Thursday, July 3, 2014

BIS Issues Strong Warning on "Asset Bubbles"

Just when things seem relatively calm, the Bank for International Settlements releases its annual report that issues a strong warning that significant problems are still out there in the world. Who is the Bank for International Settlements (BIS)? What did they say in this report that matters to us? Let's take a look.

The BIS is sometimes called the "bank for Central Banks". Here is a link to the "about us" page on their web site. It lists these bullet points as its broad mission:

  • promoting discussion and facilitating collaboration among central banks;
  • supporting dialogue with other authorities that are responsible for promoting financial stability;
  • conducting research on policy issues confronting central banks and financial supervisory authorities;
  • acting as a prime counterparty for central banks in their financial transactions; and
  • serving as an agent or trustee in connection with international financial operations.
What we can say is that when the BIS issues a warning, Central Banks around the world pay close attention and we should too. Remember that we are always on the lookout for events that could trigger a global financial crisis because that can quickly lead to major monetary system change. In a crisis, by definintion normal conditions do not exist. People are much more willing to accept policy changes that they might otherwise resist in normal times. 

In this BIS report, they warn about a lot of potential problems. We will use this Boston Globe article on the report to illustrate some of them and then add some comments. First, here are some exceprts from the Boston Globe article:

"An organization representing the world’s main central banks warned Sunday that dangerous new asset bubbles are forming, even before the global economy has finished recovering from the last round of financial excess."

"Investors, desperate to earn returns when official interest rates are at or near record lows, have been driving up the prices of stocks and other assets with little regard for the risks, the Bank for International Settlements in Basel, Switzerland, said in its annual report, published Sunday."
" . . .the BIS’s language in the 2014 edition was unusually direct, as was its warning that the world could be hurtling toward a new crisis."
“There is a disappointing element of déjà vu in all this,” Claudio Borio, head of the monetary and economic department at the BIS, said in an interview ahead of Sunday’s release of the report, which he described as “a call to action.”
The signs of financial imbalances are there,” Borio said. “That’s why we are emphasizing it is important to take further action while the time is still there.”
"The BIS report said debt levels in many emerging markets, as well as in Switzerland, “are well above the threshold that indicates potential trouble.”
my added comments:

This report certainly does not paint a picture that all is well and the future looks bright. This Boston Globe article lists a number of potential problem areas which we noted above by underlining them. New "asset bubbles" forming. It specifically mentions stock markets in this category. They see "signs of financial imbalances" and issue "a call to action" while the time is still there". They also note that debt levels are still way too high.

Notice that all these conditions are the same as what led up to the financial crisis in 2008. In that crisis Central Banks (led by the US FED) created enormous sums of new currency to stave off a collapse of the entire system. Unfortunately, what the BIS is saying is that the problems that can lead to systemic crisis were not solved. They were merely postponed.

This is why we must keep alert all the time. Even though things appear calm on the surface right now. Taking the US as an example. We have piled up a whopping $151,000 per taxpayer national debt as shown in the linked national debt clock. Even more troubling, if you add in the future obligations for US taxpayers (future Social Security, Medical expense care, etc) the debt swells to a mind boggling number over $1 million per taxpayer. This debt exceeds the entire total of all "assets per taxpayer". Let that sink in. You could tax every taxpayer in the US everything they own and it is not enough to cover the future debt obligations that exist today. This is why everyone admits the present system is unsustainable.

Remember that last time (2008) the FED and Central Banks stepped in to stave off collapse. If a new crisis arises (what the BIS is directly warning about in their annual report) the FED can't do this again. The FED now has a huge $4 Trillion balance sheet from buying assets (and a load of US bonds) already. A new global crisis would easily dwarf what the FED had to do last time because the problems were not solved as the BIS notes. All the numbers are just bigger now. "Asset Bubbles" are still being built according to the BIS.

The FED is also now in a "Catch 22" situation. They want to be able to raise interest rates to convince markets the economy is recovering. But they really cannot do that. If interest rates rise very much the huge US bond portfolio now owned by the FED will take a huge loss in value. Also, the interest on the huge existing US debt will start going up even more making it harder and harder for the US to reduce the annual deficit. All of this has already caused the US dollar to take a beating. If the FED tries another round of massive QE in another huge crisis, we can expect the US dollar to take another huge hit. And it could all happen fairly quickly if it triggered even as things appear calm. Right now it is just happening at a steady controlled pace.

This whole problem is a main reason for this blog. We believe that the present (US dollar based) system is too unstable to be sustained. At some point it will have to end and be replaced with new "rules of the game". In that process, we can expect the US dollar will not fare well as sole global reserve currency. 

Because we live in a globally interconnected financial world filled with leverage and  derivatives, a crisis that starts anywhere can spread to one everywhere (this is called contagion). It is an ever present concern for Central Banks and other global financial institutions like the BIS. This 2014 annual report from the BIS proves that clearly.

We are trying to follow all of this and also a variety of ways the change we think is coming could take place. We have mentioned several here including:

-slow and steady change where the IMF moves into a greater role and the SDR replaces the US dollar as global reserve currency (with a possible new twist that creates an "everymans SDR") . Change over time in "non crisis" conditions. (in progress but somewhat stalled at the IMF)

-rapid change as a result of a new crisis where the IMF quickly steps in as "lender of last resort" and replaces the US dollar with the SDR as above, just in a much quicker time frame (Jim Rickards forecasts this)

-slow and steady change that takes place on a regional basis where solutions to problems are tested regionally and the best solutions are adopted globally eventually (happening right now)

-change where the BRIC nations drop out of the existing global financial institutions and form their own system  and promote their currencies globally  to compete with the US dollar (happening right now) 

-chaotic rapid change from a crisis where no central problem solving entity arises. Instead the world becomes more de centralized with nations and regions taking over to address problems. the current system collapses and existing global institutions are unable to restore order and confidence (in a world like this, Bitcoin probably thrives)

The future is impossible to predict. But we can take the BIS warning seriously and try to stay informed on this important topic. Major monetary system change is something most don't really think about, but they should because it would directly impact their lives. And we do notice that more and more people are starting to understand the importance and become informed which we think is a good thing. We also know that there are good people working on these problems which is another good thing.

Update 7-5-14 11:05 pm: Bloomberg runs this article saying Central Bankers are pushing back against the BIS warning about asset bubbles. The article quotes FED Chairwoman Yellen and ECB President Draghi now is not the time to raise interest rates. This is not surprising given the "Catch 22" situation we noted above where these Central Banks just cannot allow interest rates to rise very much. The last part of this Bloomberg article makes this observation:

"It’s not the first time staff at the Basel, Switzerland-based BIS, which is owned by central banks and serves as a counterparty for them, has broken with their bosses. In 2003, BIS economists Claudio Borio and William R. White warned policy makers might need to raise rates to combat asset-price bubbles.
That advice was rejected too."

We always appreciate it when another site picks up our blog articles. It provides a broader audience for the information. We have let other sites know that our articles are available free at anytime if they think their readers will find them useful.

Added note 8-6-15: A full list of systemic risk warnings can be found on this blog page 

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