– The Bank Of International Settlements Warns The Monetary Kool-Aid Party Is Over (ZeroHedge, June 23, 2013):
When a month ago the Central Banks’ Central Bank, aka the Bank of International Settlements (or BIS) in Basel where the MIT central-planning braintrust meets every few months to decide the fate of the world, warned that the Fed-induced collateral shortage is distorting the markets, few paid attention. That the implication behind said warning was that QE can not continue at the current pace, was just as lost. A few short weeks later following the biggest plunge in markets since 2011 in the aftermath of Bernanke’s taper tantrum, some are finally willing to listen.However, they will certainly not like what the BIS just released as a follow up, both in the form of the BIS’ 83rd Annual Report, and the speech by Jaime Caruana to commemorate said annual meeting. For the simple reason that it reads like a Zero Hedge sermon, which says, almost verbatim, that the days of kicking the can via flawed monetary policy are now over, and that the time for central banks to head for the exit has finally come.
The BIS message, as summarized by the FT, is that “central banks must head for the exit and stop trying to spur a global economic recovery… cheap and plentiful central bank money had merely bought time, warning that more bond buying would retard the global economy’s return to health by delaying adjustments to governments’ and households’ balance sheets.”
Here is a better summary of the BIS unprecedented about face on its 5 year long monetary strategy, in its own selected words:
Can central banks now really do “whatever it takes”? As each day goes by, it seems less and less likely…
Six years have passed since the eruption of the global financial
crisis, yet robust, self-sustaining, well balanced growth still eludes
the global economy. If there were an easy path to that goal, we would
have found it by now. Monetary stimulus alone cannot provide
the answer because the roots of the problem are not monetary. Hence,
central banks must manage a return to their stabilisation role, allowing
others to do the hard but essential work of adjustment.
Many large corporations are using cheap bond funding to lengthen the duration of
their liabilities instead of investing in new production capacity. Overindebtedness is one of the major barriers on the path to growth after a financial crisis. Borrowing more year after year is not the cure…in some places it may
be difficult to avoid an overall reduction in accommodation because some
policies have clearly hit their limits.
Of course, it would have been more useful for the BIS to reach this commonsensical conclusion some four years ago (or roughly when we started preaching to the choir, which now includes the BIS itself), instead of allowing the global private bank controlled syndicate known as “central banks” to inject $10 trillion into global capital markets in the past 4 years, and $16 trillion (a 500% increase!) since 2000.
Some of the “shocking” and painfully late observations on the chart above:
Since the beginning of the financial crisis almost six years ago, central banks and fiscal authorities have supported the global economy with unprecedented measures. Policy rates have been kept near zero in the largest advanced economies. Central bank balance sheets have doubled from $10 trillion to more than $20 trillion. And fiscal authorities almost everywhere have been piling up debt, which has risen by $23 trillion since 2007. In emerging market economies, public debt has grown more slowly than GDP; but in advanced economies, it has grown much faster, so that it now exceeds one year’s GDP.
Some of the other, just as “shocking” observations: a dramatic surge in artificially low bond yields will result in crippling, systemic losses, amounting to trillions of dollars for bond (and certainly stock) investors around the globe, to the tune of 8% of GDP losses in the US, and a mindblowing 35% of GDP in losses for Japanese investors:
Consider what would happen to holders of US Treasury securities (excluding the Federal Reserve) if yields were to rise by 3 percentage points across the maturity spectrum: they would lose more than $1 trillion, or almost 8% of US GDP (Graph I.3, right-hand panel). The losses for holders of debt issued by France, Italy, Japan and the United Kingdom would range from about 15 to 35% of GDP of the respective countries. Yields are not likely to jump by 300 basis points overnight; but the experience from 1994, when long-term bond yields in a number of advanced economies rose by around 200 basis points in the course of a year, shows that a big upward move can happen relatively fast.
And while sophisticated hedging strategies can protect individual investors, someone must ultimately hold the interest rate risk. Indeed, the potential loss in relation to GDP is at a record high in most advanced economies. As foreign and domestic banks would be among those experiencing the losses, interest rate increases pose risks to the stability of the financial system if not executed with great care.
All of which Japan’s “sophisticated”, yet joyously cartoonish, “leaders” recently found out when they almost lost all control of the bond (and stock) market.
What’s the “wealth effect” solution: why buy stocks but don’t sell bonds. Or if selling bonds, do so vewy, vewy quietly. Alas, not even the BIS is dumb enough to fall for this (or push) possibility any longer.
The BIS report goes on, doing all it can to distance itself from those central banks who merely implemented policy that the BIS supported (and encouraged) for the past 5 years, but which has suddenly turned a cold shoulder. It does so by dramatically and rhetorically blasting a litany of questions to which it fully-well knows the answers:
How can central banks encourage those responsible for structural adjustment to implement reforms? How can they avoid making the economy too dependent on monetary stimulus? When is the right time for them to pull back from their expansionary policies? And in pulling back, how can they avoid sparking a sharp rise in bond yields? It is time for monetary policy to begin answering these questions.
Regardless of the politics behind the shift in BIS sentiment, the days of Mario Draghi’s “whatever it takes” shriek of desperation are over. Here are some more of the key soundbites from the BIS report:
Originally forged as a description of central bank actions to prevent financial collapse, the phrase “whatever it takes” has become a rallying cry for central banks to continue their extraordinary actions. But we are past the height of the crisis, and the goal of policy has changed – to return still-sluggish economies to strong and sustainable growth. Can central banks now really do “whatever it takes” to achieve that goal? As each day goes by, it seems less and less likely. Central banks cannot repair the balance sheets of households and financial institutions. Central banks cannot ensure the sustainability of fiscal finances. And, most of all, central banks cannot enact the structural economic and financial reforms needed to return economies to the real growth paths authorities and their publics both want and expect.
What central bank accommodation has done during the recovery is to borrow time – time for balance sheet repair, time for fiscal consolidation, and time for reforms to restore productivity growth. But the time has not been well used, as continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system. After all, cheap money makes it easier to borrow than to save, easier to spend than to tax, easier to remain the same than to change.
Yes, in some countries the household sector has made headway with the gruelling task of deleveraging. Some financial institutions are better capitalised. Some fiscal authorities have begun painful but essential consolidation. And yes, much of the difficult work of financial reform has been completed. But overall, progress has been slow, halting and uneven across countries. Households and firms continue to hope that if they wait, asset values and revenues will rise and their balance sheets improve. Governments hope that if they wait, the economy will grow, driving down the ratio of debt to GDP. And politicians hope that if they wait, incomes and profits will start to grow again, making the reform of labour and product markets less urgent. But waiting will not make things any easier, particularly as public support and patience erode.
Alas, central banks cannot do more without compounding the risks they have already created. Instead, they must re-emphasise their traditional focus – albeit expanded to include financial stability – and thereby encourage needed adjustments rather than retard them with near-zero interest rates and purchases of ever larger quantities of government securities. And they must urge authorities to speed up reforms in labour and product markets, reforms that will enhance productivity and encourage employment growth rather than provide the false comfort that it will be easier later.
* * *
As governments responded to the financial crisis with bank bailouts and fiscal stimulus, their indebtedness rose to new highs. And in countries that experienced a housing bubble in the run-up to the crisis, households had already accumulatedlarge debts. In the half-decade since the peak of the crisis, the hope was that significant progress would be made in the necessary deleveraging process, thereby enabling a self-sustaining recovery.
However, that never happened.
Easy financial conditions can do only so much to revitalise long-term growth when balance sheets are impaired and resources are misallocated on a large scale. In many advanced economies, household debt remains very high, as does non-financial corporate debt. With households and firms focused on reducing their debt, a low price for new credit is not terribly relevant for spending. Indeed, many large corporations are using cheap bond funding to lengthen the duration of their liabilities instead of investing in new production capacity. It does not matter how attractive the authorities make it to lend and borrow – households and firms focused on balance sheet repair will not add to their debt, nor should they.
And, most of all, more stimulus cannot revive productivity growth or remove the impediments that block a worker from shifting into a promising sector. Debt-financed growth masked the downward trend in labour productivity and the large-scale distortion of resource allocation in many economies. Adding more debt will not strengthen the financial sector nor will it reallocate resources needed to return economies to the real growth that authorities and the public both want and expect.
* * *
Six years have passed since the eruption of the global financial crisis, yet robust, self-sustaining, well balanced growth still eludes the global economy. If there were an easy path to that goal, we would have found it by now. Monetary stimulus alone cannot provide the answer because the roots of the problem are not monetary. Hence, central banks must manage a return to their stabilisation role, allowing others to do the hard but essential work of adjustment.
Authorities need to hasten labour and product market reforms so that economic resources can shift more easily to high-productivity sectors. Households and firms have to complete the difficult job of repairing their balance sheets, and governments must intensify their efforts to ensure the sustainability of their finances. Regulators have to adapt the rules to a financial system that is becoming increasingly interconnected and complex and ensure that banks have sufficient capital and liquidity buffers to match the associated risks. Each country needs to tailor the reform agenda to maximise its chances of success without endangering the ongoing economic recovery. But, in the end, only a forceful programme of repair and reform will return economies to strong and sustainable real growth.
* * *
Ultimately, outsize public debt reduces sovereign creditworthiness and erodes confidence. By putting their fiscal house in order, governments can help restore the virtuous cycle between the financial system and the real economy. And, with low levels of debt, governments will again have the capacity to respond when the next financial or economic crisis inevitably hits.
The BIS conclusion:
Is this a call for undifferentiated, simultaneous and comprehensive tightening of all policies? The short answer is no. Concrete measures need to be tailored to country-specific circumstances and needs. And the timing need not be simultaneous, although in some places it may be difficult to avoid an overall reduction in accommodation because some policies have clearly hit their limits.
Ours is a call for acting responsibly now to strengthen growth and avoid even costlier adjustment down the road. And it is a call for recognising that returning to stability and prosperity is a shared responsibility. Monetary policy has done its part. Recovery now calls for a different policy mix – with more emphasis on strengthening economic flexibility and dynamism and stabilising public finances.
Finally, today’s large flows of goods, services and capital across borders make economic and financial stability a shared international responsibility. Cross-border effects of domestic policy action are intrinsic to globalisation. Understanding spillovers and finding ways to avoid the unintended effects is central to the work of the BIS. And continued discussions among central banks and supervisors – discussions that the BIS facilitates and promotes – are essential for avoiding national biases in policymaking. Such national bias runs the risk of undermining globalisation and thus blocking the road to sustained growth for the global economy.
And yes, the central banks’ central bank really did say all of the above. Unpossible the Keynesian Magic Money Tree growers will say: surely there is an error in the BIS excel model…
Those pressed for time, if unable to read the full 204 page annual report, should at least read the following stunning speech from Jaime Caruana, General Manager of the BIS, titled “Making the most of borrowed time.” (only 9 pages – pdf here). Because, if nothing else, it validates everything Zero Hedge has said for the past 4 years.