The international body representing central banks is warning its members that record low interest rates are generating conditions for another global financial crisis that may be worse than the first.
In its annual report, the Swiss-based Bank for International Settlements (BIS) expressed serious concern that global share markets had reached new highs and the interest rate premium for many risky loans had fallen.
“Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally,” the bank wrote.
The BIS says the disconnect is largely due to continued monetary stimulus in the form of money printing and record low interest rates by many developed economy central banks.
“Financial markets have been exuberant over the past year, at least in advanced economies, dancing mainly to the tune of central bank decisions,” it observed.
“Volatility in equity, fixed income and foreign exchange markets have sagged to historical lows. Obviously, market participants are pricing in hardly any risks.”
This has led to another run up in global debt, with private debt outside the banking sector now 30 per cent bigger than it was before the financial crisis.
Of even more concern to the BIS than the total size of the debt is where it has gone, with many signs that risk is again being under-priced and finances being misdirected to speculative asset booms – just as it was in the run up to what the bank calls the Great Financial Crisis (GFC).
“Tellingly, growth has disappointed even as financial markets have roared: the transmission chain seems to be badly impaired,” the bank lamented.
It is a warning central banks and market participants should heed, as the BIS was one of the only major international financial organisations to warn of the GFC before it began.
The BIS accuses many of its major economy members of focusing on the short-term health of their economies, while failing to consider the long-term effects of their policies.
“Focusing our attention on the shorter-term output fluctuations is akin to staring at the ripples on the ocean while losing sight of the more threatening underlying waves,” warned the bank’s head of economics, Claudio Borio, in a briefing on the report.
The BIS warns that the fundamental failure of central banks and governments to deal with the underlying causes of the previous financial crisis is allowing the risk of a “bigger one down the road”.
It says continued debt accumulation over successive business and financial cycles is at the root of the problem.
These comments appear particularly directed at the US Federal Reserve, which just under a fortnight ago told markets that official rates were likely to remain near zero for “a considerable time” after it stops its bond buying stimulus program later this year.
The BIS also appears to take issue with such so-called forward guidance by the Fed.
Full article: Bank for International Settlements warns low interest rate policies may generate next global financial crisis (Australian Broadcasting Corporation)