It has become a disconcerting trend that as geopolitical events intensify and keep a majority of people engaged in the latest outbreak of political theatre, the words of central bankers fall on increasingly deaf ears.
At a seminar of the European Stability Mechanism this month, Bank for International Settlements General Manager Agustin Carstens delivered a speech called, ‘Shelter from the Storm‘.
The speech can be summarised as follows:
- The IMF may not have enough resources to manage a future financial crisis
- The post 2008 ‘recovery’ was nurtured by central banks
- Central bank intervention has coincided with the increased accumulation of debt in both major and emerging economies
- The challenge for central banks is to meet their inflation target
- Governments must quickly implement ‘growth-friendly structural reforms’ as monetary policy is ‘normalised’
The latter bullet point refers to Basel III, the regulatory reforms that were devised through the BIS in response to the financial crisis triggered in 2008. The BIS have been pushing the line in recent communications that without these reforms being fully implemented by national administrations, the financial system will remain vulnerable to a renewed downturn. Full adoption of the reforms is not due to occur until 2022.
Because of the gradual nature of the turn around from monetary accommodation to monetary tightening, central banks have avoided excess scrutiny. When market ructions do occur, as we have witnessed throughout 2018, geopolitical disorder has been held up as the leading cause. Central banks, as Bank of England governor Mark Carney recently put it, are ‘a side show‘.
As Carstens points out, sharp sell offs in equity markets are ‘generally attributed to both cumulating trade tensions and geopolitical risks.’ Which is precisely where central banks want people’s minds to be concentrated.
Aside from rising interest rates, the Federal Reserve’s policy of rolling off assets from its balance sheet began a year ago. So far they have unwound nearly $400 billion in treasury securities and mortgage backed securities combined. In Carstens’ speech he mentions how ‘asset purchase programmes may have contributed to liquidity illusion’, which may prompt investors to pull money out of ‘riskier bonds‘ and back into government bonds instead.
Read between the lines here and there is a clear indication that as the Fed withdraws liquidity, it will serve to intensity volatility in markets. Central banks did after all – in Carstens words – ‘help nurture the recovery‘. They did more than nurture it. They backstopped the entire financial system and managed to cultivate the narrative of a ‘recovery‘.
We are now beginning to see what happens when the tools that enabled the ‘recovery‘ are gradually removed. The truth is there never was a recovery, only the false impression of one.
The ‘global safety net‘ Carstens refers to is the IMF’s Special Drawing Rights (SDR), which the IMF describes as:
- an international reserve asset, created in 1969 to supplement its member countries’ official reserves.
- The value of the SDR is based on a basket of five currencies—the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.
Countries that are members of the IMF (currently 189) are assigned a quota that goes towards financing the SDR. Britain’s holdings of SDR’s as of 2017-2018 was £9.9 billion, funds which are stored in the UK’s Exchange Equalisation Account. This account also holds the UK’s reserves of gold and foreign currency assets.
According to Carstens, the IMF has access to a total of 975 billion in SDR’s. This figure represents the quotas of all members combined. One half of the IMF’s lending capacity (480 billion in SDR) comes from ‘borrowing arrangements‘ which are due to expire over the next couple of years. Without the renewal of these arrangements and an increase in national quotas, ‘the IMF’s fire power could be severely curtailed.’
Carstens concluded with this warning:
- We need an effective lender of last resort with global reach. There has been limited progress in scaling up the IMF’s core resources. Without this, the global safety net remains incomplete.
A few days after Carstens spoke, the IMF’s David Lipton (who serves as First Deputy Managing Director) made his own remarks at the Bloomberg Global Regulatory Forum. The leading topic of the speech, in Lipton’s words, was ‘the next financial crisis‘. He began with this frank assessment:
- Like many of you, I see storm clouds building, and the fear the work of crisis prevention is incomplete.
‘Shelter from the storm‘. ‘Storm clouds building‘. The similarity in language from two seemingly separate institutions (on the surface at least) is a regular occurrence. This is because their objectives for the global economy go hand in hand. In January this year the BIS and the IMF participated in a joint conference hosted by the Organisation for Economic Co-operation and Development (OECD) in Paris. It marked one of many occasions when these two economic powerhouses have coalesced. So it should come as little surprise that BIS General Manager Carstens was Deputy Managing Director of the IMF from 2003 to 2006, and in 2015 became Chair of the International Monetary and Financial Committee (IMFC) before stepping down to assume his role at the BIS.
Getting back to David Lipton, he started by outlining what the policy options would be for central banks when the next recession arrives. In 2008 banks stepped in to prevent the wholesale collapse of the financial system. The messaging today, however, is very different:
- The impairment of key U.S. capital markets during the global financial crisis, which might have produced crippling spillovers across the globe, was robustly contained by unorthodox Fed action supported by Treasury backstop funding. That capacity is unlikely to be readily available again.
Like Carstens, Lipton cites ‘incomplete reform efforts‘ and ‘rising geopolitical tensions‘ as two of the primary risks to the global economy. Getting down to specifics, Lipton mentioned that policies emanating from the Trump administration – such as increased spending and tax cuts – could ‘increase the potential need for Fed tightening.’
The true intent of Lipton’s speech is revealed further in when he discusses ‘crisis response‘. Recall that Carstens spoke about ‘crisis management‘ in his speech. Neither he or Lipton focus on crisis resolution, possibly because a perpetual state of conflict and chaos is more advantageous to the BIS and the IMF when it comes to the goal of consolidating power.
Lipton’s belief is that the ability for the IMF to respond to crisis is jeopardised because ‘too much power remains vested in national regulators and supervisors at the expense of an integrated approach across the continent.’ In other words, not enough economic power is held at the international level.
Back in 2009, former governor of the People’s Bank of China, Zhou Xiaochuan, penned an essay called, ‘Reform the international monetary system‘. It was in this essay that Xiaochuan pushed for the creation of a reserve currency ‘disconnected from individual nations‘. The SDR, according to Xiaochuan, ‘has the features and potential to act as a super sovereign currency.’
Full article: Hidden Amongst the Furore: Synchronised Warnings From the BIS and the IMF (Steven Guinness)