William White, the Swiss-based chairman of the OECD’s review committee and former chief economist of the Bank for International Settlements (the central banker’s central bank), recently made some frank statements about future debt defaults from Davos, reported here by Ambrose Evans-Pritchard. We parsed his comments and responded with a few of our own:
“The situation is worse than it was in 2007. Our macroeconomic ammunition to fight downturns is essentially all used up,” said William White.
Their ammo is used up. That may be a good thing since all the central bankers can do with their interventions is cause mischief. That won’t prevent them from trying.
“Debts have continued to build up over the last eight years and they have reached such levels in every part of the world that they have become a potent cause for mischief,” he said.
“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.
All enabled by Central Bankers Gone Wild. Since 2007 the Fed’s balance sheet quintupled. The rest of the world’s central bankers followed suit. The debt followed: cause and effect.
“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.”
It will be disorderly and there is nothing the central bankers can do to stop it. Year-to-date action in financial markets has been very orderly. That will change.
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.
No!!! The next task should be to shut down the entire central banking operation. I guess we’re going to have to endure even more pain as the central banks compound their mistakes… once again.
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.
We agree. Deutsche Bank is this cycle’s Lehman Brothers. We are heavily short.
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.
Get ready. The euro zone is headed down the bailouts-for-banks path.
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.
What a telling quote! Correct, these guys do not see around corners. Nearly all of them failed to anticipate the 2008 meltdown. Even when the subprime cracks appeared, nearly all thought the cancer was contained. It wasn’t just 2008. Interventionist economists missed the 1929 crash and 1970s inflation, failed to identify the 1989 Japan bubble and 2000 tech bubble, and thought the Soviet economy was exemplary before it collapsed in the late 1980s.
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.
Spot on. My jaw is on the floor. I can’t believe any central banker would admit how much they screwed things up by trying to prop up the financial system in 2008.
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.
True statement. There is a reason people defer spending: so they can invest today and have more in the future. Central bank suppressing of interest rates breaks the regulator on this behavior, encouraging more spending today. People are under the illusion that they can have their cake and eat it, too. Unfortunately, there are no free lunches in economics.
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.
This is central-banker-speak for “moral hazard.” Thank you very much Alan Greenspan for inventing the “Plunge Protection Team.” Also, thanks to Robert Rubin, nicknamed “Mr. Bailout” (for good reason).
“Responding to each shock with alacrity?” This is an understatement. With each crisis the response has been exponentially greater. The 2008 variant saw global central bank balance sheets probably go up 3-4 times and interest rates taken to zero for 8 years!
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.
This is a muddled statement, but revealing. China joined the world economy in the 1990s, an unmitigated positive. And yes, this extra supply masked underlying inflation. But who caused that inflation? Central bankers, of course. Were they “seduced into inaction?” Well, not exactly. They were doing what they normally do: suppressing interests below the market level. They should have gone to inaction: let interest rates rise to their natural level. The revealing part of this statement is that central bankers are always fighting the bogeyman of deflation. This is dangerous and what always give them an excuse to meddle. Btw, if we’re going into debt defaults and asset declines, central bankers will have plenty of excuses to “fight deflation.”
Btw, a similar mistake was made in the mid to late 1920s when the Fed tried to “stabilize the price level.” With electrification, new inventions and productivity gains, consumer prices should have gone down. However, the Fed would not tolerate the dreaded “deflation” so they printed money. Consumer prices were strangely (and unnaturally) flat during the second half of the 1920s. In retrospect, most of the Fed’s inflation went into asset prices, blowing a great bubble. This didn’t end well, if my recollection of history is correct.
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.
Correct. I doubt they’ve learned the lesson.
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.
Checkmate. The best they can do is shut down the operation and do something productive, like work as greeters for Wal-Mart.
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.
Bad idea!!! More government “stimulus” can only make matters worse. If Mr. White is so concerned about high debt levels, why is he encouraging even more government debt?
“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.
No, all they can do is wreak havoc.