In a world swimming in debt, the whole system could be threatened by hiking rates. The BIS' ad
ref :- "Central Banks warned on inflation risk" , The Financial Times , International
ref :- "Next financial crisis to hit "with a vengeance" ", The Daily Telegraph, Business
All financial media outlets will have something on the Bank for International Settlement's (BIS) annual report, released yesterday. The BIS is known as the "Central bankers' Central bank" ..... well, it does look after their money after all, but one suspects that their reputation as the safest pair of hands around also reflects the respect it commands in financial circles. The point is that when they speak, people tend to listen ..... and what they've had to say will be a little disconcerting for some, not least some central bankers operating on established economic theories that may no longer hold water.
Much of the BIS report is spent highlighting the extraordinarily high (and dangerous) levels of debt being run up by corporates, households and indeed governments. The Telegraph article goes into some detail examining debt levels, and if much of the focus on the issue has switched to East Asia, this remains very much a global problem -- note the problems still faced by European banks and a burgeoning Canadian real estate bubble.
The origin of this looming debt crisis lies of course in the massive stimulus measures undertaken by the US Federal Reserve and other central banks after the financial crisis -- many of which are still in operation. The policy of seemingly endless supplies of cheap money may well be judged a success in bringing economies back to life (time will tell), but the feeding frenzy for borrowing encouraged by near-zero rates has brought us close to the brink of another crisis. The sky-high levels of debt mean that sharp and unexpected interest rate hikes could risk market panic. Remember the Taper Tantrum of 2013, when Fed Chairman Ben Bernanke's mere suggestion that the Fed could start gradually reining back QE stimulus provoked hysteria amongst investors ? You could argue that the incident was a huge overreaction, but that's the way of markets these days and it has plainly left residual scars in central banking circles.
Is it at all odd then that the BIS should be advocating monetary tightening if it could cause such severe damage to markets ? Not at all ......
The BIS is well aware of the dangers of mismanaged rate hikes, but argues that the obscene levels of borrowing are precisely the reason why tightening of monetary policy must begin. Failure to do so will just allow levels of debt to increase even further, and since cheap money encourages excessive risk-taking (inflated stock valuations, soaring house prices etc), it would also multiply the chances of bubbles bursting with disastrous results. Central Banks should act sooner rather than later, or else the rate rises when they come will have go further and at a faster pace -- likely to be a very painful process indeed.
We're guessing that the BIS felt the need to offer their view so firmly because they are concerned that some central bankers are following an economic rationale that may be out of date. Regulars will have to forgive us visiting this area once again, but in our defence we'd just point out that there's no shame in following where the BIS leads. Anyway, no doubt the Fed's recent rate hike met with BIS approval but the central bank's subsequent justification of the move despite inflation falling further from its 2% target will be of more concern.
Their assertion was that lagging inflation figures were a temporary blip, and that prices would soon be boosted by rising wages in a very tight labour market. You remember : falling unemployment = rising inflation ? It's the old Phillips Curve theory, a cornerstone of economic thinking for longer than most can remember. But for a growing number, changing work practices mean that the old equations no longer apply, at least not so simplistically. Globalization (which exports wage pressure) and rampant advances in technology mean that the old truths about inflation are being superceded.
The BIS' main worry is that notwithstanding the rate rise 10 days ago, the Fed bases its policy around that 2% inflation target and there is no guarantee that in these changing times it will get there even if growth should be marked sharply higher. The Fed should be prepared to tighten policy if demand is strong even if inflation remains weak. In other words, act according to the financial cycle and not according to a measure of inflation that may no longer even be relevant.
Ah, times they are a-changin' ..... as someone once said. Whether the Fed is going to change with them anytime soon is a different matter. Make no mistake, these are very intelligent people and they will be only too aware of all the doubts hanging over old measures and rationales. But having publicly invested so much faith in them for so long, it'll be interesting to watch if the Fed feels the need to abandon one of their key policy tenets. Interesting for us, that is ..... and very uncomfortable for them.