“This will be uncomfortable for a lot of people who think they own assets that are worth something”…
Submitted by Larry White:
Last month we ran this article which quoted former Bank for International Settlements (BIS) Chief Economist William White as saying that the global debt problem is so severe that “it will become obvious in the next recession that many of these debts will never be serviced or repaid.” If that isn’t enough coming from a former BIS Chief Economist, he added “this will be uncomfortable for a lot of people who think they own assets that are worth something.“
We try here to be non sensational in covering the issues. We try not to use hyperbole or overhype the potential for serious economic problems. In this case we have an extremely credible former key official with years experience inside the system making some very strong statements in public. In order to explore these comments more in depth, we will look at a recently released two part article on the Cobden Centre web site that is an interview with William White. We strongly encourage readers here to read Part I and Part II of this interview fully. Below are some key quotes selected from the interview. After that we will add a few comments.
Max Rangeley: “Well, thank you very much for being on the call today, Bill. That’s really great. So I’ve got a few questions here, which I thought we could go through. First, now that QE has started in Europe is this likely to cause further distortions rather than stimulate the economies of Europe, especially will it favour large corporations at the expense of small businesses, do you think?”
William White: “To be honest, I’m not sure it’s going to do anything – certainly, anything that’s good. The fundamental problem here, as I see it anyway, is that the European banking system is still broken. As you know, the European economy is heavily reliant on small and medium-sized enterprises, and they are reliant in turn on bank financing. Unfortunately, it is these firms that are not getting the bank financing that they need. Until that gets fixed, we will continue to have a huge problem in Europe. . . . . . .
In any event, here in the euro zone bond yields are incredibly low already although one cannot rule out that this was in anticipation of QE. So my general sense is that I don’t think QE was needed and I am dubious that it will work in stimulating aggregate demand as intended. Moreover I remain worried that its implementation might bring with it other unintended and undesirable consequences that we haven’t even thought about. All that said, I think the ECB was under such pressure to act further that it had little choice but to do what it did. And that, in itself, I think, is really unfortunate, because it just drags another important central bank still deeper and deeper into this malaise of central bank over extension.”
Sean Corrigan: “As you say, I couldn’t agree more. It’s a question of dysfunctional banking and also of the debt hangover, which we haven’t addressed. And to me, QE is self-deceiving in that the liquidity issue, as you say, was the first rationale in the aftermath of the Lehman collapse was one thing, but to then try and use it as a macro tool when what you’re trying to do is make borrowing more attractive for people who have just been burnt by over borrowing seems”
William White: “Mad. It’s mad here and it’s mad everywhere. It’s more of what got us into trouble in the first place.”
Sean Corrigan: “We’re trying to fix banks but now we’re destroying their net interest rate margins, by trying to work this way as well. We’re also destroying all the other financial institutions like insurance and pension companies that must be bleeding everywhere.”
William White: “I’m working on a piece for the G30 which basically deals with the future of central banking and the future of monetary policy. I sense from talking to many of the members, many of whom are previous central bankers, that they are very concerned about the direction this has taken, in particular the continued over reliance on stimulative monetary policy to get us out of the predicament we are in. It has turned into a kind of Pandora’s box. Swiss Re has recently published a paper called “Financial Repression: Quantifying the Cost” which looks at the cost of these unusually low interest rates for the insurance industry. Clearly, they are really, really worried about it and I don’t blame them.
As for your other point Sean, I also agree. I guess in the early days when they started lowering the interests rates, the thought was that the deposit rates would go down before the loan rates and the banks would get a short-term benefit from the change. But in the fullness of time, however, margins are getting squeezed more and more so that even the banks are being hurt. If broken banks are a big chunk of current problems, particularly in Europe, it is a bit odd that policy is actually making the future of banks and other financial institutions still more dodgy.
As both of you may know, I’ve written a lot about this stuff, not least of which a paper that was published by the Dallas Fed in 2012 . It was called “Ultra Easy Monetary Policy And The Law Of Unintended Consequences.” It contained page after page of all the things that might go wrong. Moreover, knowing that even my imagination might be inadequate, I treated that paper as a kind of work in progress. So every time I opened up The Financial Times or something else and I saw something unpleasant that wasn’t in my paper, I clipped it out and added it to the pile. Unfortunately, the pile is getting bigger and bigger. There is a possibility at least that this whole exercise could end very badly.”
. . . . . .
William White: “Absolutely. It is notable that in the course of the last couple of years, the BIS in its Annual Reports has repeatedly used the phrase the ‘debt trap’. Very low interest rates encourage so much debt increase that central banks fear raising them again because you will bankrupt everybody. That is the debt trap. Similarly, Robert Pringle wrote a book in 2012 called “The Money Trap”, which is about the international side of this over extension. Hans-Werner Sinn has just published “The Euro Trap”, and Eswar Prasad recently published “The Dollar Trap”. There is something going on here with these dynamic processes that is being increasingly recognized as dangerous.”
. . . . .
“Similarly, I fear that central bankers may have been inadvertently drawn into what they are currently doing.. The first set of really radical policies – the zero lower bound and the QE1 and the intervention in the inter bank markets and all that stuff – was done for reasons of financial stability. My own belief is that it was absolutely the right thing to do. But then, as time wore on and as government did not do what they should have done to help resolve the crisis, central bankers got drawn into QE2 and all the rest of this stuff. But it has now got a totally different objective, one of stimulating aggregate demand. And, as I said before, my feeling is that it won’t work and may have many undesired side effects that will build up over time. Many of the central bankers at Davos this year said explicitly that they were only buying time for governments to act but, seven years into the crisis, it already seems we have been waiting forever.
One way to describe the dangers of waiting is that the effectiveness of monetary policy in terms of stimulating aggregate demand goes down with time, because you’re constantly bringing spending forward from the future. As the future becomes today, then you have to pay it back. So just by definition, this thing only works for a short time period. Unfortunately, the side effects, not least the further accumulation of debt and excessive asset prices, go up with time. And, at a certain point, those two time lines cross. Logically, at that point, central bankers should say, “We are doing more harm than good. This policy must be reversed.” But I don’t see anybody actually doing it.”
Sean Corrigan: “A couple of basis points matter here because the durations are so long. It means a nice fat market-to-market gain. So while the trend continues, total returns on bonds look pretty good but more, and more, and more of that return is simply that we’re squeezing out an extra couple of basis points, pushing the price to a higher and higher premium. And as you say, bonds could– if we’re willing to pay the government to borrow from us, as in some cases we are – actually go a lot further than we ever thought possible. But again, as I think you said earlier, if it’s unsustainable, ultimately, it must end.”
William White: “Yes. Sadly, I don’t think anybody’s capable of telling you precisely how and when the whole thing will come unstuck. Nevertheless, you know that at some point, it has to. It’s like all of these complex systems. What we know from studying them over time is that they fall apart on a regular basis, and it’s impossible to say precisely where or what the trigger will be. That raises the obvious question of what investors can do to protect themselves.”
. . . . .
Max Rangeley: “Bill, I have just one more major question actually, which is last November our Founder, Member of Parliament Steve Baker, led the first debate in Parliament for 170 years on monetary reform. So what are your thoughts on, for instance, the Chicago plan or Martin Wolf’s article in the Financial Times last year discussing endogenously created money; do you have a perspective on any of those themes?”
William White: I find it extraordinary that some economists still do not recognize that we have a fiat money system. Banks do not lend money that has been saved. They create money by making loans and simply writing up both sides of their balance sheet. This system clearly greases the wheels of commerce, but it can also get badly out of control as we have seen in recent years. There really is an issue here. Do we want to go back to 100% reserve banking, or something of that nature, as suggested by the Chicago school and Irving Fisher in the 1920’s. While I have not thought enough about it to say where I’d come out on this debate, it certainly is an issue that we should be thinking about. This has also been suggested quite recently by Martin Wolf and John Kay of the Financial Times. These are serious people whose suggestions should be treated equally seriously. And, in a similar vein, I repeat what I said a few moments ago. We also need to go back and look at the whole International Monetary System, or Non System as I and others have called it.
I’m not even sure where to start on all this. Here we have a former Chief Economist from the BIS essentially baring his soul about the massive debt problems we face globally and offering a very detailed analysis of the measures that have been tried to deal with it by central banks. As you read through this article, please note how many times Mr. White talks about how dangerous the situation is, how he fears it will all end badly, and even describes the QE policies as being “mad”. Listening to Mr. White do this interview was sort of like getting a summary version of Jim Rickards ‘Currency Wars’ and ‘The Death of Money’ all in one article. He even talks about how we cannot predict when “complex systems” will break down. It’s clear to me that he sees potential for a crisis coming similar to what Jim Rickards and others have been warning about now for years. Keep in mind this is from someone with 14 years experience inside the BIS as an Economic Adviser.