bank-of-england1Anyone with an interest in obtaining meaningful insights into the status of the global economic system would be well-served by reading the June 2012 report to the United Nations as issued by the Bank for International Settlements (BIS). According to the BIS: “The world is now five years on from the outbreak of the financial crisis, yet the global economy is still unbalanced and seemingly becoming more so as interacting weaknesses continue to amplify each other. The goals of balanced growth, balanced economic policies and a safe financial system still elude us.”

At the time of the publication of these materials the U.S. stock market was sitting at an all-time high. Notwithstanding the wealth effect brought about by higher equity markets in the west, and the unfreezing of credit markets worldwide, it seems that in the eyes of the BIS there is still much more to be done before any of us can say that we are truly “out of the woods”.

What vexes the BIS at the moment is the precarious and ongoing state of the world economy given the scale of intervention by U.S. and European central banks post the 2008 financial crises. At 30 percent of Gross Domestic Product, accumulated assets owned by central banks is now twice what it was just ten years ago. The effect of this situation is historically low interest rates — in some economies approaching zero.

Perpetually low interest rates are not good for savers living on a fixed income nor are they particularly welcome by entities trying to repair damaged balance sheets. Of course, the most profound risk associated with prolonged periods of artificially low interest rates is that they tend to encourage speculation which is something to be concerned about. Many economists believe that unbridled speculation in the housing market is at least partially responsible for the financial panic to begin with.

Some of these very same economists are fearful that when the time comes to raise rates, the major central banks will not be able to do so gracefully enough to avoid further economic shocks. Their fears stem from the sheer size of their earlier commitments. They believe that the central bank’s enormous balance sheets makes it nearly impossible for them to unwind their massive bond portfolios without causing a spike in interest rates and a collapse in international financial markets. If this were to happen, the global economy could be subject to another recession, but this time it would be worse. By that time, the central banks would lack the credibility and possibly the independence to manage another round of intervention on that scale.

 

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