It is insightful to read the book by Mervyn King, the former Governor of the Bank of England The end of alchemy: Money, banking and the future of the global economy, to understand why a repeat is so likely. He recalls that in the run-up to the 2008-2009 global financial crisis, “short-term and long-term interest rates were at historic lows,” causing spending to go on unsustainable paths.
Bank balance sheets have “exploded,” he further states. With interest rates low, “financial institutions and investors began to take on more and more risk in their increasingly desperate hunt for higher returns.”
While this is eerily similar to recent events, another of his observations underscores the view that history sometimes rhymes even when it does not repeat itself. Asset prices have skyrocketed amid low interest rates, leading to an increase in global debt. This is as true today as it was before the 2008 crisis.
If we boil this down to its essence, what it means is that low interest rates lead to irresponsible borrowing. The rise in stock and real estate prices associated with low interest rates encourages people to borrow and spend more.
Then the central banks intervene Combating the resulting inflation and the seeds of recession have been sown. But before this sometimes lengthy boom-and-bust cycle is complete, financial institutions such as banks can stumble or collapse under the weight of their own debt and inadequate capital. This slide into collapse already appeared to be underway a year ago in both the United States and Europe when Silicon Valley Bank suffered a sudden death along with others like Bank of the First Republic And Signature bank. Even the venerable Credit Suisse was forced to do so Merger with UBS. While this seemed to stem the tide of collapse despite rumors of problems surrounding Deutsche Bank, officially orchestrated bailouts do not make for a healthy banking sector.
Banks are hungry for more business in the same way that their executives, especially at senior levels, are hungry for bonuses. According to U.S. government data cited by William Cohan in the Financial Times, the four largest U.S. banks now have a record $4 trillion in loans and leases.
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US authorities are pushing to increase capital requirements for 100 major banks as part of Basel III regulation. However, the Bank for International Settlements has found that banks tend to use their increased capital to make more loans rather than reduce their debt.
We can assume that lending will continue to increase until it stops or something stops it. What is more likely are force majeure events such as: Corporate and institutional bankruptcies in contrast to official regulation. The lesson from the period before the global financial crisis 16 years ago is that it is not a proliferation of exotic financial instruments such as Subprime mortgages that trigger a systemic crisis – they are more of a symptom than a cause. The real cause is excessive lending due to low interest rates. But even now, banks and other lenders are still demanding an early reduction in recently raised interest rates US Federal Reservethe European Central Bank and others. The Bank of Japan is an exception.Kristalina Georgieva, managing director of the International Monetary Fund, speaks during the China Development Forum March 24 in Beijing. Photo: AFPCentral banks are under political pressure to cut interest rates, as Kristalina Georgieva, managing director of the International Monetary Fund, noted in a recent blog post: “Calls are increasing for Interest rate cuts, albeit premature, and is likely to get worse as half the world's population goes to the polls this year. The risk of political influence on bank decision-making and staffing is increasing. Governments and central bankers must resist this pressure.”
She said central bankers had effectively steered the world through the Covid-19 pandemic and initiated aggressive monetary easing that helped prevent a global financial crisis and accelerate the recovery. They then moved to restore price stability by tightening monetary policy. These actions by central banks have brought inflation down to more manageable levels and reduced the risk of a hard landing.
She is right to resist political pressure to change course without lowering interest rates Bankruptcy-related financial crisis seems safe too. Central banks face the dilemma that if they cut interest rates too quickly, inflation will rise, but raising them too quickly could lead to a collapse of the financial system.
The responsibility for maintaining a strong financial system is supposed to lie with both governments and central banks, but many banks are now so big that they can boast to the government – until they need a bailout. In the meantime, they are free to increase lending without regard to system security. That has to change, and the next crisis could change it. That would at least be some consolation.
Anthony Rowley is an experienced journalist specializing in Asian economics and finance
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