With one foot out of the door of Germany’s finance ministry, the former head of the German economy, Wolfgang Schäuble, 75, delivered a fire and brimstone warning over the weekend, telling the FT in an interview that there was a danger of “new bubbles” forming due to the trillions of dollars that central banks have pumped into markets. Schäuble also warned of risks to stability in the eurozone, particularly those posed by bank balance sheets burdened by the post-crisis legacy of non-performing loans, something we warned about since 2012, and an issue which remains largely unresolved.
Taking a broad swipe at the current financial regime – which he helped design – Schauble warned that the world was in danger of “encouraging new bubbles to form”.
“Economists all over the world are concerned about the increased risks arising from the accumulation of more and more liquidity and the growth of public and private debt. I myself am concerned about this, too,” he said echoing the concern voiced just one day earlier by IMF head Christine Lagarde, who said the world was enjoying its best growth spurt since the start of the decade, but warned of “threats on the horizon” from “high levels of debt in many countries to rapid credit expansion in China, to excessive risk-taking in financial markets”.
And while Schauble’s dramatic warning was not surprising – prominent economists have a habit of telling the truth once their tenure is over, and once they start selling books warning about all the consequences of policies they helped adopt – one day later a more surprising, and just as urgent warning was delivered by the Dutch central bank, DNB, which on Monday said that ultra-loose monetary policy in the euro zone has run its course, and excessive risks seem to be building up in financial markets making the financial sector vulnerable to a sudden correction.
“It increasingly feels uncomfortable to have low volatility in the markets on the one hand while on the other hand there are risks in the global economy,” said Klaas Knot, the president of the Dutch Central Bank, at the presentation of DNB’s biannual financial stability report according to Bloomberg.
Putting the current unstable equilibrium in its temporal context, Knot said that the current “picture resembles that of the period before the financial crisis.”
Taking a page out of Mark Faber playbook, the DNB labelled the threat of a sudden downturn in markets, brought on by a return of risk aversion, as an “acute” risk for the international financial sector, capable of starting a new financial crisis in weaker euro countries and beyond.
And, according to the Dutch central bank, only one thing could prevent a further build up of risks, eventually resulting in a crash: Knot reiterated a call to fellow board members at the European Central Bank to start phasing out monetary stimulus measures. The “time has come,” he said. “Economic growth has been above potential for months and the threat of deflation is gone.”
“The program has achieved what realistically could be expected from it,” Knot said about QE, adding that it supported growth, and reduced investment costs.
Of course, Knot is merely the latest to fall for the paradox of reflexivity, where he sees the product of central bank intervention as the object that was meant to be cured by said intervention – a process which has pushed yields on European junk bonds below the yield on the US 10Y Treasury, among other market distortions. In reality, if one were to reduce or eliminate the tens of trillions in liquidity injections by central banks, the world would find itself right back in the eye of a financial crisis hurricane, prompting central banks to unleash even more “unorthodox” measures, culminating eventually with central banks purchasing equities, as JPM’s Marko Kolanovic previewed last week.
Later this month, the ECB – rapidly running out of German bunds to monetize – is expected to decide on the fate of the central bank’s bond-buying programme, potentially announcing another taper of its current QE which purchases €60 billion in sovereign bonds per month.
Still, even Knot admits that whatever the ECB’s decision, any slow down or restriction in ECB intervention will have to be gradual, confirming that the ECB remains trapped by the market and any sharp, adverse reaction will promptly force the ECB to resume nationalizing the European capital markets.
“Interest rates will stay very low for a very long time, even if we decide to phase out our bond buying program at our next meeting. Nobody at the ECB is talking about raising interest rates yet.”
And, soon enough – once markets get reacquainted with gravity – nobody at the ECB will be talking about any normalization whatsoever.