Such dramatic statements have long been the staple of naysayers for decades. Usually these warnings are dismissed by the financial establishment as the ravings of fringe analysts. Yes, crashes do happen, but the naysayers are never seen as prophets, but just opportunists who happened to be right much the way a broken clock is right twice a day.
But maybe this storm is different.
There are still plenty of naysayers weighing in on the major problems with the traction-less, hobbling “recovery.” However, they are now joined by important players in the financial establishment who fear something big might be coming down the line. Indeed, this one might prove to be the big one.
The concerns come from the latest annual report issued by the Bank of International Settlements (BIS) that meets in Basel, Switzerland. The exclusive, invitation-only group is composed of bankers from all the world’s main central banks. If anyone knows what’s going on in the economy, it should be these bankers. And their findings are hardly guarded behind closed doors. If anyone wants to see the report, it is readily available to the public.
What these bankers now see are turbulent times ahead.
The language in the 2014 edition of the annual report is unusually direct with warnings that the world could be hurtling itself toward a new crisis. With a note of déjà vu, it claims the climate is now more fragile and volatile than the buildup to the Lehman Brothers crisis in 2007.
The same old signs are there. Not much has changed. Debt levels remain high everywhere, encouraged by low interest rates. Dangerous new asset bubbles are forming.
What makes this storm different is that it is not only the developed countries that are out of balance but emerging nations have joined the party. Debt ratios in the developed countries have now risen to as much as 275 percent of gross national product, while the emerging economies of China, Brazil, Turkey and others are gorging themselves on private credit booms of their own, increasing their debt ratio significantly.
It would be wrong to put the blame on abstract economic indicators, financial instruments or debt ratios. The real blame falls upon the actual people engaged in the markets. So many players in the game have thrown caution to the wind and participate in what might rightfully be called the “frenetic intemperance” of the times.
Investors are ignoring the risks of monetary tightening and are engaged in the voracious hunt for yields. Assuming low interest rates, the constant search for higher returns is compelling investors to snap up ever more risky junk bonds and stocks. Equity markets have been termed “euphoric,” calling to mind the “irrational exuberance” of the Greenspan era.
Not only are investors operating at full throttle, but they are not taking the right measures to avoid collisions.
Banks should be raising more capital as a cushion against risk. Large firms should be looking for ways to add productive capacity but are buying back shares or engaging in mergers and acquisitions instead.
Of particular concern is China’s unbridled and frenzied credit growth over the last five years. Many fear that the state-controlled banking system lacks the flexibility to avoid a hard landing that will lead to a financial day of reckoning for China with worldwide repercussions.
“The temptation to postpone adjustment can prove irresistible, especially when times are good and financial booms sprinkle the fairy dust of illusory riches,” the BIS report warns. “The consequence is a growth model that relies too much on debt, both private and public, and which over time sows the seeds of its own demise.”
The message from the central bankers is that the world has forgotten the lessons of recent years.
Unfortunately, those who forget the lessons of history are often condemned to repeat them.
Thus, there is a major financial storm brewing on the horizon.
Indeed, this might be the big one.