JUNE is the time for Wimbledon tennis, World Cup football and in Basel, hundreds of
the world’s central bankers gather for the annual meeting of the Bank for International
Settlements (BIS). When I was a young central banker carrying my governor’s bag to
attend these meetings in the late 1970s, it was mainly a grand formal affair for G7
central bankers, with a few emerging market central bankers invited as special
guests. The wine was amongst the best and every guest who attended was given a
Swiss handkerchief as souvenir, printed with the menu of the dinner.
The BIS is still the central bank of central banks, where central banks put some of
their spare cash to help invest, but its most important function is to be a forum for
discussion of the key issues that central banks face. Today, the food and wine are
much more business-like, and the issues are more balanced, because the G7 central
bankers have come down from their moral and intellectual pedestals, having made
some huge mistakes in the Great Recession of 2007-2009.
The BIS is today also more international, with the new economic advisor, Dr Hyun
Shin, coming from South Korea, and this year’s prestigious Per Jacobsson
Foundation Lecture was delivered by Malaysian central bank governor Tan Sri Dr
Zeti Akhtar Aziz on the inevitability of financial crisis, fundamentally how to manage
crises from the emerging market perspective.
Financial Times columnist Martin Wolf admonished the 2014 BIS annual report as
“bad advice from Basel’s Jeremiah”. Jeremiah was a Biblical prophet who predicted
impending doom, but his own people did not believe him. It turned out that he was
right.
Unlike Wolf, I think the BIS is right.
Anemic recovery
BIS general manager Jaime Caruana, formerly governor of the Bank of Spain and
bank supervisor, reviewed carefully the history and causes of the current Global
Financial Crisis, identifying it as debt-driven and a balance sheet crisis (www.bis.
org/speeches/sp140629.htm). He argues that central bank policy must step out of the
shadows of the past crisis, and transit in three areas: less debt-driven, more normal
monetary policy, with a more reliable financial system.
The good news is that the advanced economies are now on the way to an anemic
recovery, but the emerging market economies (EMEs) are facing a host of new and
complicated challenges, not least due to the aftermath of quantitative easing (QE).
The bad news is that no one can agree on what is to be done to get out of this mess,
with a growing debt burden globally. Debt to GDP ratios are now 275 per cent for the
advanced economies and 175 per cent in the EMEs, with the latter growing fast.
Here’s the rub. We got out of the crisis only because there was exceptionally loose
fiscal policy and incredibly unconventional monetary policy. Central bank balance
sheets are now US$20 trillion in aggregate, double what it was before the crisis and
nearly 8 per cent of total conventional financial assets (excluding derivatives).
The trouble is that financial markets are bubbly because they are almost totally
dependent on loose monetary policy. Markets go up and down because some central
banker claims to see tightness or more loosening. They are not driven by market
fundamentals, mainly because interest rates are way below their normal levels.
Interest rates are low not just because central banks are trying to keep it that way,
but because there are US$7 trillion in dollar-denominated credit outside the United
States that are being created outside the control of the Fed. The balance sheet of the
Fed is currently US$4.3 trillion (less than US$900 billion before the crisis).
Martin Wolf says that the BIS gives bad advice because it demands austerity now.
Indeed, he says that it is being foolish to argue for a withdrawal of support for
demand and embrace outright deflation.
I beg to disagree.
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