BIS annual report - sobering read

The latest BIS annual report has hit the presses and it is a sobering read. It is also refreshingly different from other central bank reports which talk about the success of quantitative easing and the fact that inflation is good for all.  There is little comment about periods of strong growth with deflation.

The current core reasoning or orthodoxy of central bankers is simple. The global economy, especially the G& need more debt to stem the pain of adjustment from a balance sheet recession. The developed economies have too much debt, but they cannot very well adjust to the pain in this credit cycle so central bankers will have governments issue more debt and and central banks will monetize. The central banks can solve the debt problem by a controlled increase in inflation.

Yes, QE may not be working as well as expected, but it would have been a lot of worse if central banks did something else. The global economy need central bankers to save the world through creating inflation that can be controlled and cutting any deflationary expecations. Of course, central banks have not been able to control inflation at keys times in the past, but this time will be different.

The BIS in its report  pulls no punches as it argues that the global economy is not in good shape. There has been improvements since the dark days of the financial crisis, but the recovery has been poor and driven by unsustainable policies of creating more debt and money. Central banks have still come to grips with the implications of a balance sheet recession. This requires structural reform not more money.

The BIS starts with a simple observation. There is a difference between the business cycle and the financial cycle. The financial cycle will last longer, anywhere from 10-20 years. The financial cycle is usually caused by low interest rates which leads to excessive credit. This excess of credit will be extended to those who cannot manage it effectively and will ultimately lead to balance sheets that will need repair. This process of repair will be long and slow. Fiscal policy can try to improve the environment, but it uses more credit as a tool. The repair and delevering  in the private sector is just shifted to more leverage in the public sector. Central banks will try to slow the process of balance sheet repair becasue it will cur aggregate demand, but again it will do it through providing more credit through the creation of money.

The BIS has been accused of housing "Austrian" economists who believe in liquidation and creative destruction after a periods of excess. Who would have thought they central bankers would shame other with such name calling. The BIS does believe in the broad concept of a Wicksellian natural rate of interest whereby the real rate of interest should be equal to the real growth rate in the economy. If the rate of interest is held below its natural rate, there will be excess credit and financial markets will be out of equilibrium. Monetary policy which keeps real rates too low will have to deal with an expansionary credit cycle which will have lead to speculative and banking excesses. This will eventually lead to balance sheet repairs and a cut in credit.

If the BIS was reviewing central bankers as doctors of a sick economic patient, they would accuse the lot of them of malpractice. An unusual assessment from the central bankers' banker.