From Volume 4, Issue Number 35 of EIR Online, Published Aug. 30, 2005

World Economic News

BIS Chief Economist Warns About Threats to 'Financial Stability'

In an extended interview in Frankfurter Allgemeine Zeitung Aug. 23, Bank for International Settlements (BIS) chief economist William White notes that central bankers most of the time are focussed on inflation. They think: "Once inflation is under control, everything is just fine." However, if we take a look at the 1920s, there wasn't that much of inflation in the U.S., but soon after we were heading into "deflation and depression." We therefore have to draw the conclusion that "low interest rates are not sufficient guarantee for financial and macro-economic stability."

Today, we are dealing with "very expansionary monetary policy as a global phenomenon," which is central bankers' language for a financial system flooded by liquidity. "We have never seen anything like this before." In line with monetary policy, there has been a huge credit growth in several leading economies since the late 1990s. "The abundant liquidity can generate excesses and imbalances." Prices are reaching unreasonable levels, and at some point they will certainly fall down. When asked by FAZ to what markets he is referring, White replied that he is referring to many areas, in particular, to "the prices of long-term bonds, the risk premiums for corporate bonds, and emerging market bonds, as well as to the stock markets in several countries. But, more than everything else, to real estate prices. Almost everywhere in the world—besides Germany and Japan—there is a strong rise of housing prices." In Anglo-Saxon countries like the U.S., Britain, and Australia, rising housing prices are the basis for rising mortgage borrowing, which in turn is being channelled into consumption.

On a macro-economic level, housing prices do not represent "wealth," contrary to popular belief, White emphasized. Either they are just being pushed up temporarily and then fall. Or, if they are being maintained over a longer period, they increase the cost for everybody to buy or rent a home. Once housing prices fall, the mortgages are still there. It is "really worrisome," he concludes, to see such a dynamic taking place "almost everywhere in the world" at the same time.

Volatility in Emerging Markets Worries Wall Street

There is nervousness over the fact that so-called emerging markets are showing signs of volatility, the Wall Street Journal—putting it mildly—noted Aug. 24. The first hint of trouble in the current round was from Brazil; now the Indonesian rupiah is under pressure, which is being attributed to rising oil prices—so that the Indonesian President held an emergency late-night meeting with Central Bank. The Journal worries that rising oil prices and rising U.S. interest rates are draining the supply of easy money that's been flooding the market in recent years. "The liquidity premium is being taken out of the market," said one analyst.

As liquidity is drawn out of these markets, one place that it is going, is into feeding the U.S. real estate bubble. The previous day's Journal reported that, despite all the warnings of the dangers of the housing bubble, overseas money is still pouring into mortgage-backed securities in U.S. Cash is flowing in from Europe and Asia, and even China. Foreigners held 6% of U.S. mortgage-backed securities in 2004; this rose by 26% last year, and it is continuing to increase this year.

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