Disconnect Between Euphoric Markets and Economy Could Cause Another GFC

July 30th, 2014

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A recent report by the Bank for International Settlements (BIS) found that there’s a disconnect between euphoric markets and the economy which could lead to another global financial crisis (GFC), wrote Philip Baker of The Australian Financial Review.

Banks comfort themselves with uplifting stats and facts and create reasons as to why people won’t make the same mistakes that caused the 2008 GFC. However, the BIS says that banks will make new mistakes that could cause another GFC.

Financial markets are currently in a state of euphoria due to very low interest rates set by the central banks. This cheap money has led to a disconnect between the markets’ euphoria and the real economic state worldwide (for example, an instability in the share, bond and property markets). Therefore, the BIS wants all of the central banks in the world to increase interest rates in order to reduce market euphoria and thus avoid a new GFC.

The BIS made similar warnings more than 10 years ago. Their chief economist Bill White said that the cheap money offered by the central banks will only end in tears, but nobody heeded his warning. Now, White is warning people again that with low rates and an unstable global economy, the market is doomed to crash once more. The warnings are based on the fact that investors are building up bubbles, which also happened back in 2007, with overvalued shares and low credit spreads in bonds.

The BIS report also argued that policymakers have maintained an “easing bias” which has created a false sense of security, reducing government reforms and allowing investors to become accustomed to record low interest rates. These low interest rates and higher debt levels make it difficult to increase rates without harming the economy. But low rates will ultimately become ineffective and may cause a market crash.

In the end, it’s the policies of the central banks that will instigate the next GFC, with debt levels increasing. Private debt outside the banking sector is 30% higher than before the 2008 GFC. The BIS worries that the accumulation of debt is going to the wrong areas yet again and also warns that the governments’ failure to deal with issues that led to the first GFC will create an even bigger crisis in the near future.