We have documented the many warnings issued by both the IMF and the BIS over the past couple of years here on the blog. Here is the latest warning from BIS General Manager Jaime Caruana in a speech he gave at the London School of Economics and Political Science.
The UK Telegraph noted the warnings in this recent article. Here is a quote from their article:
"The BIS seems to be telling us that reckoning can still be orderly if we face up to reality, or end in a chaotic wave of defaults if we do not. Either way, the debt must clear."
Below are the concluding remarks from his speech. I emphasized some key points using bold type. Below that are some added comments.
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Conclusion
Eight years after the great financial crisis, the global economy is still finding it difficult to reach sustainable and balanced growth. Global recovery continues, albeit modestly by historical standards. Many uncertainties and downside risks remain. In the latest installment of a movie that began before the crisis, emerging market economies have seen a significant growth slowdown, and commodity prices, exchange rates and asset prices have experienced a major realignment. EME firms that have borrowed in dollars have been especially hard hit by the sharp appreciation of the dollar in recent months, as they have reduced investment and curtailed their operations, contributing to the overall slowdown. The slowdown in China associated with the transformation of its economy has been an especially important factor for the global economy as a whole. It has weakened demand for commodities and has added further impetus to the downturn in commodity markets that has depressed the outlook for commodity exporters.
To be sure, there are important idiosyncratic factors, which complicate the stylized perspective that I have presented today. However, rather than being regarded as separate, exogenous “shocks”, the combination of disappointing growth, large adjustments in exchange rates and falls in commodity prices is better seen as a set of outward manifestations of the combination of maturing financial cycles, this time in a number of emerging economies, and shifts in global financial conditions, which have influenced in particular exchange rates and the dollar component of debt. This perspective highlights the amplifying mechanisms and risks associated with the cumulative growth in the stock of debt.
To the extent that these transformations, realignments and adjustments in global conditions help to right financial imbalances and slow down the overall growth of debt globally, they can be seen as a necessary development in a welcome path towards normalization. Unfortunately, these processes are not smooth and linear and pose significant challenges. These challenges need to be managed to avoid major financial distress and to reduce headwinds to growth. We should not be surprised if the feedback loops set in motion by the deleveraging and divergent conditions lead to financial market turbulence. The temptation may be to try to keep the financial booms going, or to give them a new lease of life, but this will be just a palliative unless the stock of debt is adjusted and vulnerabilities are reduced.
We have learned from advanced economies that managing turning financial cycles, against the backdrop of high stocks of debt, modest growth and low inflation, is not easy. We also know that the world is more interconnected than ever and that there are challenges for emerging and advanced economies alike. The spill backs from EMEs can be significant. One consequence of turning financial cycles and of the impact of a dollar appreciation on their common US dollar component is that credit conditions have tightened due to the feedback loop generated by the deleveraging. Given the close connection between debt and risk-taking, the shift in sentiment accompanying the turning financial cycles and in conditions on dollar borrowing can be quite abrupt. Since a substantial amount of the debt was incurred in foreign currency, the pullback from risk-taking is closely intertwined with the exchange rate.
Hopefully, we are better prepared to deal with some of the problems. The regulatory reforms have strengthened the resilience of the banking system, new policy tools have been explored, including macro prudential policies, and emerging economies are better prepared, after years of improving policy frameworks and increasing cushions, such as higher foreign reserves. However, the challenges should not be underestimated, the policy room for maneuver has been shrinking and, most importantly, the global economy seems unable to avoid debt-fueled growth patterns.
This leads me to my concluding remarks, from the long-term perspective that we at the BIS try to bring to the policy debates:
− The need to have a more balanced combination of policies. Monetary policy has been overburdened for too long. A longer-term perspective means paying more attention to the more entrenched impediments to growth – factors that may be slow-moving but whose effects accumulate over time. In particular, we can count impaired balance sheets, the build-up of financial imbalances and resource misallocations, which harm productivity growth. Bumpiness should be expected, but should not be a reason per se to delay normalization.
− The need to recognize and internalize the importance of international spillovers and spill backs. The principle of keeping one’s house in order is necessary but is not enough. Policymakers will have to rely on sound judgment and possibly skillful intervention to mitigate the possible contagion effects that may accompany deleveraging. Central bank cooperation will become more important than ever.
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My added comments:
When you combine this speech by current BIS General Manager Caruana with the recent interview given by former BIS Chief Economist William White (which we covered here), a clear trend begins to emerge.
We should expect that all the easy monetary policies we have seen tried are reaching an end point. We should expect that the end of these policies will bring more market volatility and increase the risk of a major systemic crisis at some point along the way.
We are told that there are tools to try and deal with the problems and that we should be better prepared for a crisis. Mr. Caruana says this in his conclusion quoted just above:
"Hopefully, we are better prepared to deal with some of the problems. The regulatory reforms have strengthened the resilience of the banking system, new policy tools have been explored, including macro prudential policies, and emerging economies are better prepared, after years of improving policy frameworks and increasing cushions, such as higher foreign reserves."
However, we need to keep in mind that he also adds this comment:
"However, the challenges should not be underestimated, the policy room for maneuver has been shrinking and, most importantly, the global economy seems unable to avoid debt-fueled growth patterns."
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As an added note, Mr. Caruana has repeatedly suggested that we will eventually need new "rules of the game" for the monetary system in previous speeches as we have covered here on the blog.
What we will continue to watch for here is any indication that we will get a major systemic crisis worse than 2008 such as Jim Rickards has predicted and then what solutions would be put forward to deal with the crisis.
These are the major events that could impact our daily lives and prompt major monetary system changes. Without such a crisis, expect major change to evolve gradually over time. Recently Jim Rickards put out a twitter message suggesting he thinks we still have a ways to go yet before a crisis arrives. Others think we are seeing the start to the crisis now with the increased market volatility, falling commodity prices, and various economic indicators suggesting the economy is slowing down. One thing is sure, a lot of people are watching closely to see what happens.
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