We seldom hear about the risk of a major financial crisis if rates were to rise – almost never within the official networks and mainstream media. One has to listen to independent “marginal” economists outside the banks or universities, such as our own Egon von Greyerz, or Olivier Delamarche, Bill Bonner, Gerald Celente etc. Because at the institutional level, to the contrary, everything is honky-dory: “I don’t see any systemic risk,” said Mario Draghi, the ECB’s chairman, last September 7. So, are those experts just trying to get some attention?
No, not at all. These worries about the disastrous effects of low rates have found a remarkable echo with a most official, most institutional, most well-informed entity: the Bank for International Settlements (BIS). The BIS, called the “central bank of central banks”, is the central banks’ consultative body, and it supervises the banks’ solvency agreements throughout the world, known as the Basel I, II and III accords, the BIS being headquartered in Basel, Switzerland.
At the publication of its last quarterly report, Claudio Borio, head of the BIS’s Monetary and Economics Department, did not mince his words:
- The world hasn’t recovered from debt: After the 2008 crisis “global debt levels in relation to GDP have continued to rise. Deleveraging has not really occurred. Where private debt levels have adjusted, at least to some extent, public debt has taken over.”
- Low rates create bubbles: “All this underlines just how much asset prices appear to depend on the very low bond yields that have prevailed for so long (...) “equity prices are quite stretched. Valuations seem to be aligned with historical benchmarks only after account is taken of the level of bond yields."
- The number of zombie companies (surviving with debt at zero% rates) is ever increasing : “The increase in the percentage of firms unable to cover their interest payments with their earnings - so-called zombie firms - does not bode well." (Who would have thought that the phrase “zombie firms” would show in an official report? Well, that’s the case now!)
- Central banks are stuck: “There is a certain circularity in all this that points to the risk of a debt trap: the protracted decline in interest rates to unusually low levels, regardless of the strength of the underlying economy, creates the conditions that complicate their subsequent return to more normal levels.”
- One must expect banking crises: “Leading indicators of potential banking distress point to material risks in the years ahead in a number of economies less affected by the crisis, both emerging and advanced.”
Let’s thank the BIS for being straightforward: Prolonged low rates are a mistake – they create bubbles in assets – they will bring about a new crisis with bank defaults. Everyone has been warned.
The BIS report also points to the risk of inflation, which remains low at the moment, but maybe not for long. “This puts a premium on understanding the "missing inflation", because inflation is the lodestar for central banks. It feels like Waiting for Godot. Why has inflation remained so stubbornly low despite economies approaching or surpassing estimates of full employment and unprecedented central bank efforts to push it up? This is the trillion dollar question that will define the global economy's path in the years ahead and determine, in all probability, the future of current policy frameworks. Worryingly, no one really knows the answer."
By seeking inflation constantly, central banks are at risk of letting the monster out of the box... Well, again, thanks to the BIS for validating the analyses of a certain number of “marginal” economists – soon to become much less marginal.