The Bank of International Settlements, an international finance watchdog that serves as a counter-party for national central banks, has again warned that investors are unprepared for a potential financial crash.
Jaime Caruana, head of the BIS, told The Telegraph that he believed the world economy is as vulnerable to crisis now as it was in 2007, because nobody in stocks seems prepared for the idea that at some point soon central banks will begin raising interest rates again.
Currently, most major central banks — including the Bank of England and the U.S. Federal Reserve — are holding rates at around zero per cent. That is boosting stocks, because there is no point in investors keeping their money in savings accounts at such low returns.
Thus, an “irrational” bubble is looming again in stocks, Caruana says:
Mr Caruana declined to be drawn on when the bubble will burst. “As Keynes said, markets can stay irrational longer than you can stay solvent,” he said.
Emerging markets have racked up $US2 trillion in foreign currency debt since 2008. They are a much larger animal than they were during the East Asia crisis of the late 1990s, so any crisis would do more damage. “The ramifications would be particularly serious if China, home to an outsize financial boom, were to falter,” it said.
And that’s not even the scary part. Look at China, Caruana says, which has had a private credit boom of its own, also fuelled by low interest rates (if interest is low, people tend to get further into debt because the cost of the debt is so low). China is unprepared to shed that debt without pain, BIS sources told The Telegraph:
BIS officials doubt privately the whether China can avoid a ‘hard landing’, fearing that the extreme credit growth over the last five years must lead to a financial reckoning. They also doubt whether the aftermath will in the end be easier to deal with in a state-controlled banking system where the Communist Party controls the credit levers.
Right on cue, Mohamed El-Erian, the former PIMCO chief and current chief economic adviser to Allianz, wrote an op-ed in the Financial Times that sees the world looking much the same way. Stocks are booming in a way that doesn’t reflect the underlying economic fundamentals, he says:
… unusually sluggish economic growth has not harmed stock market performance as much as would have been expected from traditional models; second, that hyperactive central banks have boosted asset prices using experimental measures, not as an end in itself but as a means of stimulating higher economic activity through the “asset channel”. The result has been a notable gap between a buoyant Wall Street and a struggling Main Street.
And mergers and acquisitions set a new frothy benchmark, the FT’s John Authers says:
According to Dealogic, $US1.83tn was spent on M&A in the first half of this year, up from $US1.3tn in the first half of last year, and the biggest deal volume since the first half of 2007, just ahead of the credit crisis. This is a global phenomenon with cross-border deals, at $US626.3bn, up 84 per cent from the first half of 2013.
However, M&A still isn’t anywhere near where it was in 2000, when it set a record, as a proportion of the entire market. Then, M&A was 10% of the world’s market cap. In 2007, it was 6%. Now, it’s less than 2%, Authers writes.
So the bubble still has some room to grow, maybe …
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