Sunday, June 24, 2012

BIS: money printing putting global economy at risk

In a Telegraph article, the Bank for International Settlement says that the combination of low interest rates and money printing is putting the UK economy at risk (since the ECB and Fed are pursuing the same policies, it is the global economy at risk).

The BIS solution is the Swedish model with ultra transparency put forth by your humble blogger.

Confirming what I have been saying about the policies pursued under the Japanese model for handling a bank solvency led financial crisis, the BIS says

artificially low rates and inflated asset prices could also be holding back growth by masking lenders' bad debts and deterring them from cleaning up their balance sheets. 
"Prolonged and aggressive monetary accommodation may delay the return to a self-sustaining recovery," BIS said. "It can undermine the perceived need to deal with banks' impaired assets." 
Please re-read the highlighted text as the whole goal of the Japanese model is to protect bank book equity levels.  By definition this means that banks do not recognize their bad debt let alone clean up their balance sheets.

Instead, under policies like regulatory forbearance, banks engage in the practice of 'extend and pretend' to keep zombie borrowers from defaulting.

At the same time, policymakers pray for a miracle.
Political pressure for loose monetary policy, including quantitative easing (QE), also threatened to damage central banks' credibility and destroy their independence, BIS said. 
The world's financial regulator spelt out the risks of relying too heavily on the likes of the Bank of England and other central banks as it pressed Europe's leaders to step up their efforts to fix the eurozone's problems. 
"The extraordinary persistence of loose monetary policy is largely the result of insufficient action by governments in addressing structural problems," it stated. "Simply put: central banks are being cornered into prolonging monetary stimulus as governments drag their feet and adjustment is delayed. This intense pressure puts at risk the central banks' price stability objective, their credibility and, ultimately, their independence."
Enough of the excuse making, the Fed chose these policies.  It was not force to engage in zero interest rate and other destructive policies.  These policies are a product of the lessons the Fed Chairman learned from studying the Great Depression.  Lessons and policies that the co-author of the book on monetary policy, Anna Schwartz, said were wrong for handling a bank solvency led financial crisis.

The analysis came as part of a wider warning from BIS that governments, banks and households struggling with too much debt were dragging down the world's economy and that more needs to be done to make the banking system safer. 
"The world is now five years on from the outbreak of the financial crisis, yet the global economy is still unbalanced and seemingly becoming more so," it stated. "Big banks continue to have an interest in driving up their leverage without enough regard for the consequences of failure: because of their systemic weight, they expect the public sector to cover the downside. 
"Another worrying sign is that trading, after a brief crisis-induced squeeze, has again become a major source of income for large banks. These conditions are moving the financial sector towards the same high risk profile it had before the crisis." 
Stephen Cecchetti, head of BIS's monetary and economic department, said central banks should not be expected to carry the entire load of supporting growth and debt reduction. 
"In the middle of all this we find the overburdened central banks, pushed to use what power they have to contain the damage," he said. "But there are very clear limits to what central banks can do." 
Low rates have allowed borrowers who will never be able to repay their debts to limp on, BIS said, encouraging "wasteful support of effectively insolvent borrowers and banks". It cited the high level of forbearance by Britain's banks that was identified by regulators last year, and resulted in the largest quarterly corporate debt write-off in UK history after lenders were told to be more honest about their positions.
Please re-read the highlighted text as it nicely summarizes the result of adopting the Japanese model for handling a bank solvency led financial crisis.  The burden of too much debt is shifted to the real economy which contracts under the burden.
BIS also recommended governments took action to "reduce household debt to sustainable levels" as "the recovery cannot become self-sustaining until the debt of households is brought down to a level that can actually be repaid".

Please re-read the highlighted text as this is the policy recommendation that your humble blogger has been making.

The BIS is recommending adoption of the Swedish model with ultra transparency.  Under the Swedish models, banks recognize all the loss on the excesses in the financial system today.  Recognizing the losses requires bringing down borrower debt levels to what can actually be repaid.

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