The Bank Of Central Banks Reveals The Biggest Threat To The Global Financial System

The Bank for International Settlements (BIS) is in the unique position of serving global economic stability in general… and central banks in particular.

It functions as a master hub for all the world’s central banks. It settles transactions among central banks and other international organizations. It doesn’t serve private individuals, businesses, or national governments

It can, therefore, criticize central banks more freely than politicians, bankers, or business leaders can. The BIS is usually gently critical in public documents. But, their recent report ratchets up the public level of the BIS’s concerns.

Here’s the problem with current monetary policy

Right now, the problem is that monetary policy is carrying a load it was not designed to bear. Strong central bank action during the crisis was necessary, says the BIS report, but the extended wind-down hasn’t served the desired goals.

This long-term reliance on extraordinary monetary policy carries a big risk—causing the rest of us to lose faith in the policymakers. The BIS warns:

Financial markets have grown increasingly dependent on central banks’ support, and the room for policy maneuver has narrowed. Should this situation be stretched to the point of shaking public confidence in policymaking, the consequences for financial markets and the economy could be serious. Worryingly, we saw the first real signs of this happening during the market turbulence in February.

In other words, what happens when banks, investors, and the public lose trust in the Fed, the ECB, the Bank of England, and the Bank of Japan?

The BIS isn’t talking about the routine grousing we all engage in. Everyone gripes about the Fed in good times or bad. But beneath our chronic irritation, we still maintain a basic trust that the Fed will step in to prevent any disaster.

What if that’s not true? What if the Fed really is out of bullets? If you ask almost anyone connected with the Fed, they’ll tell you, it still has choices and ammunition.

The problem I worry about is, does the Fed actually have any more live bullets?

We all hope not to learn the answer to my question. The BIS drops a pretty loud hint, though. With its “Worryingly” sentence, the BIS confirms that we are right to wonder about the continued value of central bank action.

The BIS says liquidity was underpriced before the crisis

The BIS goes on to offer some policy suggestions. They group their ideas into three sections: prudential, fiscal, and monetary.

By “prudential” policy, the BIS means bank regulation and capital requirements. Much has changed on that front since the last crisis. The Basel III framework is forcing banks to hold more capital to cover the risks they take. This requirement is having the effect, according to many traders, of drastically reducing bond market liquidity.

John Mauldin
July 22, 2016
Forbes