit markets.
The edifice of inflated equity and asset markets is built on the premise that interest rates will remain pinned to the floor.
The latest stability report by the US Treasury’s Office of Financial Research warned that a 100-basis point rate rise would slash US$1.2t of value from the Barclays US Aggregate Bond Index, with further losses once junk bonds, fixed-rate mortgages and derivatives were included.
The global fallout could be violent. Credit in dollars beyond US jurisdiction has risen fivefold in 15 years, to over US$10t.
‘‘This is a very big number. As soon as the world gets into trouble, a lot of people are going to have trouble servicing that dollar debt,’’ White said.
Borrowers would suffer the double shock of a rising US dollar and rising interest rates.
The great disinflation of the last three decades was essentially a global ‘‘supply shock’’, White said.
The opening up of China and the fall of the Berlin Wall added 800 million workers to the traded economy, depressing wages and unleashing a tsunami of cheap goods, he said.
The ‘‘Amazon effect’’ of digital technology capped price rises. The demographics of the baby boom era played their part by boosting the global savings glut.
But there was another feature that was often neglected, he said. Central banks intervened ‘‘asymmetrically’’ with each cycle, letting booms run but stepping in with stimulus to cushion busts.
The BIS says one result of this was keeping insolvent ‘‘zombie’’ companies alive, hindering productivity.
Central banks are now caught in a ‘‘debt trap’’. They cannot hold rates near zero as inflation pressures build, but they cannot easily raise rates either because it risks blowing up the system.
‘‘It is frankly scary,’’ White said.