Tuesday, March 8, 2016

Claudio Borio (BIS) - "Confidence in Central Banks Healing Powers has been Faltering"

The Bank for International Settlements issues a quarterly review. Lately these reviews have been sounding warnings that there are a number of growing problems creating stress on the global financial system. This latest review continues that trend. Below are some interesting quotes from BIS official Claudio Borio and then a few added comments. I used bold type for points I wanted to emphasize.

"The uneasy calm has given way to turbulence. In the previous Quarterly Review issue, we highlighted the uneasiness of the calm reigning over financial markets. The tension between the markets’ tranquillity and the underlying economic vulnerabilities had to be resolved at some point. In the recent quarter, we may have been witnessing the beginning of its resolution."

. . . . . 

But if we wish to look for clues to the deeper forces at work, we need to go beyond the markets’ all too familiar oscillation between hope and fear. Once we do so, the clues are not hard to find. Against the backdrop of a long-term, crisis-exacerbated decline in productivity growth, the stock of global debt has continued to rise and the room for policy manoeuvre has continued to narrow – a set of factors that might be termed the “ugly three” (see comments below). Let me just say a few words about rising debt and the narrowing room for manoeuvre, in particular.

Debt was at the root of the financial crisis, and it has risen further globally in relation to GDP since then. In the advanced economies at the heart of the crisis, some private sector deleveraging has taken place, although public sector debt has grown steadily. But the most worrying development has been the steep rise in private sector debt elsewhere, especially in several emerging market economies (EMEs), including the largest – the main engines of global growth post-crisis. The increase has been strongest among corporates, whose profitability has been declining, and among commodity exporters. Often, as indicated by our latest statistical release, this has gone hand in hand with strong property price booms on the back of aggressive risk-taking – all eerily reminiscent of the financial booms seen pre-crisis in the economies subsequently hit by it

. . . . . 

Debt, therefore, is what helps understand apparently unrelated developments. It sheds light on the slowdown in EMEs. It provides clues about the worrying vicious cycle between US dollar appreciation and tightening financial conditions for firms or countries that have heavily borrowed in dollars. It gives a hint about the reason for the weakness in oil prices, as countries such as China demand less and highly indebted oil-producing firms come under pressure to keep the spigots open to meet their service burdens. And it may even illuminate the puzzling slowdown in productivity growth: recent BIS research finds evidence that credit booms sap productivity growth as they gather pace, largely by allocating resources to the wrong sectors. The impact of these misallocations lingers on and becomes more powerful if a financial crisis subsequently erupts. In turn, weaker productivity makes it harder to sustain debt burdens. Put differently, we may not be seeing isolated bolts from the blue, but the signs of a gathering storm that has been building for a long time.

And then we have the narrowing room for policy manoeuvre. The latest turbulence has hammered home the message that central banks have been overburdened for far too long post-crisis, even as fiscal space has been dwindling and structural measures lacking. 

Despite exceptionally easy monetary conditions, in key jurisdictions growth has been disappointing and inflation has remained stubbornly low. Market participants have taken notice. And their confidence in central banks’ healing powers has – probably for the first time – been faltering. Policymakers too would do well to take notice

My added comments: The "ugly three" mentioned by Claudio Borio above is a reference to his recent speech (which we covered here - see slide #3). The slide presentation for the speech listed the "ugly three" as follows:

 Symptoms of the malaise: the “ugly three” 

    Debt too high 
    Productivity growth too low 
    Policy room for maneuver too limited 

It's not really necessary to make in depth comments on these remarks by Claudio Borio. It's crystal clear to me that the BIS sees the potential for more economic turbulence up to and including another financial crisis at some point in the future. Mr. Borio suggests we may be seeing "the beginning" of the resolution of "the tension between markets' tranquility and the underlying market vulnerabilities." 

On this blog we are following two big questions over time:

1) Will we get another major financial crisis worse than 2008 as predicted by Jim Rickards and others?

2) If we do, will that lead to a more prominent role for the SDR used at the IMF to replace the US dollar as the global reserve currency? 

The ongoing comments by Mr. Borio at BIS appear to suggest that the conditions for another major crisis do exist and we may even be seeing the beginning stages of a resolution of the "too much debt" problem right now.

If we do get another crisis, former head of the SDR Division at IMF Warren Coats gave us this quote: (see this recent article

“In this presentation we were able to outline why it would be a good thing to replace national currencies as international reserves with an international one such as the SDR and to outline some steps toward that goal. It is generally believed that only an international financial crisis will precipitate a change in the international monetary system. Perhaps, but if so it is important to have a strong SDR waiting in the wings to take on that role when the crisis hits.”


We have presented solid evidence (based on statements from high credibility sources) that the conditions for another major financial crisis exist and if we get one the role of the SDR might increase in a significantly changed monetary system. Watching for major monetary system change is what this blog is all about.

We have also said that absent such a crisis, we would expect the kind of major monetary system change we watch for here to evolve much more gradually over time (years to decades). This agrees with the comments made by IMF official Dr. Thomas Krueger (who works with SDRs now) and former head of the SDR Division Dr. Warren Coats in a recent video presentation we covered here.

There is another wild card mentioned by Claudio Borio in his comments quoted above. He says, "confidence in central banks healing powers has been faltering" and policy makers "would do well to take notice." That is another point we have made here. How the public would react to another major crisis is an unknown in a complex system. They might trust the existing central banks (and/or the IMF) to come up with a solution or they might not if confidence is completely lost. The political winds blowing right now suggest massive distrust by many people. Claudio Borio says policy makers should take notice, but will they? Hopefully they will.

At this point we are satisfied that we have covered our two main questions as well as we can up to this point in time. Now, we simply have to wait and see if we will get another major crisis or not. We don't know the answer to that question. All we can do is watch for signals and stay alert. What are some signals? The bullet point list below is good for starters.

- sovereign debt defaults or major restructuring

- global corporate entities in deep distress or in bankruptcy

- too big to fail banks in deep distress or in bankruptcy (watch their stock prices, bail-ins, etc)

- sharply falling currencies (including the US dollar at some point)

- extreme volatility in global stock markets

- failure of central bank policies to achieve desired results - loss of public confidence

- sharply rising gold and silver prices 

Several items on the bullet point list above were mentioned in the BIS quarterly review. We are already seeing some early signs of some of the others as well. A crisis can unfold suddenly with little warning or over time in waves. If we get the latter, we might be seeing the first wave here in early 2016.  Jim Rickards said recently the volatility we have seen lately is not the major crisis he has predicted. Perhaps a crisis will be avoided altogether if good decisions are made. Time will tell.

Added note: IMF says growth is weak - lists risks

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