Saturday, September 16, 2017

Former BIS Chief - "System Dangerously Unanchored"

Former BIS Chief - "System Dangerously Unanchored"
Former chief economist of the Bank for International Settlements, William White, told Bloomberg TV recently that "the system is dangerously unanchored." This is not the first time White has issued a warning that global financial markets were not on sound footing. Underlining his grave concern the former chairman of the Economic and Development Review Committee at OECD, stated the current situation "looks very similar to 2008," He then added that OECD sees "more dangers" today than in 2007. Even as stock markets across the world continue to set new records and make all time new highs we should see this as an acknowledgment all is not well.
White voiced his concerns such as prices being very high, in particular for high-yield assets and equities, VIX at very low levels, and house prices are rising strongly. What stood out in my mind was his indication that central banks cannot or will not be able to solve what might be seen as a growing "liquidity problem." The idea that we have too much debt and we have a debt resolution or insolvency problem that only governments can address is a huge reason for concern as governments have a poor history when it comes to addressing such issues in a fair manner. It is no small matter deciding how to handle an avalanche of bankruptcies and defaults.

It should be noted that White has voiced many of these concerns for some time, in January of 2016 the Telegraph reported White said, "The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians." He then made it clear a major task awaiting the global authorities is how to manage debt write-offs - and therefore a massive reordering of winners and losers in society - without setting off a political storm.

Global Debt Has Grown Much Faster Than GDP
During that interview, White pointed out that Europe's creditors are likely to face some of the biggest haircuts. European banks have already admitted to $1 trillion of non-performing loans and are heavily exposed to emerging markets. This indicates they are almost certainly rolling over other bad debts that have never been disclosed. I must again reiterate that situation has yet to be addressed and that the European banking system will most likely have to be recapitalized on a scale yet unimagined. The new "bail-in" rules mean that any deposit holder above the guarantee of €100,000 will have to help pay for it.

White said stimulus from quantitative easing and zero rates by the big central banks after the Lehman crisis have been leaking out across Asia and emerging markets. This has stoked credit bubbles and a surge in dollar borrowing that is difficult to control in a world of free capital flows. The bottom-line is that even more countries have now been drawn into debt. Combined public and private debt has surged to all-time highs in both emerging markets and for those in the OECD since the top of the last credit cycle in 2007. QE and easy money policies by the US Federal Reserve and its peers have had the effect of bringing spending forward from the future in what is known as "inter-temporal smoothing," this has become a toxic addiction over time and no longer has the traction it once had. In the end, the future catches up with you. This makes it easy to argue that central banks have only postponed the inevitable by continuing to print money and expanding the monetary base.

Among the slew of issues currently facing the global economy White noted:

  • India’s debt problems, these go back a long way and include governance issues including those at state-owned banks.
  • China’s debt situation that is rapidly growing and credit expansion that indicates maybe some of these loans won’t be repaid or serviced.
  • Central banks printing money is not the solution to growing liquidity problems  
  • The world needs more fiscal expansion, structural reforms, and also have to look closely at debt write-off and to recapitalize some financial institutions.
  • The mix of income that goes to capital versus labor in many countries needs to be addressed
  • Central bank tightening is inevitable yet problematic 

The warnings from White should carry a special gravitas since Mr. White was one of the very few voices in the central banking fraternity who stated loudly and clearly between 2005 and 2008 that the financial system and global economy had become compromised. Like many of those who have witnessed debt exploding, I agree that governments have failed to address or make the necessary structural reforms which would lead to a more sustainable economy. I like many economy watchers find it disingenuous that after years of pursuing an unorthodox policy of monetary expansion which has distorted markets and failed to produce real growth that central banks may soon start pointing fingers. Clearly, during times when hope was high and central banks claimed they had the answers such blame games took a backseat to their arrogance and hubris.

Footnote; We cannot underestimate the importance currencies play in a stable economy. Wild swings in the value of a currency have a major impact on the wealth of those holding it. The article below delves into some of what we are seeing play out currently in the market.

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