With the volatility in
the world's stock and commodity markets being foremost on many investors minds,
I wanted to take a look at some recent comments by William
White, a Canadian economist. His main claim to fame are his
prescient views on the debt crisis of 2008. He is currently the chairman
of the Economic and Development Review Committee at the OECD, a position that
he was appointed to in 2009. He was the Head of the Monetary and
Economic Department of the Bank for International Settlements from May 1995 to
June 2008 and spent 22 years in various positions at the Bank of Canada, rising
to the position of Deputy Governor of Canada's central bank. For those of
you who are not aware of the Bank for International Settlements or BIS, it
is a Basel-based organization that was founded in 1930 and is owned by 60
of the world's largest central banks whose home nations make up 95 percent of
the world's GDP. The BIS' mission is to act as a central bank for central
banks and it functions under a high level of secrecy.
As far back as 2003, Dr.
White observed that there was a real estate bubble developing in the United
States, and that there was simply too much cheap money available to consumers.
With the economy bursting at the seams with money "printed" by
the Federal Reserve, America's banking system had to find somewhere for all of
that money to go, thus, the invention of increasingly imaginative (and
ultimately toxic) financial products. At the time, central bankers
universally agreed that if there was no inflation, there was no problem,
totally ignoring the development of asset bubbles. Dr. White suggested
that interest rates should be raised even when the economy is in good shape and
there is no sign of inflation since this would counteract the formation of
asset bubbles and will allow central banks to rearm their monetary policy "tool kits" so that they can
lower interest rates when the economy inevitably turns down. His suggestion would
have prevented the Federal Reserve and other central banks from painting
themselves into a policy corner as they have now with their prolonged period of
near-zero interest rates.
Now, in light of the
volatility in the world's markets, let's look at some of Dr. White's more
interesting comments from one of his recent speeches. Here are some
excerpts from a speech entitled "False beliefs and unhappy endings" given
on December 11, 2015 in Canada. Any bolds are mine:
"In a nutshell,
central bankers in the major advanced economies have been pursuing increasingly
risky policies for some time. In large part,this reflects the political reality
that monetary policy is the “only game in town”. Yet, in no small measure, it
also reflects some long held, but false, beliefs about how the economy actually
works. Moreover, absent any discipline imposed by an international monetary
system (we have in fact a non-system), virtually every central bank around
the world is now engaged in a process of unprecedented monetary easing. As a
result, I think the global economy could now be in an even more dangerous
situation than it was in 2007...
It is now impossible to
deny that something has gone seriously wrong with the global economy. Moreover, for most
economists, it seemed to come out of nowhere and its effects have lingered far
longer than most originally anticipated.
While recognizing the
great contribution of central banks to restoring financial stability, early in
the crisis, there are good reasons for doubting that monetary policy will prove effective in stimulating
aggregate demand over time. Much of what has been done recently smells of
panic. Arguably, by increasing uncertainty, it might even have encouraged
people, both companies and households to hunker down and spend less rather than
more. What is more certain is that easy money works by bringing spending
forward in time. However, by definition, tomorrow eventually becomes today and
it is payback time. In short, inciting more spending through taking on higher
levels of debt simply cannot go on forever. And not only has debt
accumulation been accelerating for over thirty years, in the advanced market
economies, but global debt ratios (non-financial debt) have even risen
substantially since 2007...with US interest rates so low and the dollar
falling in value (up to mid 2014), much of the borrowing was in US dollars.
With the dollar now rising, a mismatch problem could threaten barring an
adequate level of prior hedging. Finally, much of the proceeds went into
enlarging the capital stock in sectors (like property) where profits are
already under strong downward pressure.
As for the unintended
consequences, we are observing sharp declines in productivity growth almost
everywhere and a slowdown in the formation of new businesses. I think it is not
implausible that easy money has encouraged the “evergreening” of zombie
companies by zombie banks which has led to this outcome. Moreover, we are
all aware of how the prices of almost all assets, financial certainly but also
property in many cases, have been bid up to levels where potential future
losses might conceivably be severe. Who will suffer and what might be the
systemic implications? We simply do not know. Monetary policy has led us into
truly uncharted territory. Perhaps when (if?) the Fed starts raising rates,
we will get more clarity on these issues, though we might not like what we see.
Finally with respect to
unexpected consequences, the health of many financial institutions (especially
in the advanced market economies) are also under threat. Bank profits, needed for
capital accumulation, are being reduced by low credit spreads and low term
spreads. Pension funds and insurance companies, whose liabilities tend to be of
longer duration than assets, are similarly threatened and fearful of their
longer term solvency. Everywhere, there is the temptation to “gamble for
resurrection”, again with unknown consequences.
To boil down Dr. White's
comments to one key point, he is concerned about the massive growth in debt, particularly toxic debt, over the last eight years because of near zero interest rates. Let's look
at a few examples:
1.) Here is a graphic from Vox showing
how Europe's non-performing loans by country have risen since 2008:
2.) Here is a graphic from McKinsey showing how
the global sovereign debt-to-GDP ratio has risen by measuring the
change in debt-to-GDP ratio from 2007 to 2014:
The ratio of debt-to-GDP
has risen for all advanced economies since 2007 and has fallen or remained
steady for only six developing economies.
3.) From Visual
Capitalist, here is a graphic showing the percent of total
global debt by country, current to August 2015:
While the United States
economy makes up 23.3 percent of the world's GDP, it has 29.1 percent of the
world's total sovereign debt. Japan's economy makes up 6.18 percent of
the world's GDP but has 19.99 percent of the world's total sovereign debt.
4.) Here is what has happened to non-financial
corporate debt levels in the United States since 2007, keeping in mind that a great deal of this debt is considered "junk":
While there was relatively modest corporate debt deleveraging during and immediately after the
Great Recession, non-financial corporate debt is now $1.403 trillion or 21
percent higher than it was in the third quarter of 2008. This is due, in
no small part, to ultra-low interest rates on corporate paper.
It has become
increasingly apparent that the next recession could well be different.
All levels of the economy have leveraged up as central bankers have
prolonged their long-term interest rate experiment. Governments,
businesses and individuals (particularly in nations like Canada) have lined up
at the trough, eagerly availing themselves of ultra-cheap credit without
thought for the long-term ramifications of their foolishness. As Dr.
White noted so aptly, central bankers have failed to realize that the nature of
the global economy is far too complex to be well understood.
Let's close this posting
with a recent quote that Dr. White gave to the
Telegraph:
"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."
