London:- THE Bank For International Settlements (BIS) has issued a stark warning that the global economy has become too dependent on consumerism and excessive foreign-currency debt.
The risks to both developed and emerging economies are thus a combination of a rise in the US dollar and higher interest rates, which could cause an ultimate slide in global financial markets and a downturn in economies.
This is the overall message of the latest quarterly report of the BIS, the central banks’ central bank. Its report highlights disturbing statistics of both government, corporate and household debt and speculation in property, shares and other assets, following years of exceptional central bank ease and virtually zero interest rates.
The report said: “In a global environment devoid of growth but plentiful in liquidity, central bank decisions appeared to draw investors into common, successive phases of buying or selling risk.”
Claudio Borio, head of the Monetary and Economic Department in a press briefing, said: “Markets turned on a dime following the US presidential election, shrugging off previous long-standing concerns about a future of stagnant growth and stubbornly low inflation. All the talk was about a revival of animal spirits and reflation.
“Political events in advanced economies have put the spotlight on vulnerabilities in emerging market economies (EMEs).
“These countries have been caught between a rock and a hard place – the rock being the prospect of a tightening of US monetary policy (even if gradual), an appreciating dollar and their foreign-currency debt, and the hard place, the threat of rising protectionism.
“This sensitivity is evident from the relative performance of their exchange rates, which has been closely tied to their US trade exposure.”
Huge foreign debts denominated in dollars
Hyun-Song Shin, BIS head of Research, cautioned that total dollar-denominated debt of non-banks outside the US was US$10.5 trillion at end-September 2016, an increase of US$420 billion in the previous six months. Dollar credit to non-bank borrowers in EME rose by US$87 billion to $3.6 trillion over the same period. These totals, however, now include statistics reported by China and Russia, which have joined the group of BIS reporting countries.
Mr Shin said: “The revision accounts for around US$500 billion of the US$10.5 trillion global total, and around US$300 billion of the EME total of $3.6 trillion.”
The size of foreign debt of borrowing nations and businesses is a major reason for the underpinning of the greenback and relative weakness of emerging currencies. Asian, Latin American and other governments and businesses need to sell their currencies and buy dollars to repay debt.
The report said: “Judging from exchange-rate movements, market participants (also) seemed to fear that a sharp reduction in international trade flows could bring heightened stress to some EMEs. The size of the bilateral trade surplus vis-à-vis the United States has been a relevant factor in explaining the difference in the recent depreciation of EME currencies vis-à-vis the dollar.”
Protectionism counter productive
In a side swipe against the Trump administration’s intended protectionism and massive state spending and borrowing, the BIS commented: “While large exporters to the US such as China and Mexico were in the spotlight, a shock to global trade could spread more widely through the disruption of global value chains. Moreover, market developments reflected concerns that a stronger dollar and higher interest rates, on the expectation of fiscal stimulus and monetary normalisation in the United States, could put pressure on EME borrowers’ balance sheets.”
In a separate paper in the quarterly report, BIS economists Enisse Kharroubi and Emanuel Kohlscheen caution that “economic growth is systematically weaker when it is led by consumption rather than other drivers such as investment”.
Growing debt burden crimps consumption and growth
Government and consumer spending can lift economic growth in the short term, their research found, but inevitably, a growing debt burden crimps consumption and growth over time. Sustained direct investment in job creating, plant and equipment is far better for long-term growth, the economists concluded.
A period of growth driven by faster credit expansion or greater housing wealth (which often go hand in hand) becomes less durable when prices stagnate or decline. When growth is driven by borrowing, households are burdened by higher debt, which acts as a drag on future demand, they add. (Statistical tables in the report illustrate individual nation property price rises and falls and the extent of household debt.)
In another paper within the quarterly report, two other BIS economists, Benjamin Cohen and Gerald Edwards, found that new accounting standards for banks’ expected credit loss provisioning that anticipate future losses, could well dampen financial and economic cycles.
The major accounting standard setters (the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have developed new provisioning standards that take a forward-looking approach to credit risk, which could reduce bank lending, the economists contend.
© copyright Neil Behrmann- Originally published in The Business Times, Singapore
Neil Behrmann is author of Trader Jack- The Story of Jack Miner and anti-war children’s novel Butterfly Battle- The Story of the Great Insect War
Signed copies and background can be obtained directly from http://www.thestoryofjackminer.com/?page_id=14
and Butterfly Battle at http://www.readmore-books.com/
Reviews are on both sites and Amazon. The updated, 2015 Waterloo commemoration version of Butterfly Battle is on Kindle and e-books.
We welcome readers’ reviews on Amazon. A sequel to Trader Jack will be published in coming months.