STOCK MARKET WATCH -- Wednesday, 28 October 2015

[Demeter]

12. Ben Bernanke Identifies The Global Economy's Largest Problem: Bankers' Short Term Memories

AND I THOUGHT IT WAS THE CENTRAL BANKING QE PONZI SCHEME....

http://www.forbes.com/sites/timworstall/2015/10/28/ben-bernanke-identifies-the-global-economys-largest-problem-bankers-short-term-memories/

Tim Worstall: I’m not sure that I actually agree with this identification of the global economy’s largest problem by Ben Bernanke. The pointing to it as “a” problem in the short to medium term, yes, that I’ll go along with. But I’m afraid that I have a rather different problem in mind for the largest one we face. Still, Bernanke’s the economist, not me, so perhaps we should take his idea as being correct. And what he’s really saying here is that our major problem is that the collective memory of the banking industry just seems to be too short:

Speaking at an event organised by the Spectator in London, Mr Bernanke said: “One thing that puzzles me a bit is that we thought we learned in the Nineties that currency mismatches – that borrowing in dollars and then lending in whatever the local currency was – was a dangerous thing.”

Emerging markets enjoyed huge capital inflows after central banks in advanced economies such as the Fed slashed rates and investors sought higher returns.

However, the International Monetary Fund has warned that tighter US monetary policy could trigger a wave of emerging market corporate defaults and a fresh credit crunch as the dollar strengthens.

Mr Bernanke said: “It’s probably the most meaningful financial risk right now, the emerging market situation.”

I can certainly see that as being a large problem. The Fed did indeed slash interest rates, as they should have done, and investors did indeed go off searching for yield. That was rather the point of QE in fact, to get investors going off searching for yield by moving out along the risk curve. So, in the short term, mission accomplished because investors did exactly what the central bank wanted them to do. However, there’s been rather a lot of leakage of this into those emerging markets. And that’s not so comfortable. For the problem is that the borrowings are generally in US dollars while the earnings to repay them, even if not the denomination of the loans themselves, are in the local currencies. And in many of those emerging economies the earnings were between somewhat and largely dependent upon the commodity boom as China developed. So far, nothing wrong with this. However, now we’ve got a combination of China’s growth slowing and also various commodity production schemes coming on line, increasing supply. Increasing supply just as demand growth starts to falter. The result has been what we’ve seen, collapsing commodity prices.

That means in turn lower earnings from said commodities: and as this is happening the currencies of many of those emerging economies are falling against the US dollar, as they would. So, we get a double whammy: lower earnings in currencies that are worth less, against which the value of the debt isn’t going down at all. And that could indeed be a serious problem. But this is just an example of, a symptom of, what might be a larger problem for us free market types. For we generally think that people learn from past mistakes and don’t do them again. Thus we don’t, say, have to worry about people over stoking the US housing market as the memories of how that played out are still fresh. On the other hand there’s the financial markets meme that banking mistakes aren’t repeated until all the people who remember the last one have retired. At which point someone rediscovers the perpetuum mobile and off we all go into another bubble and crash.

So what Bernanke is really pointing to is that in the 90s we really did learn that currency mismatches in lending can be rather dangerous. But only 20 years later we seem to have the same mistake looming. And that’s not comforting for the free market types like me. Because it means that finance is a whole lot dumber than we thought it was: if the institutional memory is that short then it must be. So, not a comforting thought. And one that leads to the conclusion that perhaps more risk oversight is needed. Not, by the way, on Wall Street or in the City. They can take care of themselves and the amounts outstanding aren’t of systemic importance to them. But in those developing countries, perhaps more of an eye should be kept on “hard currency” borrowing than has been so far.

As to what I do think is our largest problem it’s that, despite the stunning success in poverty reduction, at the end of this year still a little under 10% of humanity will be stuck in the peasant destitution of absolute poverty. That strikes me as the world’s greatest problem for moral if no other reasons. Policy should be devoted, as far as it can be, to dealing with this and all other issues come behind it in the queue.

My latest book is "The No Breakfast Fallacy, why the Club of Rome was wrong about us running out of resources." Amazon and Amazon.co.uk. $6.99 and relevant prices in other currencies.