Alongside their October annual meeting, the IMF has released its 2016 Global Financial Stability Report. This year the report includes a number of warnings and is somewhat pessimistic that global growth will improve any time soon. Below are some excerpts from the IMF press conference on this. I used bold type to indicate some key points.
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"MR. DATTELS (MMF): Thank you everybody for being here this morning. Today, we
find ourselves in a low-growth, low-rate, era characterized by increased
political
and policy uncertainty. This is creating many challenges for banks,
policymakers, and corporates, in all parts of the world.
Failure to
adapt to this new
era could undermine the health of financial institutions and add to
the pressures of financial and economic stagnation. This report analyzes
these
challenges and offers solutions to foster stability in this new era.
First, some good news. Short‑term risks have declined." . . . . .
"But medium‑term risks are building, because we're entering a new era of
challenges. Low, uneven, and unequal growth is opening the door to more
populist
and inward looking policies, leading to a loss of political cohesion
and a rise in policy uncertainty in some countries. This could increase
volatility and
undermine growth.
A striking outcome of this weak economic environment and heavy reliance
on unconventional monetary policies is that
markets expect negative
policy rates in
the euro area and Japan to last through the end of this decade. The
weak outlook has pushed hopes for normalizing monetary policies well
into the future.
As a result, almost 40 percent of advanced economy government bonds
carry negative yields. This is unprecedented! Financial stability now
depends on how
well financial institutions adapt to this new era."
. . . .
"
Markets have serious concerns about the ability of many banks to
remain viable and healthy. Equity valuations are well below the book
values of many banks
as the focus of investors has shifted from the level of capital to
the business models that banks need to maintain that capital through
profits. This is
the fundamental reason why some banks have come under pressure this
year.
The question that we raise in this report is whether an economic
recovery is sufficient to restore sustainable profitability. Or, are the
problems more
deep‑rooted and structural?"
To answer this question, we conducted a detailed bottom‑up analysis of
some 280 banks, covering about 70 percent of U.S. and the EU banking
systems.
We
found that a cyclical recovery helps, but is not enough. . . . "
. . . .
"First, European
banks need to resolve the legacy of nonperforming
loans. This requires supportive policy action to strengthen insolvency
and recovery
regimes to reduce foreclosure times. If this were to be achieved, it
would turn the capital cost of removing nonperforming loans from
balance sheets of
some 80 billion euros to a benefit of capital of about 60 billion
euros. Progress has been made, more is needed.
Second, European banks need to become more efficient. There are
simply too many branches with too few deposits and too many banks with
funding costs well
above their peers. Addressing these business model challenges is
vital to ensure sustainable profitability.
Third,
weak banks will have to exit and some banking systems will
have to shrink. This will ensure a vibrant banking system that supports
economic
recovery.
Fourth, policymakers will have to complete regulatory reforms to
reduce uncertainty without an across‑the‑board increase in capital
requirements.
Procyclical outcomes must be avoided.. . . . "
. . . . .
"
Can emerging markets achieve a smooth deleveraging? In a new era of weak
global growth, commodity prices and reduced global trade, substantial
debt
reduction will take a long time. Under our baseline scenario,
indebtedness declines only gradually, returning to 2014 levels only by
2021."
"Let me conclude. Action is needed now to ensure that the financial
system adapts to this new era and remains healthy. These measures are
also necessary to
avoid sliding into financial and economic stagnation. They form part
of the Fund's three‑pronged strategy of structural, fiscal, and
monetary policies
within and across countries and over time, and sustained growth and
financial stability.
Thank you very much. We will happily take your questions."
QUESTIONER: In this report you talk about markets having questions
over the viability of some banks, but you don't name any names here. I
wonder if you
could talk a little bit about Deutsche Bank, which has come under
questions in the market over its financial strength after the request
for fines against
it. Is Deutsche Bank viable? Will it need a bailout?
MR. DATTELS: As we focus on in the report, many banks need to adapt
to this new era of low growth and low rates, as well as a changing
regulatory and
market environment. We have one third of the banks struggling to
show sustainable profitability. So let me break that down a little bit,
which I think is
helpful.
We can break it down ultimately into three groups. Banks with legacy
challenges owing to high nonperforming loans; banks that have been
restructured, taken
over by the government and recapitalized, but still struggling to
find their footing; and third, investment banks that are in transition
away from dated
business models that relied heavily on large scale balance sheets.
Deutsche Bank, we can say, is in the midst of this latter challenge.
It is in that third bucket of banks that need to continue to adjust to
convince
investors that its business model is viable going forward, that it
has addressed the issues of operational risk arising from litigation and
so on. I think
that is the new environment that we are in, and I'm sure that those
challenges will be met.
QUESTIONER: Just to follow‑up on that, Pete. I know it wasn't your
division, but a few months ago the IMF came out and said Deutsche Bank
posed a systemic
risk to the global markets, that was before a lot of what we have
talked about today really came into focus. So I would like to press you a
little bit on
Deutsche Bank in particular. In light of what you just said, do you
think that it poses systemic risk to the financial markets?
MR. DATTELS: What you are referring to is the Germany’s Financial
Sector Assessment Program from June, and
that report highlighted that
Deutsche Bank is a
large and interconnected bank and is therefore systemically
important, domestically and globally. In that context, we are confident
the German and European
authorities are monitoring the situation and working to ensure that
the financial system remains resilient.
. . . .
"QUESTIONER: Firstly, in your previous report, the one in April you
gave a figure for nonperforming loans, I think it was around 900 billion
euros and you
also broke down that figure a lit. You said 350 of that was Italy. I
wonder if you could give us an update on some of those figures? . . .
MR. DATTELS: As for nonperforming loans, we have updated some of the
numbers in the text. We are seeing a gradual reduction, with the ECB
having put in
targets for the banks that are under its direction for a sharper
reduction in nonperforming loans, and that is certainly the case in a
number of countries.
But, the actual level, the overall level remains high and much more
progress needs to be made.
QUESTIONER: Is the EUR 900 billion figure still relevant?
MR. DATTELS: That is still broadly correct. I can circle back and provide you with that."
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My added comments: This IMF report strikes me as an admission that while the monetary policies employed in recent years around the world may have staved off a global depression, the big problems are still out there. The IMF suggests here that we should not expect these problems to be resolved any time soon and warns banks that they need to expect the current low growth, low interest rate environment to last many more years. They warn we should expect many banks to go under along the way.
If this report's forecast turns out to be correct, it implies a long and continued dis-inflationary period of time where policy makers simply try to hang on and prevent some kind of sudden deflationary event. It sounds like years of ongoing bank failures and debt restructuring rather than one big and rapid event to clear out the rot in the system very quickly.
The question is whether or not policy makers will really get that much time to work on these problems or not without a new crisis intervening. That is a big unknown question hanging over the system until the excess debt is finally written off one way or another.
Also, many people are expecting that in an effort to fight off deflation, central banks will eventually ramp up new massive monetary expansion policies (see Jim Rickards here). This is the reasoning behind some very high forecasts for future gold prices. However, if the policy makers were to follow the path suggested here in this IMF report, it is more likely that we would see continuing deflation/deleveraging in the system for many years negating efforts to get more inflation.
This would probably lead to lower prices for everything including gold since the IMF does not lay out a plan to deal with these problems that includes more expansionary monetary policies (in fact they say time is running out for those kinds of policies). So, will gold help someone ride all this out or not if we get deflation rather than inflation?
I think owning some gold (or silver) is a good idea no matter how this plays out. If central banks do react with panic and ramp up expansionary policies anyway, that is obviously good for gold. If they don't and we do see ongoing dis-inflation for years to come, gold may drop in nominal price, but still go up in relative purchasing power to other alternatives such as stocks for example. Jim Rickards put it this way recently on his Twitter feed.
"If gold goes from $1270 to $800 and the Dow Jones goes from 18,000 to 4,000, which do you prefer to own?"
Harald Malmgren