A warning from the Bank for International Settlements

Posted by ProjectC 
'Term and risk premia can only be compressed up to a point, and in recent years they have already reached or approached historical lows. The risk is that, over time, monetary policy loses traction while its side effects proliferate. These side effects are well known (see previous Annual Reports) .. The risks of failing to act should not be underestimated.'

<blockquote>'A warning from the Bank for International Settlements

Last week, the Bank for International Settlements, which acts as the central bank to central banks, issued its annual report. It is about the most insightful warning that one is likely to see from the central banking system, even if the Federal Reserve, ECB and other individual central banks are the ones being warned.

“Financial markets have been exuberant over the past year, at least in advanced economies, dancing mainly to the tune of central bank decisions. Volatility in equity, fixed income and foreign exchange markets has sagged to historical lows. Obviously, market participants are pricing in hardly any risks. In advanced economies, a powerful and pervasive search for yield has gathered pace and credit spreads have narrowed. The euro area periphery has been no exception. Equity markets have pushed higher. To be sure, in emerging market economies the ride has been much rougher. At the first hint in May last year that the Federal Reserve might normalize its policy, emerging markets reeled, as did their exchange rates and asset prices. Similar tensions resurfaced in January, this time driven more by a change in sentiment about conditions in emerging market economies themselves. But market sentiment has since improved in response to decisive policy measures and a renewed search for yield. Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally.

“In the countries that have been experiencing outsize financial booms, the risk is that these will turn to bust and possibly inflict financial distress. Based on leading indicators that have proved useful in the past, such as the behaviour of credit and property prices, the signs are worrying.

“Term and risk premia can only be compressed up to a point, and in recent years they have already reached or approached historical lows. The risk is that, over time, monetary policy loses traction while its side effects proliferate. These side effects are well known (see previous Annual Reports). Policy may help postpone balance sheet adjustments, by encouraging the evergreening of bad debts, for instance. It may actually damage the profitability and financial strength of institutions, by compressing interest margins. It may favour the wrong forms of risk-taking. And it can generate unwelcome spillovers to other economies, particularly when financial cycles are out of synch. Tellingly, growth has disappointed even as financial markets have roared: the transmission chain seems to be badly impaired. The failure to boost investment despite extremely accommodative financial conditions is a case in point.

“Good policy is less a question of seeking to pump up growth at all costs than of removing the obstacles that hold it back. When policy responses fail to take a long-term perspective, they run the risk of addressing the immediate problem at the cost of creating a bigger one down the road. Debt accumulation over successive business and financial cycles becomes the decisive factor.

“In contrast to what is often argued, central banks need to pay special attention to the risks of exiting too late and too gradually. This reflects the economic considerations just outlined: the balance of benefits and costs deteriorates as exceptionally accommodative conditions stay in place. And political economy concerns also play a key role. As past experience indicates, huge financial and political economy pressures will be pushing to delay and stretch out the exit.

“The current weakness of aggregate demand may suggest the need for further monetary stimulus or for easing the pace of fiscal consolidation. However, these policies are likely to be either ineffective in current circumstances or unsustainable: taking a long-term perspective, they may simply succeed in bringing forward spending from the future rather than increasing its overall amount over the long run, while leading to a further rise in public and private debt. Instead, the only way to boost demand in a sustainable manner is to raise the production capacity of the economy by removing barriers to productive investment and the reallocation of resources. This is even more important in the face of declining productivity growth.

“The benefits of unusually easy monetary policies may appear quite tangible, especially if judged by the response of financial markets; the costs, unfortunately, will become apparent only over time and with hindsight. This has happened often enough in the past. And regardless of central banks’ communication efforts, the exit is unlikely to be smooth. Seeking to prepare markets by being clear about intentions may inadvertently result in participants taking more assurance than the central bank wishes to convey. This can encourage further risk-taking, sowing the seeds of an even sharper reaction. Moreover, even if the central bank becomes aware of the forces at work, it may be boxed in, for fear of precipitating exactly the sharp adjustment it is seeking to avoid. A vicious circle can develop. In the end, it may be markets that react first, if participants start to see central banks as being behind the curve. This, too, suggests that special attention needs to be paid to the risks of delaying the exit. Market jitters should be no reason to slow down the process.

“The temptation to postpone adjustment can prove irresistible, especially when times are good and financial booms sprinkle the fairy dust of illusory riches. The consequence is a growth model that relies too much on debt, both private and public, and which over time sows the seeds of its own demise. More generally, asymmetrical policies over successive business and financial cycles can impart a serious bias over time and run the risk of entrenching instability in the economy. Policy does not lean against the booms but eases aggressively and persistently during busts. This induces a downward bias in interest rates and an upward bias in debt levels, which in turn makes it hard to raise rates without damaging the economy – a debt trap. Systemic financial crises do not become less frequent or intense, private and public debts continue to grow, the economy fails to climb onto a stronger sustainable path, and monetary and fiscal policies run out of ammunition. Over time, policies lose their effectiveness and may end up fostering the very conditions they seek to prevent. In this context, economists speak of ‘time inconsistency’: taken in isolation, policy steps may look compelling but, as a sequence, they lead policymakers astray.

“The risks of failing to act should not be underestimated.” '

- John P. Hussman, Ph.D., Quotes on a Screen and Blotches of Ink, July 7, 2014</blockquote>

Context ((Hapto)praxeology) - '..Mises’s warning to the world .. not to suppress the market rate of interest in the name of creating prosperity.'

<blockquote>'The conclusion is simple: low interest rates do not solve the problem of high debt.' - BIS

'..monetary knowledge .. of currency reform under difficult conditions you have to go to Carl Menger.'

(Praxeology) - Review: Money, Bank Credit, and Economic Cycles

'..Our central bank has clearly learned nothing from earlier crises..'

'..Austrian theory is absolutely essential to successfully navigate the treacherous macro investment landscape..'

(Global) - '..excessive credit growth.'

((Monetary) bureaucracy) - '..a historic global Credit boom..' - 'They are delusional.'

'..there’s too much left unlearned from the Fed’s checkered 100-year history.' - '..made the Second World War possible, though not inevitable..'

'..the system as such is very rarely questioned..' - '..the widespread public ignorance of the functioning of the financial system.'

'..Draghi's money. It covers up problems..' - inflationism .. intervention, obfuscation, rationalization and degradation..'

(Private property) Money and Credit - 'Centuries of monetary fiasco..'

'The use of GNP .. exaggerating the importance of consumption in the economy..'

'Krugman had no explanation of why the bubble occurred .. he apparently has no understanding of the Austrian School insight..' - Murray Sabrin

The Austrian School; Fear the Boom, not the Bust - Critique of Marxism

Liberty - '..tyranny, the great and eternal foe of mankind.'

The Fed and Money - By Doug Noland

'..Like monetarists, Keynes held no capital theory .. the role time plays..' - Jesús Huerta de Soto

'..avoiding a “secondary depression,” or for preventing the severity of one..' - Jesús Huerta de Soto

Economic Recessions, Banking Reform, and the Future of Capitalism - By Jesús Huerta de Soto

Affectivity, Action, Electricity - '..in order to preserve society itself..'

'..ethics in particular .. absolute principle of ethics..' - '..deze fundamentele ethiek..'

(Haptonomy - Affectivity) - Praxeology as the Method of the Social Sciences - (Affective) Phenomenology of the Social World</blockquote>