Leading monetary theorist William White, chairman of the OECD’s review committee and former chief economist of the BIS, has predicted that political and social stability will be tested by an avalanche of bankruptcies in the global financial system.
White spoke to The Telegraph ahead of the World Economic Forum in Davos, and bemoaned the state of the global financial system. He claimed that “the situation is worse than it was in 2007. Our macroeconomic ammunition to fight downturns is essentially all used up.”
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According to White the challenge for authorities is how to manage a wave of defaults that could provoke instability. “It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something,” he said.
Creditors in Europe are likely to be worst hit, and the European banking system may have to be recapitalized on a massive scale. Due to “bail-in” rules, anyone with more than €100,000 in the bank will have to contribute.
White as one of a tiny group of bankers that warned of the dangers of a financial crash between 2005 and 2008. He now believes that quantitative easing and zero rates encouraged credit bubbles and dollar borrowing in east Asia and emerging markets, drawing these countries into the mess of the global financial system.
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Emerging markets now have combined public and private debt of 185% of GDP, an all-time high, while the figure for the OECD club is 285%. These numbers represent an increase of 35 percentage points since the top of the last credit cycle in 2007.
“Emerging markets were part of the solution after the Lehman crisis. Now they are part of the problem too,” the ex-chief economist at the BIS said.
“Debts have continued to build up over the last eight years and they have reached such levels in every part of the world that they have become a potent cause for mischief,” he said.
“It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something,” he told The Telegraph on the eve of the World Economic Forum in Davos.
“The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians.”
White believes that the U.S. Federal Reserve and other central banks have used QE and easy money policies to effectively bring spending forward from the future, He calls the phenomenon “inter-temporal smoothing,” and claims that its effects diminish over time before the future eventually catches up with you. “By definition, this means you cannot spend the money tomorrow,” he said.
Another hit came in the 1990s when China and Eastern Europe brought a wave of cheap exports to the global economy, resulting in a “positive supply shock.” While the price of manufactured goods fell, it only served to disguise the rampant inflation in the price of assets. “Policy makers were seduced into inaction by a set of comforting beliefs, all of which we now see were false. They believed that if inflation was under control, all was well,” he said.
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One alternative would have been to allow the benign deflation to continue as a temporary phase of globalization. However they decided to stoke debt bubbles, a decision which may cause a classic 1930s-style “Fisherite” debt-deflation.
According to White there are some tough decisions to be made at the Fed if it is to improve the global financial system. “It is a debt trap. Things are so bad that there is no right answer. If they raise rates it’ll be nasty. If they don’t raise rates, it just makes matters worse,” he said.
While White says that there is no easy solution to the current quandary, he does believe that governments around the world should end their dependence on central banks and return to fiscal primacy, He proposes that governments instigate a wave of investment in infrastructure which will pay for itself through higher growth.
“It was always dangerous to rely on central banks to sort out a solvency problem when all they can do is tackle liquidity problems. It is a recipe for disorder, and now we are hitting the limit,” he said.