Global Economy
Global markets euphoria not reflection of economic reality; Warns on ultra-low rates
By Michael Hennigan, Finfacts founder and editor
Jun 30, 2014 - 7:04 AM

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The Bank of International Settlements (BIS) says in its annual report which was issued Sunday that the current global markets euphoria does not reflect economic reality and its general manger warned on interest rates that: " if they persist too long, ultra-low rates could validate and entrench a highly undesirable type of equilibrium - - one of high debt, low interest rates and anaemic growth."

The BIS is the bank for central banks and is the oldest international financial organisation, having been founded in Basel, Switzerland in 1930.

The annual report says: "The overall impression is that the global economy is healing but remains unbalanced. Growth has picked up, but long-term prospects are not that bright. Financial markets are euphoric, but progress in strengthening banks' balance sheets has been uneven and private debt keeps growing. Macroeconomic policy has little room for manoeuvre to deal with any untoward surprises that might be sprung, including a normal recession."

The Wall Street Journal reported on Saturday:

From stocks to bonds to commodities, world financial markets have rallied in unison during the first half of 2014, a feat not seen in more than 20 years and a reflection of investors' optimism that central-bank policies will boost growth.

Six closely tracked gauges of world stock, bond and commodity performance are headed for gains in the first six months of the year, the first time they have done so since 1993. The Dow Jones Industrial Average is up 1.7% for the year, putting it on pace for its fourth-straight first-half rise.

Through Friday, gold was up 9.7%, the Dow Jones UBS Commodity Index 8.1%, the 10-year U.S. Treasury note 6.4%, the MSCI World Index of developed-world shares 4.8% and the MSCI Emerging Markets Index 4.3%."

"Financial markets are euphoric, in the grip of an aggressive search for yield…and yet investment in the real economy remains weak while the macroeconomic and geopolitical outlook is still highly uncertain," said Claudio Borio, the head of the BIS's monetary and economic department.

The BIS said growth is still below its precrisis levels and while the world economy expanded 3% in the first quarter of 2014 compared with a year earlier -- weaker than the 3.9% average growth rate between 1996 and 2006, in some advanced economies, output, productivity and employment remain below their precrisis peaks.

“Good policy is less a question of seeking to pump up growth at all costs than of removing the obstacles that hold it back,” the bank said pointing to the recent upturn in the global economy as a precious opportunity for reform while warning that policy needed to become more symmetrical in responding to both booms and busts.

Global markets are currently “under the spell” of central banks and their unprecedented accommodative monetary policies, it said and warned that returning to normal monetary policy too slowly could also be dangerous for government finances.

"Keeping interest rates unusually low for an unusually long period can lull governments into a false sense of security that delays the needed consolidation," it said, as the glut of cash encourages cheap government borrowing.

Jaime Caruana, general manager of the BIS gave a speech on Sunday at the annual meeting of central bank governors.

Jaime Caruana was governor of the Bank of Spain in 2000-2006 and in 2004 he gave into pressure to relax the requirement on the main banks to make special 'rainy day' provisions during the good times - - Charlie McCreevy, the European Commission's financial services commissioner who was a former Irish finance minister, also pushed for a relaxation of the rules.

Caruana decamped to Washington DC in 2006 to take a job at the IMF where Rodrigo Rato, a former Spanish finance minister, was managing director. He then moved onto Basel in 2009 and his IMF job as financial counsellor and director of the Monetary and Capital Markets Department was given to José Viñals, a former Bank of Spain colleague.

So two leading executives of the boomtime Bank of Spain have been lecturing on prudence since the bust but like the sinning preacher while the credibility should be tarnished, the warnings of pestilence maybe merited!

Caruana said on Sunday:

Since 2007, in the G20 economies, the ratio of total non-financial sector debt to GDP has risen by more than one fifth. This is the legacy of the massive fiscal stimulus during the Great Recession in the advanced economies and the significant new issuance of debt by corporates in EMEs. Since then, the advanced economies have made some progress in reducing their fiscal deficits. But the upshot is that aggregate debt levels continue to grow. Overall, debt-to-GDP ratios are now 275% in the advanced economies and 175% in EMEs.

A negative aspect of this debt-driven growth pattern is the relative weakness in investment in advanced economies. True, at the global level, total fixed investment as a share of GDP has continued to rise thanks to rapid growth in the EMEs. It is also true that, in some countries, a correction of
overinvestment in housing and construction was overdue. But other investment patterns do not bode well for future growth. In many advanced economies, for example, companies are holding back on investment in plant and equipment. Infrastructure investment is also languishing, particularly in a
number of EMEs but also in some advanced economies.

Most importantly, if they persist too long, ultra-low rates could validate and entrench a highly undesirable type of equilibrium – one of high debt, low interest rates and anaemic growth."

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