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The Voice of Sanity

Pinchas-LandauIn the hierarchy of the financial world, there are banks and central banks. The latter are tasked — along with directing the monetary policy of their country — with supervising the former and acting as ‘lender of last resort’ in the event that a specific banking institution gets into severe trouble. Furthermore, in the post-crisis world, central banks have been tasked with a new role, “macro-supervision”. As the term implies, this involves supervising not merely individual entities, but the entire system — the “macro” — so that a systemic crisis like that of 2008 does not recur.

That’s the theory. In practice, the world’s key central banks — the Fed, the ECB, the Bank of Japan, the PBOC (People’s Bank of China) and the Bank of England — have spent the six years since the crisis conducting an unprecedented, hitherto unimaginable, monetary policy. Interest rates have been held at or near zero — last month the ECB went still further, to NIRP, or negative interest rate policy — and systematic intervention in the bond markets has become the norm. On the other hand, reform of the banking systems, to make them less prone to potentially disastrous behavior, has been fitful and partial.

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Many observers view this policy as doubly damaging. On the one hand, it has not achieved its declared goals of restoring economic activity to pre-crisis norms — although it has succeeded in driving the prices of both financial and real assets to even higher nominal levels and valuations than they achieved in 2007, thereby further enriching the rich and very rich. On the other hand, it has massively distorted every area of economic activity, punishing saving and rewarding borrowing, diverting “investment” into financial speculation and adding new layers of debt to economies already mired in record amounts of debt.

This critique has been voiced with increasing concern, but decreasing impact, by people outside of the large financial institutions or currently occupying senior regulatory posts. Interestingly, quite a few former senior regulators have joined the skeptical camp — after leaving office. Meanwhile, the evidence regarding the degree to which the markets are now manipulated and the extent of their malfunctioning has been steadily mounting — leading to official investigations, exposure of the scale and extent of systematic malpractices and thus confirmation of the supposedly “wild” claims of “fringe” commentators.

Now back to that hierarchy: beyond the banks and the central banks is a third level — an institution called the Bank for International Settlements (BIS) that functions as the central bank of central banks. Given the unwavering commitment of the big central banks to hugely expansionary monetary policy and their belief that this is effective and its drawbacks are minor and worth suffering, you would expect the BIS to support and promote those views and policies.

But you would be totally wrong. Last year’s annual report from the BIS made clear the institution’s skepticism toward its members’ policies — but this year’s really takes the axe to them. Published on June 29, the report is a remarkable document which, at the least, will exonerate the BIS from responsibility for the next crash, but to which nobody will currently pay the slightest attention, as this week’s action in the equity markets amply demonstrated.

Had I not titled two recent columns “Disconnect” and “More Disconnect”, I would have fed off the following damning quote from the first page of the report: “Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally” (emphasis added, PL). But this is merely the entrée. The BIS staff and management pull no punches in telling the bald truth and puncturing the complacency that the central bankers and their governments have been promoting. Here is one paragraph which succeeds in presenting four central truths and, conversely, exposing four areas of make-believe: “Despite the euphoria in financial markets, investment remains weak. Instead of adding to productive capacity, large firms prefer to buy back shares or engage in mergers and acquisitions. And despite lacklustre long-term growth prospects, debt continues to rise. There is even talk of secular stagnation.”

In other words financial markets are rising relentlessly, while real investment — the sine qua non of economic growth — is woefully inadequate; large corporations are engaged in self-serving financial manipulation exercises, rather than increasing production and employment; debt is rising everywhere; and the long-term prospects are bleak.

Nor does the report shrink from spelling out what the consequences of this global and systemic irresponsibility will be, in due course: “Financial markets have been exuberant over the past year dancing mainly to the tune of central bank decisions. Volatility has sagged to historical lows. Obviously, market participants are pricing in hardly any risks.” Consequently,  “Macroeconomic policy has little room for maneuver to deal with any untoward surprises that might be sprung, including a normal recession”.

That’s a fair sample, but you can read it all at Or you can ignore it and enjoy the dance — until the music stops.



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