By Joseph T. Salerno
On the eve of the World Economic Forum in Davos Switzerland, William White, chairman of the Economic Development and Review Committee of OECD and former chief economist of the Bank for International Settlements, delivered a dire warning concerning an impending meltdown of the global financial system:
The situation is worse than it was in 2007. . . . Debts have continued to build up over the last eight years and they have reached such levels in every part of the world that they have become a potent cause for mischief. It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something.
White, whose clear and vigorous forewarnings from 2005 to 2008 of the last financial crises went unheeded, now points out that European banks are heavily exposed to emerging market debt, especially China’s, and have already disclosed at least $1 trillion worth of “non-performing” loans on their books. They are still hiding additional bad debts by continuing to roll them over. The next financial crisis, according to White, is likely to require a massive recapitalization of these banks, which will be partly paid for by the “bail-in” of depositors holding balances in excess of the deposit guarantee of €100,000.
White blames quantitative easing and zero-rate policies for creating assets bubbles and over-indebtedness around the globe. White traces what he calls “the inflationary bias in monetary policy” back to 1987 when the Fed tried to prevent the recessionary purging of bad investments after the October stock market crash. With each successive business cycle, interest rates were reduced further and further below the “Wicksellian natural rate,” which is the rate that brings saving and investment into sustainable equilibrium in a dynamic economy. The inflationary bias was intensified during the 1990s when the Fed and other central banks attempted to stifle the “benign deflation” that was the natural effect of globalization and other market forces that greatly accelerated economic growth.
If all this sounds familiar, it is. For White’s diagnosis of the current monetary and financial scene incorporates central elements of the Austrian theory of the business cycle, with which he has shown a heart-warming familiarity in his recent publications (here and here).