Posts Tagged ‘BIS’

News flash: Secret central bankers’ summit in Sydney

Sunday, February 7th, 2010

We just received this news tip from one of our readers: Secret summit of top bankers,

The world’s top central bankers began arriving in Australia yesterday as renewed fears about the strength of the global economic recovery gripped world share markets.

Representatives from 24 central banks and monetary authorities including the US Federal Reserve and European Central Bank landed in Sydney to meet tomorrow at a secret location, the Herald Sun reports.

This news article is reported on Rupert Murdoch’s Herald Sun on Friday/Saturday. Is this secret meeting organised in response to big trouble brewing on the horizon? That is what seemed to be implied in the article. Curiously, one paragraph reported,

Organised by the Bank for International Settlements last year, the two-day talks are shrouded in secrecy with high-level security believed to have been invoked by law enforcement agencies.

Was the meeting planned last year? Or perhaps it was brought forward because of the growing crisis in Europe? We don’t know. The central bankers’ club is certainly one of the most opaque organisations in the world- a fertile ground for conspiracy theories.

Anyway, the Greek fiscal crisis have the potential to break up the Euro i.e. currency crisis. If this turns out to be the outcome, then the trouble we wrote about in Currency crisis: first countries in the line of fire- PIIGS just a couple of weeks ago proved to be very timely.

So far, only Sydney’s Herald Sun is the only newspaper reporting this.

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Posted in Market Observations | 4 Comments »

Will governments be forced to exit from ‘stimulus?’

Tuesday, August 25th, 2009

Currently, there’s a belief in the financial markets that the worst of the Global Financial Crisis (GFC) is over and that it’ll be blue sky from now on. Indeed, it is possible that the the US economy may see a positive GDP growth in the next few quarters to come.

But here, as contrarians, we see a different picture. As we quoted the Bank for International Settlements (BIS) in Bank for International Settlements (BIS) warning on stimulus spendings, the ‘green shoots’ of growth is largely contributed to government bailouts, ‘stimulus’ spendings, money printing and cheaper money (e.g. zero interest rates in US).

Make no mistake about this: Government interventions cannot be sustained forever without increasing negative consequences in the longer term. Governments cannot ‘stimulate’ the economy. In fact, the word ‘stimulus’ is the most misleading word in economics lexicon because it conveys the idea of a surgeon ‘stimulating’ a heart into self-sustained beating. In reality, what government interventions did was to put the economy on a crutch. The longer the economy leans on the government crutch, the more dependent it will be on the government. Eventually, the government will become the economy. For those who haven’t already, we encourage you to read Preserving jobs at all costs leads to economic stagnation and Are governments mad with ?stimulating??.

Letting the economy lean on crutches indefinitely will result in decreasing economic health as time goes by. Furthermore, there’s always the risk that the side-effects will pressure governments to remove the crutches. As we quoted the BIS in Bank for International Settlements (BIS) warning on stimulus spendings,

Perhaps the largest short-term risk associated with the expansionary policies is the possibility of a forced exit. Monetary and fiscal authorities of the major economies have so far been relatively unconstrained in their ability to follow expansionary policies. This need not last. An extended period of stagnating economic activity could undermine the credibility of the policies in place. Governments may find it hard to place debt if market participants expect the underlying balance to remain negative for years to come. Under such circumstances, funding costs could rise suddenly, forcing them to cut spending or raise taxes significantly.

How will a pressure for a “forced exit” from crutches (bailouts, stimulus, money printing and cheaper money) happen? We can look no further than China as an example where ‘stimulus’ is most effective. As we wrote in Will August 2009 be the top for the year in China?,

Forcing credit growth in this case does not result in economic ?stimulation.? Instead, the result was a dangerous asset price bubble. Apparently, the Chinese government flipped its position and decided to rein in the bubble before it’s too late.

China is right now in a dilemma. Turning the credit tap off will result in many projects failing, which in turn will result in bad debts. Not turning the credit tap off will result in price inflation and asset price bubbles.

The problem with economic crutches is that there will be negative side-effects. It is only a matter of time before excess liquidity leaked into asset and commodity prices. Initially, this may not be a problem. But as we saw last year (see Who is to blame for surging food and oil prices?), this will eventually result in acute problems of price inflation (unless the next deflation pressure comes, for which it will be déjà vu again). If governments decide to withdraw the economic crutches, they risk letting the already weakening economy fall into deflation. If they decide not to withdraw them, they risk letting acute price inflation run amok.

What is likely to happen is that governments will attempt to walk on the middle ground by pretending to ‘fight’ inflation (e.g. raising interest rates too slowly and talk tough on inflation) and support the economy at the same time, hoping that the economy will turn out fine. It may work initially, but it’s a matter of time before the public will see through it.

Tougher times is ahead for everyone.

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Posted in Economics/Finance, Looking Forward, Market Observations | 14 Comments »

How are central bankers going to deal with asset bubbles?

Sunday, July 12th, 2009

Prior to the Global Financial Crisis (GFC), central bankers tend to adopt the ostrich’s mentality to asset price bubbles. Alan Greenspan, the chief architect of this school of thought believes that central bankers should only target price stability and price inflation with their interest rate levers. Greenspan argued that since it is impossible to know when bubbles will burst, it is impossible to intervene at the right moment (we heard of another twist to Greenspan’s argument- one can never know whether it’s a bubble until it bursts).

What about Australia? As we reported in What should the RBA do?, the RBA, regardless of whether it believes asset price bubbles are dangerous or not, do not have the mandate to prick them,

The masses have not given the RBA the mandate to spoil the asset price inflation party. Although, Ian Macfarlane acknowledged that asset price bubbles can be very dangerous for the economy, his hands were tied. Elsewhere, Coalition opposition politicians were toeing the populist line by demanding that Glen Stevens (the current head of the RBA) be grilled more frequently in order to pressure him against hiking interest rates.

This ostrich mentality of central bankers is strongly criticised by the Bank for International Settlement (BIS). As we wrote before in Bank for International Settlements (BIS) warning on stimulus spendings, the BIS is the

… only international body that had correctly anticipated the global financial crisis (GFC) and warned of another great depression back in June 2007, when they released their 77th annual report (see Bank for International Settlements warns of another Great Depression).

The BIS is dubbed as the central banker of central banks. Its chief-economist, William White, whom we believe is from the Austrian School of economic thought, warned central bankers repeatedly of impending global financial disaster and implored them to re-think their strategy as early as 2003.

Greenspan and White stood at opposing sides. It seemed that Greenspan’s views held sway among the central bankers. He was dubbed as the “Maestro” and was celebrated as the world’s greatest central banker. No one in the world of central banking dared to openly criticised Greenspan, except for William White of the BIS. Since Greenspan was a member of the board of directors of the BIS, he was technically White’s superior. Greenspan had the upper hand until…

… until the GFC erupted and the financial world order came close to collapse in 2008. And so, Greenspan is dis-credited today. White’s theory gained ascendency. As this article reported,

The group of the 20 most important industrialized and emerging nations, which is now left with the task of cleaning up the wreckage of the crisis, apparently faces less academic problems. At the London G-20 summit in April, the group decided to promote a crisis-prevention model based on White’s theories.

They want to introduce what might be called his hoarding model, which calls for banks to build up reserves in good times so that they can be more flexible in bad times. The central banks, according to White, must actively counteract bubbles and exert stronger control over the financial industry, including hedge funds and insurance companies.

As an adviser to German Chancellor Angela Merkel’s group of experts, White helped to shape the basic tenets of the new order. And the 79th annual report of the BIS, published in Basel last week, also reads like pure White. It lists, as the causes of the crisis, extensive global imbalances, a lengthy phase of low real interest rates, distorted incentive systems and underestimated risks. In addition to improved regulation, the BIS argues that “asset prices and credit growth must be more directly integrated into monetary policy frameworks.”

What does this imply for investors?

It means that any investments and investment strategy that depends on ever rising asset prices to work will no longer work in this new global financial order. To put it bluntly, in this new financial order, the Reserve Bank of Australia (RBA) will not let property prices balloon as it did over the past 10 years. As the RBA governor Glenn Stevens said (as reported in this Bloomberg article),

 Australian central bank Governor Glenn Stevens said policy makers must be cautious about cutting interest rates too far because that may encourage some borrowers into debt they can?t afford.

?It is the intention of current monetary policy settings to lower debt-servicing costs, assist efforts to reduce leverage and support demand,? Stevens told a conference in Townsville, Australia, today. ?It would be counterproductive, though, if further reductions in interest rates induced a large number of marginal borrowers into debts they could service only at unusually low interest rates.?

This is just an example of a sea-change in thinking among central bankers.

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Posted in Looking Forward | 4 Comments »

Bank for International Settlements (BIS) warning on stimulus spendings

Sunday, July 5th, 2009

This week, the Bank for International Settlements (BIS), which is known as the central bankers’ central bank, warned governments all over the world from getting carried away with economic ‘stimulus’ spending. The BIS is the only international body that had correctly anticipated the global financial crisis (GFC) and warned of another great depression back in June 2007, when they released their 77th annual report (see Bank for International Settlements warns of another Great Depression).

In the 79th annual report, they warned,

Perhaps the largest short-term risk associated with the expansionary policies is the possibility of a forced exit. Monetary and fiscal authorities of the major economies have so far been relatively unconstrained in their ability to follow expansionary policies. This need not last. An extended period of stagnating economic activity could undermine the credibility of the policies in place. Governments may find it hard to place debt if market participants expect the underlying balance to remain negative for years to come. Under such circumstances, funding costs could rise suddenly, forcing them to cut spending or raise taxes significantly. External constraints could also bind for some countries. Particularly in smaller and more open economies [e.g. Australia], pressure on the currency could force central banks to follow a tighter policy than would be warranted by domestic economic conditions.

In other words, if economic stimulus spending failed to re-ignite economic growth, the bond vigilantes will lose their patience and make governments accountable. This means they will sell down government bonds, resulting in rising long-term interest rates. As a result, governments will find it harder and harder to raise money to spend in order to ‘stimuluate’ the economy further.

From this point, there can be two choices for governments:

  1. Cut spendings and raise taxes
  2. Print money

In a stagnating economy (with high household debts), we doubt the government will have the guts to undertake option (1). In Australia, judging from the howls of protests over the latest budgets, it is clear that the masses will not tolerate government austerity. The only alternative will be to undertake option (2)- printing money.

For countries like Australia, as we highlighted in bold in the above quotation of the BIS report, there is an added risk. Should there be any run on the Australian dollar, the RBA will be forced to raise interest rates regardless of how bad the domestic conditions are. With the Rudd government promising the moon (see Australian government?s contingent liability to exceed AU$1 trillion),the risk is that should they be required to deliver the moon, the Australian dollar will come under immense pressure and the Australian government bonds can be relegated to junk bonds.

At this point in time, the BIS is not sure whether stimulus spendings will work,

An open question as of this writing is whether the expansionary set of policies enacted in response to the sharp contraction in economic activity in late 2008 and early 2009 will succeed in stabilising the economy. A major cause for concern is the limited progress in addressing the underlying problems in the financial sector. The experience of the Nordic countries in the 1990s and other historical episodes suggest that a precondition for a sustainable recovery is to force the banking system to take losses, dispose of non-performing assets, eliminate excess capacity and rebuild its capital base. These conditions are not being met. A significant risk is therefore that the current stimulus will lead only to a temporary pickup in growth, followed by protracted stagnation. Moreover, a temporary respite may make it more difficult for authorities to take the actions that are necessary, if unpopular, to restore the health of the financial system, and may thus ultimately prolong the period of slow growth.

Without the financial system restored to health, it will result in economic stagnation, which will result in even more government economic stimulus, which eventually can only be financed by printing money. Evemtually, if this goes on, it will be, as we wrote in Supplying never-ending drugs till stagflation

Like drugs, the more you ?print? money, the less effective it will be in stimulating economic growth (see What causes economic booms and busts?). Eventually, it will come to a point that the economy will not respond positively anymore no matter how much money is being ?printed.? That is the nightmare of stagflation (low or negative real growth with sky-rocketing price inflation- look at Zimbabwe).

Currently, we are in this “temporary pickup in growth” stage.

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Posted in Economics/Finance, Looking Forward | 18 Comments »

Is this the beginning of the loss of confidence in fiat money?

Sunday, September 21st, 2008

Events from the past week are tumultuous. It started from the nationalisation of Freddie and Fannie (we were mulling about the implication of nationalisation 2 months ago in How do we all pay for the bailout of Fannie Mae and Freddie Mac?). Then came the bankruptcy of Lehman Brothers and takeover of Merrill Lynch. Then we have the nationalisation of AIG. Gold prices surged by more than US$100 in two days (it had declined since), which was the most rapid surge in 26 years. At the same time, the Dow plunged by more than 400 points. It looked as if there was a panic from stocks straight to gold, which meant even cash was distrusted.

Then we have another massive rally in stocks for the past two days when there was hope that the US government, in conjunction with the Federal Reserve are doing something to solve the root of the rot in the financial system. Reports come out that they are planning to use taxpayers’ money to buy up bad assets at sale price. As always the case, the devil is in the details. At this point in time, there is no definitive figure on the cost. Make no mistake about this: this is no trivial task. As this New York Times article reported, Ben Bernanke warned the Congressional leaders,

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program ?Good Morning America,? the congressional leaders were told ?that we?re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.?

Mr. Schumer added, ?History was sort of hanging over it, like this was a moment.?

When Mr. Schumer described the meeting as ?somber,? Mr. Dodd cut in. ?Somber doesn?t begin to justify the words,? he said. ?We have never heard language like this.?

By now, it should be clear that this global financial disaster has the potential of even surpassing the Great Depression of the 1930s!

Is this crisis a surprise? If you listen to the mainstream economic schools of thought, central bankers, mainstream financial media, captains of the financial industry and so on, it looked as if this looming financial disaster is something that no one can see coming. The common underlying excuse (that was un-said, un-written but implied) goes something like this: “No one could ever foresee this! It’s impossible! Only hindsight can tell!”

Now, we would like to make it clear that this is completely false. Please note that we are not accusing individuals of lying. Instead, our point is that this excuse is a sign of collective mass delusion. If you look at the 6000 years worth of the history of human civilisation, you will find that humanity is repeatedly capable of mass delusions. Always, only the minority could see through the lie. In this case, students and practitioners of the non-mainstream Austrian School of economic thought SAW IT COMING. Some of them sounded the alarm as early as 2004! To press our point further, let’s us show you the chronicle of our warnings in this blog since 2006…

  1. In May 2008, when the world was in denial about the precarious state of the global financial system, Satyajit Das warned that the credit crisis was just the end of the beginning (see Is the credit crisis the end of the beginning?).
  2. Back in November 2007, if you look at the list of major US financial institutions that was compiled by Nouriel Roubini at How solvent are some of the major US financial institutions?, only half of them are left standing. Interestingly, Merrill Lynch was the safest among the insolvents and today, it failed to live. If Merrill Lynch was insolvent, what about the remaining ones today (i.e. Goldman Sachs, Morgan Stanley, Citigroup)?
  3. In June 2007, in Epic, unprecedented inflation, we warned that

    How much longer will the roaring global economy fly? We do not know the answer, for this boom may last longer than what we anticipated. However, please note that in the entire history of humanity, all bubbles (and we repeat, ALL) burst in the end. Thus, a global painful hangover will ensue?the greater the boom, the more painful the eventual bust. This is the theme that we had repeated many times.

    Thus, do not be surprised if a second Great Depression were to strike.

  4. In the same month, the Bank for International Settlements (BIS) warned that the world was in danger of another Great Depression (see Bank for International Settlements warns of another Great Depression).
  5. Back in January 2007, in Spectre of deflation, we wrote that

    But we smell danger.

    It is a danger in which many in the finance industry failed to fully appreciate?deflation. Such complacency is beyond our belief. In the 1990s, Japan experienced it, with dire consequences for their economy. At least, the ordinary Japanese had their savings to fall back on. For many Americans, with their negative savings rate, what can they fall back on? Have they not learned from the mistakes of others in the past?

  6. In the same month, Trichet, the president of EU central bank warned of a coming asset re-pricing (see Prepare for asset repricing, warns Trichet).
  7. Back in November 2006, in How will asset-driven ?growth? eventually harm the economy?, when the global economy was still booming in apparent ‘prosperity’, we quoted the late Ludwig von Mises (the in which the Mises Institute of the libertarian Austrian School of economic thought is named after) and warned that

    That collective error in judgement resulted in the economy misallocating scarce resources into housing sector?in the case of the US, a significant proportion of the jobs created during the asset-driven ?growth? was related (both directly and indirectly) to the housing boom. Since economic resources are always scarce, any misallocation of it implies an opportunity cost on the other sectors of the economy. The result is a structural damage to the economy that can only be corrected through a recession.

    This is the reason why we believe a recession is on its way.

  8. In October 2006, we quoted the late Dr. Kurt Richebächer (an Austrian School economist) and questioned in The Bubble Economy,

    9. These are some of the serious questions we would like to ask:

    1. As the US spends its way into economic ruin, its economy is being damaged structurally. How much longer can the US sustain its colossal debt?
    2. Right now, the US housing bubble is deflating. Will it eventually burst and wreck havoc on the rest of the economy?

Other contrarians who sounded the alarm long ago (and we quoted often) include Marc Faber, Jimmy Rogers, Robert Shiller, Peter Bernstein, Nouriel Roubini and our local Aussie economist, Professor Steve Keen.

Our readers should, by now, appreciate the colossal magnitude of this financial crisis. When you listen the media, the phrase “since the Great Depression” is often mentioned. Make no mistake about this, this has the potential to be worse than the Great Depression (note: we are NOT predicting that it will happen).

The world’s stock market is rallying in the hope that the US government’s plan to nationalise the financial industry will be successful in stopping the core of the rot. New legislations has to be rushed through Congress by the end of next week to change the rules to make the plan legal. As in everything done in haste, we believe there will not be enough thought put into them to understand the long-term ramifications. It is probable that once the changes are in place, they will not be revisited again.

As we warned in Recipe for hyperinflation,

There is no way any politician can sell the message that America needs a severe recession (or even a depression) to cleanse the economy from the gross excesses, imbalances, blunders and mal-investments. Thus, it is very likely that they will have to fight deflation till the very bitter end, till the last drop of blood from their last soldier. Since the current structure of ?rules? will be too restrictive in such a war against deflation, there will be popular momentum towards the bending and rolling back of these ?rules.? If they press on relentlessly till the final end, there can only be one outcome: the US dollar will be joining the long list of failed fiat paper money in the annals of human civilisation.

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Posted in Looking Forward, Market Observations | 30 Comments »