'Global financial system is as dangerously stretched today as it was at the peak of the last bubble (2008)' - William White - who also predicted the GFC.
January 24, 2018
Nine years of emergency money has had a string of perverse effects and lured emerging markets into debt dependency, without addressing the structural causes of the global disorder. "All the market indicators right now look very similar to what we saw before the Lehman crisis, but the lesson has somehow been forgotten," said William White, the Swiss-based head of the OECD's review board and ex-chief economist for the Bank for International Settlements. Professor White said disturbing evidence of credit degradation is emerging almost daily.
Professor White said there was an intoxicating optimism at the top of every unstable boom when people convince themselves that risk is fading, but that is when the worst mistakes are made. Stress indicators were equally depressed in 2007 just before the storm broke. This time central banks are holding a particularly ferocious tiger by the tail. Global debt ratios have surged by a further 51 percentage points of GDP since the Lehman crisis, reaching a record 327 per cent (IIF data). This is a new phenomenon in economic history and can be tracked to QE liquidity leakage from the West, which flooded East Asia, Latin America, and other emerging markets, with a huge push from China pursuing its own venture. "Central banks have been pouring more fuel on the fire," he told The Daily Telegraph, speaking before the World Economic Forum in Davos. "Should regulators really be congratulating themselves that the system is now safer? Nobody knows what is going to happen when they unwind QE. The markets had better be very careful because there are a lot of fracture points out there," he said.
The US Federal Reserve is already reversing bond purchases - ignoring warnings by former Fed chairman Ben Bernanke - and will ratchet up the pace to $US50 billion a month this year. It will lead to a surge in supply of US Treasury bonds just as the Trump Administration's tax and spending blitz pushes the US budget deficit toward $US1 trillion, and China and Japan trim Treasury holdings. It has the makings of a perfect storm. At best, the implication is that yields on 10-year Treasuries - the world's benchmark price of money - will spike enough to send tremors through credit markets.
The edifice of inflated equity and asset markets is built on the premise that interest rates will remain pinned to the floor. The latest stability report by the US Treasury's Office of Financial Research warned that a 100 basis point rate rise would slash $US1.2 trillion of value from the Barclays US Aggregate Bond Index, with further losses once junk bonds, fixed-rate mortgages, and derivatives are included. The global fallout could be violent.
Credit in dollars beyond US jurisdiction has risen fivefold in 15 years to over $US10 trillion. "This is a very big number. As soon as the world gets into trouble, a lot of people are going to have trouble servicing that dollar debt," said Prof White. Borrowers would suffer the double shock of a rising dollar, and rising rates.
The great disinflation of the last three decades was essentially a global "supply shock". The opening-up of China and the fall of the Berlin Wall added 800m workers to the traded economy, depressing wages and unleashing a tsunami of cheap goods. The "Amazon effect" of digital technology capped price rises. The demographics of the baby boom era played its part by boosting the global savings glut. But there was another feature that is often neglected. Central banks intervened "asymmetrically" with each cycle, letting booms run but stepping in with stimulus to cushion busts. The BIS says one result was to keep insolvent "zombie" companies alive and block the creative destruction that leads to rising productivity. "Everything could now go into reverse:
Central banks are now caught in a "debt trap". They cannot hold rates near zero as inflation pressures build, but they cannot easily raise rates either because it risks blowing up the system. "It is frankly scary," said Prof White. The authorities may not yet have reached the end of the road but this strategy is clearly pregnant with danger.