Debt is above 2008 level and failure to reform banking system could trigger crisis
The world economy is at risk of another financial meltdown, following the failure of governments and regulators to push through all the reformsneeded to protect the system from reckless behaviour, the International Monetary Fund has warned.
With global debt levels well above those at the time of the last crash in 2008, the risk remains that unregulated parts of the financial system could trigger a global panic, the Washington-based lender of last resort said.
Much has been done to shore up the reserves of banks in the last 10 years and to put in place more rigorous oversight of the financial sector, but “risks tend to rise during good times, such as the current period of low interest rates and subdued volatility, and those risks can always migrate to new areas”, the IMF said, adding, “supervisors must remain vigilant to these unfolding events”.
A dramatic rise in lending by the so-called shadow banks in China and the failure to impose tough restrictions on insurance companies and asset managers, which handle trillions of dollars of funds, are highlighted by the IMF as causes for concern.
The growth of global banks such as JP Morgan and the Industrial and Commercial Bank of China to a scale beyond that seen in 2008, leading to fears that they remain “too big fail”, also registers on the IMF’s radar.
The warning from the IMF Global Financial Stability report echoes similar concerns that complacency among regulators and a backlash against international agreements, especially from Donald Trump’s US administration, has undermined efforts to prepare for another downturn.
The former UK prime minister Gordon Brown said last month that the world economy was “sleepwalking into a future crisis,”and risks were not being tackled now “we are in a leaderless world”.
Speaking this week before the fund’s forthcoming annual meeting – taking place next week on the Indonesian island of Bali – the IMF’s head, Christine Lagarde, said she was concerned that the total value of global debt, in both the public and private sectors, has rocketed by 60% in the decade since the financial crisis to reach an all-time high of $182tn (£139tn).
She said the build-up made developing world governments and companies more vulnerable to higher US interest rates, which could trigger a flight of funds and destabilise their economies. “This should serve as a wake-up call,” she said.
In a separate analysis, as part of the IMF’s annual economic outlook, it warned that “large challenges loom for the global economy to prevent a second Great Depression”.
It said the huge rise in borrowing by corporates and government at cheap interest rates had not shown up in higher levels of research and development or more general investment in infrastructure.
Even in this current range, higher oil prices will add inflationary pressures and downward economic strain in both Emerging and Developed markets.
In fact, the spike in oil prices Monday helped drive already-sinking EM currencies significantly lower. Turkey’s lira and South Africa’s rand declined sharply as the Indonesian rupiah sunk to a 20-year low. And the MSCI index of EM equities fell 1.38 percent, its biggest percentage decline in nearly a month.
Since oil prices, which are dollar based, are climbing as EM currencies are sinking, the higher oil prices rise and the lower their currencies fall, the cost burden adds more downward pressure to their economies.
Beyond the rising dollar, which has pushed many EM currencies to record and/or yearly lows while putting downward pressure on their economies, there is growing concern of a global economic slowdown.
For example, China, the world’s second largest economy, is in the early stages of an economic downturn. And its cooling housing market, mounting household debt and its fixed-asset investment, which slowed to a record low in August, have nothing to do with trade war or tariff fears.
And the International Monetary Fund has just warned that “risks on the horizon are increasing and beginning to materialize,” and danger signs are flashing that “global growth has plateaued.”
On the European front, Moody’s warned Tuesday that the region is at high risk and highly vulnerable to another economic downturn. This warning was issued despite years of negative interest rate and Quantitative Easing cheap money policies following the Panic of ’08 that artificially boosted the markets and economies.
“Overall, the amount of wiggle room available to mitigate the impact of another downturn is shrinking,” said Paolo Leschiutta, senior vice president at Moody’s.
Interest rates are climbing quickly.
The yield on the 10-year US Treasury hit the highest level since 2011 in the midst of a massive bond sell-off Wednesday. The selloff spread across the globe on Thursday morning. ZeroHedge called the spike in yields a “monster move.”
The 10-year US Treasury yield jumped 11 basis points on Wednesday to 3.16%. In European trading, the yield on the 10-year went as high as 3.2192%. The selloff was “promoted by stronger than expected US economic data, and which accelerated after upbeat, hawkish comments from Fed Chair Jerome Powell.”
Meanwhile, global stock markets took a big hit Thursday morning. Investors were greeted with a sea of red.
ZeroHedge said the selloff took traders by surprise with both its velocity and magnitude.
Pepperstone Group head of research Chris Weston said, “It’s a very rare occurrence to see US Treasuries undergo such a huge move.”
Most of the mainstream analysis emphasized the strength of the US economy and the expectation of more Federal Reserve tightening. They seem to be ignoring the darker side of this phenomenon.
Bond yields (interest rates paid) rise as the price of bonds falls. When there is a glut of bonds in the marketplace, you will see rising yields and falling prices as a function of supply and demand. There is already a huge supply of bonds as the US tries to finance its massive deficits.
Earlier this year, we asked the question: who is going to buy all of this US debt? The US Treasury Department plans to auction off around $1.4 trillion in Treasuries in 2018 alone. And it won’t end there. The department expects that pace of borrowing to continue over the next several years. That’s a lot of bonds. Who will buy them?
The three biggest buyers aren’t in the market. Both the Chinese and Japanese have been selling US debt. The Federal Reserve has embarked on quantitative tightening, so it is shedding bonds from its balance sheet. With these big boys out of the market, it appears we could already be seeing a Treasury glut. That means interest rates will likely rise even further. That’s not good news in an economy built on piles of debt.
Not to mention the cost of servicing the massive US federal debt.
Rising interest rates could also serve as the pin that pricks the stock market bubble.
“This withdrawal of liquidity and gradual tightening of monetary policy” is reverberating across financial markets according to Bob Baur, chief global economist at Principal Global Investors “We look for 10-year Treasury yields to hit 3.5% at some point – later this year, early next year – and I think that’s going to be a real problem for stock markets.”
And of course, rising rates will eventually trickle down to the average consumer. Last spring, we gave an in-depth overview of what rising interest rates could mean to you.
How all of this will play out remains to be seen, but it seems clear rates are pushing upward and the sea of debt isn’t going to drain anytime soon. This is a toxic combination.
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