It's late June which means it is time for the annual warning by the Bank of International Settlements about the growing futility of monetary policy and central bank impotence. Exactly one years ago, the BIS asked "Of What Use Is A Gun With No Bullets?", in which the BIS said central banks are defenseless against the coming crisis. Well, it underestimated just how far the central banking "magic people" are willing to reach inside their "magic bag of tricks" to preserve the status quo: to be sure nobody at the time expected the ECB to begin buying not just corporate bonds but junk bonds too.
Fast forward one year and the song and dance has been repeated, with the issuance of the BIS' 86th Annual report in which we read that "Easy-money policies and unprecedented monetary stimulus have started to backfire in global financial markets" as Bloomberg summarizes the 130 page report, which is largely full of data and analyses quite familiar to regular readers.
In its report, the BIS "says that historically low interest rates and bond-buying programs - which have sent yields below zero on more than $8 trillion of government bonds, a record amount - are causing anomalies in asset values. One example is that small price differences in related securities or assets, which banks traditionally eliminated through arbitrage, are persisting more often."
"Monetary policy is running out of room for maneuver," said Hyun Song Shin, head of research at the BIS, in an interview. “It is not clear how much further stimulus of the real economy can be achieved using monetary-policy tools alone without inviting unwanted distortions.”
Like on virtually every occasion since 2013, the BIS on Sunday once again called on governments to reduce their reliance on extraordinary monetary policy for spurring economic growth. "Instead, they should redouble efforts on structural and financial reforms, it said. The stimulus produced by the world’s monetary authorities will approach the limits of its effectiveness, according to the BIS, which was formed in 1930 and acts as the central bank for many of those institutions."
With the cost of money so close to zero, the profitability and resilience of banks has been sapped, impairing their ability to lend to the wider economy and make markets for securities... When banks choose not to hold as many securities, that reduces depth and liquidity in bond and currency markets, threatening to disrupt their smooth functioning.
Lenders across Europe from Deutsche Bank AG to Societe Generale SA are struggling to increase revenue as the European Central Bank pushes interest rates below zero, regulators demand bigger capital buffers and market volatility spooks investors, according to their financial reports last month. Intesa Sanpaolo SpA, Italy’s second-largest bank, said in May its first-quarter profit dropped 24 percent due to such reasons.
“It’s far better for banks and broker-dealers to have a strong capital base because it allows them to lend more in support of the real economy and on better terms,” the BIS’s Shin said. “It allows them to make markets in a robust way.”
Another point the BIS makes is something we have discussed over the past year, namely the blow out in cross-currency basis swaps, which as we futher pointed out on Friday, blew out to the most negative print since 2012:
Following up on a report the BIS' Hyun Song Shin wrote just a few days ago, the BIS makes the case that "under the theory of so-called covered-interest parity, interest rates implied by currency trading should be consistent with market interest rates. Yet, current implied dollar rates from currency swaps are above Libor. This means that borrowers in dollars through the currency swap market are paying more than the rate available in the open market."
What is new and notable in the current report is the BIS' indirect allegation that the ongoing period of economic malaise, record low rates, and collapsing productivity is itself the result of previous (and current) central bank policy.
We suggest that the current predicament in no small measure reflects the failure to get to grips with hugely costly financial booms and busts (“financial cycles”). These have left long-lasting economic scars and have made robust, balanced and sustainable global expansion hard to achieve – the hallmark of uneven recovery from a balance sheet recession. Debt has been acting as a political and social substitute for income growth for far too long.
More on debt:
Debt can help better explain what would otherwise appear as independent bolts from the blue. First, it sheds light on the EMEs’ slowdown and on global growth patterns. Debt is at the heart of domestic financial cycles and of the tightening of financing conditions linked to foreign currency borrowing. This is most evident for commodity producers, especially oil exporters, who have seen their revenues and collateral strength collapse – hence the large holes in fiscal accounts and big investment cuts. And debt may be one reason why the boost to consumption in oil-importing countries has been disappointing: households have been shoring up their balance sheets.
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... debt may even shed light on the puzzling slowdown in productivity growth. When used wisely, credit is a powerful driver of healthy economic growth. But as the previous evidence indicates, unchecked credit booms can be part of the problem and leave a long shadow after the bust, sapping productivity growth. In addition, debt overhangs depress investment, which weakens productivity further. In turn, weaker productivity makes it harder to sustain debt burdens, closing the loop.
But, but... Janet Yellen was so confused just this past week:
BARR: In your prepared remarks, you indicated that business investment was surprisingly weak. Maybe the reason why the Fed is surprised and continued to miss on forecasts. And the Fed as the Washington journal pointed out, estimated 2.4 percent growth in December, that had fallen to 2.2 percent by March. This month, it was down to 2 percent. And it follows the Federal Reserve's consistent record of forecasting error from a standpoint of predicting stronger growth than is actually occurring.... I would like you to comment on that."
YELLEN: Well, growth has been disappointing. I'm not sure of the reason.
Now you know Janet.
Incidentally, this is another thing that this tinfoil, "conspiracy" site has been warning about for the past 7 years: in lieu of real reform and structural changes, the entire world has relied exclusively on more debt, and thus, permissive lower rates, to buffer the failure of politicians and to thrust all responsibility for "growth" in the hands of central bankers. Seven years later, with growth faltering and the world on the edge of a recession, is it any wonder central bank credibility has never been lower.
It may also be the BIS' code word that it is time for a global, debt jubilee or reset, since the very same central bank policies have made rising rates impractical, and thus "inflating the debt away" is impossible. It only leave bankruptcies as an option. To be sure, the BIS is more nuanced in its wording:
This interpretation argues for an urgent rebalancing of policy to focus more on structural measures, on financial developments and on the medium term. A key element of this rebalancing would be a keener appreciation of the cumulative impact of policies on the stocks of debt, on the allocation of resources and on the room for policy manoeuvre. For it is this lack of appreciation that constrains options when the future eventually becomes today. Intertemporal trade-offs are of the essence.
The problem is that going forward, central banks will have far less room to maneouvre, and if anything, may be forced to tighten policy as further easing may now be frowned upon by markets:
... we witnessed a rotation in financial booms and busts around the world after the crisis. The private sector in the advanced economies at the heart of the crisis slowly started to deleverage; elsewhere, especially but not only in EMEs, the private sector accelerated the pace of releveraging as it left behind the memory of the 1997–98 Asian crisis. Signs of unsustainable financial booms began to appear in EMEs in the form of strong increases in credit and property prices and, as in previous episodes, foreign currency borrowing. Currency appreciations failed to arrest the tide. In fact, as BIS research suggests, they may have even encouraged risk-taking, as they seemingly strengthened the balance sheet of foreign currency borrowers and induced lenders to grant more credit (the “risk-taking channel”).
What we have been witnessing over the past year may be the beginning of a major, inevitable and needed realignment in which these various elements reverse course. Domestic financial cycles have been maturing or turning in a number of EMEs, not least China, and their growth has slowed. Commodity prices have fallen. More specifically, a combination of weaker consumption and more ample production has put further pressure on the oil price. In addition, actual and expected US monetary policy tightening against the backdrop of continued easing elsewhere has supported US dollar appreciation. This in turn has tightened financing conditions for those that borrowed heavily in the currency .
The most eye-opening part in today's report was the BIS' admission that it really is all the central banks' fault in the form of boom-bust cycles "gone wrong" which in turn lead to "long-lasting damage" to wit:
The world has been haunted by an inability to restrain financial booms that, once gone wrong, cause long-lasting damage. The outsize and unsustainable financial boom that preceded the crisis masked and exacerbated the decline in productivity growth. And rather than being the price to pay for satisfactory economic performance, the boom contributed, at least in part, to its deterioration, both directly and owing to the subsequent policy response. The key symptom of the malaise is the decline in real interest rates, short and long, alongside renewed signs of growing financial imbalances.
There is much more in the report which clearly "gets it", even the unpleasant observation what monetary policy failure means for the world's politicians: namely, that they wil finally have to do their job!
The need to rebalance the policy mix puts a greater onus on structural policies. Their implementation, of course, faces serious political economy obstacles. In addition, they do not necessarily yield near-term results, although this depends on the specific measures and their impact on confidence. But they provide the surest way of removing impediments to growth, unlocking economies’ potential and strengthening their resilience.
What this means is that for anyone who thinks we have seen the full extent of populist revulsion to New Normal policies is hang on to your hats cause we ain't seen nothing yet: if the BIS' prescription of the world's ills is taken seriously by policymakers, it means that only now will politicians no longer be able to punt to central banks in lieu of making unpopular, debt-funded decisions, and the result will be an historic surge in popular anger as suddenly the debt-funded welfare state sees its funding to keep the majority content, is no longer quite so generous.
The BIS' conclusion:
A shift to more robust, balanced and sustainable expansion is threatened by a “risky trinity”: debt levels that are too high, productivity growth that is too low, and room for policy manoeuvre that is too narrow. The most conspicuous sign of this predicament is interest rates that continue to be persistently and exceptionally low and which, in fact, have fallen further in the period under review. The global economy cannot afford to rely any longer on the debt-fuelled growth model that has brought it to the current juncture.
A shift of gears requires an urgent rebalancing of the policy mix. Monetary policy has been overburdened for far too long. Prudential, fiscal and, above all, structural policies must come to the fore. In the process, however, it is essential to avoid the temptation to succumb to quick fixes or shortcuts. The measures must retain a firm long-run orientation. We need policies that we will not once again regret when the future becomes today.
As the UK has found out the hard way, it's too late for that now.
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In closing we will remark what we said one year ago today:
If you know anything about the history of the BIS, you know that the bank’s latest annual report is glaringly ironic and somewhat hypocritical. The “bank for central banks” as the highly profitable institution is known, has for decades served as a secretive club for the world’s most influential central bankers. The lavish governors’ weekends hosted by the bank in Basel allow the world’s most powerful monetary policy mavens to discuss the most important issues facing the global financial system in complete privacy with no fear that anything will leak to the public or to the press.
In other words, the BIS serves to encourage and perpetuate the power and prestige of the world’s central bankers and provides a top secret forum for the monetary policy cabal to meet and commiserate safe at all times from the prying eyes of those to whom the bankers should by all rights be accountable.
In this context it’s somewhat absurd that the bank’s annual report — which, as a reminder, is required reading in treasury departments and monetary policy circles around the globe — contains a scathing critique of the very same policies which were no doubt devised, tweaked, and honed over dinner and fine wine in Basel. Nevertheless, the BIS’ latest tome is replete with criticism for the idea that the very people who make up the bank’s Board of Governors are indeed omnipotent.
Last but not least, let's not forget where the world's central bankers were located on Friday morning when they announced the barrage of monetary policy responses they would unleash in the aftermath of Brexit to soothe global capital markets: the 18th floor of the BIS tower.
So you will please excuse us if we ignore this latest annual rant by the BIS against the policies implemented by the BIS' very own board of directors. If anything, we would expect much more of the same failed policies; we certainly will expect even louder and more dire warnings from the BIS one year from today when everything else that central banks unveil between now and June 2017 is implemented, and fails to do anything but keep global equity markets propped up "whatever it takes."