To Avoid Another Crisis We Must End QE

Economists at big, powerful institutions generally think alike. From HM Treasury to the Bank of England, consensus views dominate. Whether it’s the Organization for Economic Cooperation and Development or the International Monetary Fund, dismal scientists tend to converge towards a single “house view”.

This is, perhaps, hardly surprising. You don’t generally make your career within a large, hierarchical organization if you like thinking “outside the box”. More fundamentally, these “top” institutions are essentially political and strategic in nature – with the strategy determined elsewhere. For all the scientific pretense, resident economists will overwhelmingly serve up what their political masters want to hear.

These realities explain why economics, or at least the “official” economics that dominates our newspapers and airwaves, is so often captured by “groupthink”. An example of groupthink from a few years ago was that the UK should join the single currency. Any economist who thought otherwise was treated like a pariah. A more recent illustration was that if the UK votes to leave the European Union, that would spark, in the Treasury’s words, “an immediate and profound economic shock”.

An on-going example of group think, which holds right across the Western firmament of “leading” economists, is that quantitative easing is a good idea. Any economist who objects, or asks awkward questions about what happens when QE ends, is – once again – dismissed as unsophisticated or willfully obtuse.

Groupthink indulges lazy, line-of-least-resistance analysis. It leaves inconvenient nostrums unchallenged and encourages bad, sometimes disastrous, decision-making. Groupthink is a terrible thing. Yet, the main economic research bodies across the Western world, taxpayer-funded and granted widespread respect, are drenched in groupthink.

There is though, one sizeable, entirely respectable body that’s a bit different. Based in Basel, the Bank for International Settlements tends to operate away from the fray of national and international politics, ploughing its own intellectual furrow. Known as “the central banks’ central bank”, the BIS has a laudable and deserved reputation for honest and extremely well-informed analysis of international economic trends. I always pay attention to what it has to say.

In its latest annual report, published last week, BIS warns about the serious debt-related vulnerabilities in today’s global economy. At a time when financial markets and most policy-makers are complacent, BIS highlights asset price bubbles and poor banking practices across some of the world’s major economies.

The principal BIS concern is that global debt-to-GDP levels are, on average, some 40 percentage points higher than before the 2008-2009 global market meltdown. Equally troubling is that debt levels have increased by even larger amounts in a number of systemically important countries. BIS notes that since 2008, overall debt-to-GDP levels are up by 50 percentage points in Japan, 70ppts in Canada and France, and by a colossal 190ppts in China. The Anglo-Saxons have been slightly more restrained – the UK debt-GDP ratio is up 36ppts, that of the US up 29ppts. But these economies were already carrying heavy debt burdens when the financial crisis struck.

BIS exposes the basic choice now facing the world’s leading central banks. Interest rates have been at “emergency” levels for almost a decade. Justified in the immediate aftermath of the Lehman Brothers collapse, ultra-low rates, and on-going QE, are entirely unjustified now. So, either central banks start raising rates from their artificially low levels, which could cause short-term pain, or policy-makers risk creating an even more dangerous debt and asset-price bubble, which will burst with a louder and more damaging “bang” several years on.

While the US Federal Reserve is now raising rates, the European Central Bank and Bank of England are still resisting – despite Governor Mark Carney’s belated acknowledgement last week that rates may one day have to go up. “Keeping interest rates too low for long could raise financial stability and macroeconomic risks further down the road,” says the BIS report, “as debt continues to pile up and risk-taking in financial markets gathers steam”. While accepting that raising too quickly could cause panic, BIS still argues that delaying would see rates eventually go up further and faster – making expanded debt burdens even tougher to manage.

“There is tension,” says Claudio Borio, who runs the BIS monetary and economic department, “between stock markets, which have soared, and sovereign bond yields”. With this comment, Borio is highlighting the distortions caused by QE. Such “extraordinary measures” have kept bond yields nailed to the floor – allowing governments to keep borrowing like billy-o. But this has warped financial markets, turning trillions of dollars of conventional financial instruments into over-priced, loss-making timebombs.

“Leading indicators of financial distress point to financial booms that in a number of economies look qualitatively similar to those that preceded the global financial crisis,” says Borio. The current period of global growth, he adds, could come to an end “with a vengeance”.

This coming weekend sees the Hamburg G20 summit – a meeting of the group comprising the largest developed economies, together with leading emerging markets. Ahead of this, BIS placed particular emphasis on the dangers posed by China, suggesting the world’s most populous economy could trigger the next global financial crash.

Chinese corporate debt is now at 166pc of GDP, having doubled since 2007, while household debt has also soared. In May, Moody’s cut China’s credit rating for the first time since 1989, which could potentially raise the cost of borrowing for the Chinese government.

This is the only main aspect of the BIS analysis with which I disagree. China has massive fiscal strength. It also has, by a long way, the world’s largest financial reserves. It’s not China that poses the biggest threat to global financial stability. It’s the massively indebted, incoherent, eurozone. Although that’s not a view you’ll hear from the hallowed houses of groupthink.

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