'Irrational exuberance' has reached new heights, warns BIS

The former chief economist of the Bank for International Settlements (BIS) has warned that the current unsustainable level of global debt coupled with the emergence of asset bubbles in emerging economies could prove to be a combustible mix. BIS, regarded as the world's central bank, has in its latest quarterly review also sounded a red alert over the 'exuberance' - reminiscent of the situation just before the 2008 financial crisis - of investors for riskier assets and loans.

T Rajamoorthy

---

THE former chief economist of the Swiss-based Bank for International Settlements (BIS - commonly referred to as the international central bank) has warned that the level of global credit has reached or surpassed that before the collapse of Lehman Brothers. It is generally agreed that it was the bankruptcy of the Wall Street investment bank that proved to be the trigger for the 2008 financial crisis.  

In an interview with the UK's Daily Telegraph, William White, who now heads the OECD's Economic Development and Review Committee, characterised the present situation as eerily reminiscent of the bloated global credit markets in 2007 which metamorphosed the following year into the worst financial crisis since the 1930s Great Depression.

'This looks to me like 2007 all over again, but even worse,' he said and went on to elaborate: 'All the previous imbalances are still there. Total public and private debt levels are 30% higher as a share of GDP in the advanced economies than they were then, and we have added a whole new problem with bubbles in emerging markets that are ending in a boom-bust cycle.'

Quantitative easing

The problem of 'bubbles in emerging markets' referred to is largely a consequence of the policy move known as quantitative easing (QE), under which some $85 billion is pumped by the Federal Reserve (the US central bank) every month into the US economy. The avowed aim of this move, which has been in operation in one form or another since 2008, has been to stimulate the US economy by making cheap money available to business. However, speculators who borrow such monies at low interest rates (almost zero) have no interest in genuine business investments but have been using them for short-term gains within the US and abroad.

The result is that the US stock markets have registered record highs even as the real economy has been struggling with recovery. More importantly, borrowers have been using these monies to speculate in developing-country assets and currencies, inflating them artificially. The risk of asset bubbles is therefore very real.

The problem facing the Fed is not only when to start 'tapering' -  i.e., reduce the amount of money pumped every month with a view to halting the process altogether - but how to do it. The mere announcement by the Fed in May this year that it would start tapering the amounts pumped in as the US employment situation improved was enough to cause a financial stampede. Fearful that the era of cheap monies was over, speculators began pulling out their monies from the developing countries, causing the value of many of their currencies to drop and engendering turmoil in world financial markets.

In a desperate attempt to calm the whole situation, the Fed, along with the European Central Bank and the Bank of England, announced in July that monetary policy would be continued unchanged until the economy was on solid footing. While this may have ended the turmoil in the financial markets in the West, the damage to the developing countries which had been the main victims did not really abate. As the BIS Quarterly Review of September 2013 explains: 

'The market-led tightening of financial conditions generated serious tremors in emerging market economies, which had been in a soft spot. The outlook for these economies was deteriorating, as imbalances inherited from a period of rapid credit and GDP growth were unwinding. The imported tightening thus amplified pressures on local markets and brought to the fore the vulnerability of countries dependent on fickle foreign capital. In the face of additional strong headwinds from escalating geopolitical tensions, the downward pressure on currency and equity values persisted in a number of emerging economies even after the sell-off had abated in advanced economies.'

The same Review highlights another disturbing and ominous development in the financial markets. Since around mid-2012, investors have exhibited an attraction for riskier assets and loans. These include 'securities carrying a credit risk premium, which reduces duration, all else the same'. As for riskier lending, a 'concrete manifestation was the growing popularity of "leveraged" loans, which are extended to low-rated, highly leveraged borrowers paying spreads above a certain threshold. The share of these loans in total new signings reached 45% by mid-2013, 30 percentage points above the trough during the crisis and 10 percentage points above the pre-crisis peak.'

Most disturbing of all is the Review's observation that the financial turmoil which broke out in May upon the Fed's announcement failed to dampen this lust for high-yield riskier securities. On the contrary, 'This extended the squeeze of credit spreads and fuelled strong issuance of bonds and loans in the riskier part of the spectrum, a phenomenon reminiscent of the exuberance prior to the [2008] global financial crisis.'

The Telegraph reports White as saying that 'the five years since Lehman have largely been wasted, leaving a global system that is even more unbalanced, and may be running out of lifelines'.

Few would disagree with this bleak assessment.                                 

T Rajamoorthy, a member of the Malaysian Bar, is Editor of Third World Resurgence.

*Third World Resurgence No. 276/277, August/September 2013, pp 39-40