Former Chief Economist Of BIS: World Faces Wave Of Epic Defaults, Central Banks Out Of Ammo
by The Telegraph •
By Ambrose Evans-Pritchard at The Telegraph
The global financial system has become dangerously unstable and faces
an avalanche of bankruptcies that will test social and political
stability, a leading monetary theorist has warned.
“The situation is worse than it was in 2007. Our macroeconomic ammunition to fight downturns is essentially all used up,”
“It will become obvious in the next recession that many of these
debts will never be serviced or repaid, and this will be uncomfortable
for a lot of people who think they own assets that are worth something,”
he told The Telegraph on the eve of the World Economic Forum in Davos.
“The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians.”
The next task awaiting the global authorities is how to manage debt write-offs – and therefore a massive reordering of winners and losers in society – without setting off a political storm.
Mr White said Europe’s creditors are likely to face some of the biggest haircuts. European banks have already admitted to $1 trillion of non-performing loans: they are heavily exposed to emerging markets and are almost certainly rolling over further bad debts that have never been disclosed.
The European banking system may have to be recapitalized on a scale yet unimagined, and new “bail-in” rules mean that any deposit holder above the guarantee of €100,000 will have to help pay for it.
The warnings have special resonance since Mr White was one of the very few voices in the central banking fraternity who stated loudly and clearly between 2005 and 2008 that Western finance was riding for a fall, and that the global economy was susceptible to a violent crisis.
Mr White said stimulus from quantitative easing and zero rates by the big central banks after the Lehman crisis leaked out across east Asia and emerging markets, stoking credit bubbles and a surge in dollar borrowing that was hard to control in a world of free capital flows.
The result is that these countries have now been drawn into the morass as well. Combined public and private debt has surged to all-time highs to 185pc of GDP in emerging markets and to 265pc of GDP in the OECD club, both up by 35 percentage points since the top of the last credit cycle in 2007.
“Emerging markets were part of the solution after the Lehman crisis. Now they are part of the problem too,” Mr White said.
Mr White, who also chief author of G30’s recent report on the post-crisis future of central banking, said it is impossible know what the trigger will be for the next crisis since the global system has lost its anchor and is inherently prone to breakdown.
A Chinese devaluation clearly has the potential to metastasize. “Every major country is engaged in currency wars even though they insist that QE has nothing to do with competitive depreciation.
They have all been playing the game except for China – so far – and it is a zero-sum game. China could really up the ante.”
Mr White said QE and easy money policies by the US Federal Reserve and its peers have had the effect of bringing spending forward from the future in what is known as “inter-temporal smoothing”. It becomes a toxic addiction over time and ultimately loses traction. In the end, the future catches up with you. “By definition, this means you cannot spend the money tomorrow,” he said.
A reflex of “asymmetry” began when the Fed injected too much stimulus to prevent a purge after the 1987 crash. The authorities have since allowed each boom to run its course – thinking they could safely clean up later – while responding to each shock with alacrity. The BIS critique is that this has led to a perpetual easing bias, with interest rates falling ever further below their “Wicksellian natural rate” with each credit cycle.
The error was compounded in the 1990s when China and eastern Europe suddenly joined the global economy, flooding the world with cheap exports in a “positive supply shock”. Falling prices of manufactured goods masked the rampant asset inflation that was building up.
“Policy makers were seduced into inaction by a set of comforting beliefs, all of which we now see were false. They believed that if inflation was under control, all was well,” he said.
In retrospect, central banks should have let the benign deflation of this (temporary) phase of globalisation run its course. By stoking debt bubbles, they have instead incubated what may prove to be a more malign variant, a classic 1930s-style “Fisherite” debt-deflation.
Mr White said the Fed is now in a horrible quandary as it tries to extract itself from QE and right the ship again. “It is a debt trap. Things are so bad that there is no right answer. If they raise rates it’ll be nasty. If they don’t raise rates, it just makes matters worse,” he said.
There is no easy way out of this tangle. But Mr White said it would be a good start for governments to stop depending on central banks to do their dirty work. They should return to fiscal primacy – call it Keynesian, if you wish – and launch an investment blitz on infrastructure that pays for itself through higher growth.
“It was always dangerous to rely on central banks to sort out a solvency problem when all they can do is tackle liquidity problems. It is a recipe for disorder, and now we are hitting the limit,” he said.
Source: World Faces Wave of Epic Debt Defaults, Fears Central Bank Veteran – The Telegraph
DEFINITION of 'Quantitative Easing'
An unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. Quantitative easing is considered when short-term interest rates are at or approaching zero, and does not involve the printing of new banknotes.BREAKING DOWN 'Quantitative Easing'
Typically, central banks target the supply of money by buying or selling government bonds. When the bank seeks to promote economic growth, it buys government bonds, which lowers short-term interest rates and increases the money supply. This strategy loses effectiveness when interest rates approach zero, forcing banks to try other strategies in order to stimulate the economy. QE targets commercial bank and private sector assets instead, and attempts to spur economic growth by encouraging banks to lend money. However, if the money supply increases too quickly, quantitative easing can lead to higher rates of inflation. This is due to the fact that there is still a fixed amount of goods for sale when more money is now available in the economy. Additionally, banks may decide to keep funds generated by quantitative easing in reserve rather than lending those funds to individuals and businesses.Bridgewater's Dalio: Fed's next move toward QE, not tightening
Amid the global market turmoil, the Federal Reserve is more likely to ease than tighten interest rates again, Ray Dalio, founder of the world's largest hedge fund, said Wednesday.
"I think a move to a quantitative easing would bolster psychology," he told CNBC's "Squawk Box" at the World Economic Forum in Davos, Switzerland.
The Fed hiked rates in December, the first such move in more than nine years.
At the time, central bankers telegraphed four more possible rate increases in 2016. But with the horrible start for the markets in the new year, many investors are questioning the wisdom of such an aggressive path higher.
"This will be a negative for the economy, this market movement. The Fed should remain flexible. It shouldn't be so wedded to a path," Dalio said. "We're going to have a lower level of growth in six months from now ... about 1.5 percent."
"The risks are asymmetric on the downside, because asset prices are comparatively high at the same time there's not an ability to ease," he added. "That asymmetric risk exists all around the world. So every country in the world needs an easier monetary policy."
"It's going to be much more difficult ... next time," he said, because the U.S. needs movement on fiscal policy from lawmakers in addition to monetary policy from the central bank.
Dalio's Bridgewater Associates has $155 billion in assets under management and counts the World Bank among its investors. He's advised various U.S. treasury chiefs including, Tim Geithner and Larry Summers.
The firm's flagship Pure Alpha fund was up 4.7 percent, and its Pure Alpha Major Markets fund was up 10.6 percent in 2015, even after fees were taken out. Since inception in 1991, Pure Alpha has generated an annualized net return of 13 percent.
The S&P 500 ended last year down 0.73 percent, after three-straight years of double-digit gains.
However, Bridgewater's All Weather portfolio, a long-only fund designed to hold a well-diversified asset mix, ended 2015 down 7 percent.
"All Weather ... is a portfolio in which the assets are supposed to balance each other," Dalio said. "[But] the problem last year is that almost all asset classes in the world went down in value. That can't go on too long without producing a depression."
Since inception in 1996, All Weather has generated an annualized net return of 7.7 percent.
In a recent private note to Bridgewater clients obtained by CNBC, Dalio wrote, "[China] went from being underappreciated and cheap to being loved and expensive, and is going back again, fueled by leveraging and deleveraging."
Dalio goes on to say that policymakers need to:
"I think the China situation with the currency is very important," Dalio said Wednesday. "If there's significant currency weakness, that will mean more imported deflation [to the U.S.]. And it'll make things more difficult."
He said the dollar will be strong temporarily because of a short squeeze. "Emerging countries owe dollars. So they have to buy dollars," he said. "Once that squeeze is over, it undermines the dollar longer term."
"I think a move to a quantitative easing would bolster psychology," he told CNBC's "Squawk Box" at the World Economic Forum in Davos, Switzerland.
The Fed hiked rates in December, the first such move in more than nine years.
At the time, central bankers telegraphed four more possible rate increases in 2016. But with the horrible start for the markets in the new year, many investors are questioning the wisdom of such an aggressive path higher.
"This will be a negative for the economy, this market movement. The Fed should remain flexible. It shouldn't be so wedded to a path," Dalio said. "We're going to have a lower level of growth in six months from now ... about 1.5 percent."
"The risks are asymmetric on the downside, because asset prices are comparatively high at the same time there's not an ability to ease," he added. "That asymmetric risk exists all around the world. So every country in the world needs an easier monetary policy."
"It's going to be much more difficult ... next time," he said, because the U.S. needs movement on fiscal policy from lawmakers in addition to monetary policy from the central bank.
Dalio's Bridgewater Associates has $155 billion in assets under management and counts the World Bank among its investors. He's advised various U.S. treasury chiefs including, Tim Geithner and Larry Summers.
The firm's flagship Pure Alpha fund was up 4.7 percent, and its Pure Alpha Major Markets fund was up 10.6 percent in 2015, even after fees were taken out. Since inception in 1991, Pure Alpha has generated an annualized net return of 13 percent.
The S&P 500 ended last year down 0.73 percent, after three-straight years of double-digit gains.
However, Bridgewater's All Weather portfolio, a long-only fund designed to hold a well-diversified asset mix, ended 2015 down 7 percent.
"All Weather ... is a portfolio in which the assets are supposed to balance each other," Dalio said. "[But] the problem last year is that almost all asset classes in the world went down in value. That can't go on too long without producing a depression."
Since inception in 1996, All Weather has generated an annualized net return of 7.7 percent.
In a recent private note to Bridgewater clients obtained by CNBC, Dalio wrote, "[China] went from being underappreciated and cheap to being loved and expensive, and is going back again, fueled by leveraging and deleveraging."
Dalio goes on to say that policymakers need to:
- Manage debts: i.e., bring debt growth down toward income growth and restructure a lot of debt.
- Restructure the economy: i.e., help new businesses and industries replace old businesses and industries.
- Develop all forms of capital markets, including making credit, equity and currency markets more efficient.
- Manage the pressures on the balance of payments and currency.
"I think the China situation with the currency is very important," Dalio said Wednesday. "If there's significant currency weakness, that will mean more imported deflation [to the U.S.]. And it'll make things more difficult."
He said the dollar will be strong temporarily because of a short squeeze. "Emerging countries owe dollars. So they have to buy dollars," he said. "Once that squeeze is over, it undermines the dollar longer term."
Source: http://www.cnbc.com/2016/01/20/bridgewaters-dalio-feds-next-move-toward-qe-not-tightening.html
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