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BookmarkBanks face another global financial crisis worse than 2007-8 warns the normally conservative Swiss-based Bank of International Settlements as a $10 trillion central bank bond mountain leaves them perilously exposed to higher interest rates.
The Federal Reserve recently triggered a global tightening of interest rates with hints it may start to wind down its money printing as soon as this September.
Bondholders
The problem is that higher interest rates mean lower bond prices, and the banks are stuffed full of this supposedly safe debt. HSBC has 42 per cent of its balance sheet in US bonds, for example, and that’s arguably the safest of the large bank balance sheets.
When interest rates go up the banks therefore make losses on their huge bond portfolios. Global central banks have accumulated $10 trillion in bonds that will also face massive losses.
‘Someone must ultimately hold the interest rate risk,’ concludes the BIS. ‘As foreign and domestic banks would be among those experiencing the losses, interest rate increases pose risks to the stability of the financial system if not executed with great care.’
The BIS has issued an urgent appeal for fiscal and monetary prudence but you can’t help reaching the conclusion that it is probably too late for action now.
‘Public debt in most advanced economies has reached unprecedented levels in peacetime,’ says the report. ‘Even worse, official debt statistics understate the true scale of fiscal problems. The belief that governments do not face a solvency constraint is a dangerous illusion. Bond investors can and do punish governments hard and fast.
‘Governments must redouble their efforts to ensure that their fiscal trajectories are sustainable. Growth will simply not be high enough on its own. Postponing the pain carries the risk of forcing consolidation under stress – which is the current situation in a number of countries in southern Europe.’
The BIS sees the global economy heading for a 1994-style bond market crash. However, the world has moved on since then and China is very much a part of the global economy, and its emerging debt crisis could be the biggest of all.
Shanghai surprise
A recent spike in short-term interest rates well above 30 per cent is a red light flashing in Shanghai. The overnight repurchase rate today is 6.5 per cent, more than double this year’s average. But what can the Chinese government really do now, having made its policy errors many years ago?
Where can you put your money if you cannot trust bonds or the global banking system? You end up back with precious metals as George Soros’ ‘ultimate financial bubble,’ and the only place for investors to hide when things go seriously wrong.
Old sages like Dr. Marc Faber are personally buying up precious metals while prices are temporarily depressed, knowing that the real crisis is around the corner. And you don’t have to believe him. The BIS report says it all very clearly. No wonder many bankers are themselves very nervous these days.
