The Bank for International Settlements – the Swiss-based multinational institution which is known as “the central bankers’ central bank” – has issued its 83rd annual report, which warns of the potentially massive implications of a spike in bond yields.
BIS argues that an increase in average yields of 300 basis points – 3 percentage points – would lead to losses on US Treasury bills of over $1trn, and it warns that such a big move can happen “relatively fast”:
Someone must ultimately hold the interest rate risk. 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 warning fits into a narrative which began last week: that the US Federal Reserve’s decision to “taper” its quantitative easing program will end the period of artificially low bond yields. There has certainly been a spike in yields: a 10-year UK gilt yields 2.48 per cent, compared to 1.90 a month ago, while 10-year US is up to 2.58 per cent from 2.01.
But the BIS has its scope set wider. The rises we’ve seen this month are merely the difference between “low” and “very low” cost of debt for solvent sovereigns; it doesn’t yet change the overall story of the last thirty years, which is continued decline in yields.
Instead, as the Economist‘s Ryan Avent writes, to understand BIS’s advice, we have to remember its background as an institution where the central bankers go to tell each other the myths on which their self-esteem rests. And key amongst those myths is the argument that interest rates – the key driver of monetary policy in most open economies – have been too low in recent years.
If interest rates have been too low, then bond yields are doubly depressed, first by QE and second by the low rates. It’s easy to see how that belief spirals into warning of an inevitable spike in yields.
But, Avent points out, rates aren’t low (or rather, too low) when they are low in absolute terms. Instead, we have to look at where they are compared to where they should be to encourage full employment. Given the deeply depressed economies in the developed world, it is almost certainly the case that interest rates at the level the Bank of England’s 0.5 per cent are too high: that, rather than running the risk of causing the economy to overheat, they are dampening investment and growth.
There’s a similar infestation of central-bank-ese in the BIS’s treatment of sovereign debt, which Avent summarises as “Something something fiscal policy”:
Central bankers have strong views on what governments ought to be doing with their budgets, many of which make most sense when given the least scrutiny. The BIS knows what it wants to say: that fiscal consolidation is almost universally necessary and the only real question is how to pursue it. Picking a path toward this argument that doesn’t immediately cave in under the weight of self-contradiction proves to be a difficult task.
Paul Krugman is even harsher, writing that:
Part of what makes the report so awesome is the way that it trots out every discredited argument for austerity, with not a hint of acknowledgement that these arguments have been researched and refuted at length.
The BIS pulls the classic two-step of looking at problems from within the Eurozone – where sovereigns without central banks have seen massive explosions in debt and borrowing costs – and extrapolating that to non-Eurozone nations. In short, it’s not moved on from the economic “debate” which occurred in the spring of 2010, over whether Britain was the next Greece. (In case you’ve missed this one: it’s not.) But even within the Eurozone, the BIS analysis is problematic, demanding massive deleveraging in countries which are already struggling to cut what spending they can. It fails to acknowledge the first rule of Eurozone budgets: if you are trying to cut debt/GDP ratios, it’s more important in the current economic climate to keep growth up than it is to cut government spending.
BIS goes one step still, though. It calls for mass private sector deleveraging at the same time, inveighing against general balance sheet overhang. Quite apart from the fact that it’s tricky for all sectors of the economy to deleverage at the same time – someone has to buy the debt – there’s that whole paradox of thrift thing which we’ve known about for a little over three hundred years.
“If the world is lucky,” writes Avent, “central bankers will discount the recommendations of the BIS.” If the world was lucky, there’d have been better recommendations in the first place.
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