OECD: Mind the financial gap that lies ahead

Pierre Moscovici, Minister of Finance of France, Angel Gurría, Secretary-General of the OECD, Anton Siluanov, Finance Minister of Russia and George Osborne, UK Chancellor of the Exchequer. Moscow, Russia, G20 meeting (from left to right). OECD photographic library, 19 July 2013.

Pierre Moscovici, Minister of Finance of France, Angel Gurría, Secretary-General of the OECD, Anton Siluanov, Finance Minister of Russia and George Osborne, UK Chancellor of the Exchequer. Moscow, Russia, G20 meeting (from left to right). OECD photographic library, 19 July 2013.

A rather disappointing picture of the world economy drew OECD Deputy Chief Economist Jorgen Elmeskov last week, when he said that “The gradual pick-up in momentum in the advanced economies is encouraging but a sustainable recovery is not yet firmly established. Major risks remain”. If it was not for China’s predicted growth during the last quarter of this year at 8% world economy would have been a very sluggish place. The argument that a possible improvement of the global economy may hinge on Eurozone’s growth potential does not convince anybody. This is not however the only danger that OECD sees for the immediate future. Actually the dangers lie again with the banks.

Elmeskov went much further in this line of thinking. He added “The euro area is still vulnerable to renewed financial markets, banking and sovereign debt tensions. High levels of debt in some emerging markets have increased their vulnerability to financial shocks. And a renewal of brinksmanship over fiscal policy in the US could weaken confidence and trigger new episodes of financial turmoil. ” His last remark about the American questionable fiscal and monetary policies hides much deeper fears. By the same token he underlined also the financial dangers lying hidden within the European banking system and the fragile structures of the emerging economies. Let’s take one thing at a time starting from, where else, New York banks.

The US time bomb

A lot of people shivered and lost their sleep at the beginning of this summer, when Ben Bernanke the President of the American central bank, the Fed, started thinking aloud about reversing the Fed’s over relaxed monetary policies. He knows very well that a good part of those trillions the US central bank has lent to the country’s banks have found their way to over indebted countries and other borrowers who are willing to pay high interest rates.

However with the slightest financial headwinds or a political accident in those countries or even a more sluggish world economy and Turkey or Brazil will be unable to repay their debts to American banks. Then the new credit crunch will be more violent than the previous one in 2008. This is what the OECD Deputy Chief Economist means when talking about “new episodes of financial turmoil”.

In this risky way though the American banks managed in a few years to recapitalise themselves. They didn’t discover a new Eldorado. The major US banks simply lent money to untrustworthy borrowers, willing to pay high interest rates for the Fed’s money the lenders received at zero interest rate. In this way they are making at least 8% yearly on the trillions Fed handed to them without any guarantees. It is exactly the same old story that brought the world to its knees in 2008.

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Bernanke, when he sensed the storm that his remarks brought about made a full U-turn and postponed the reversal of Fed’s over relaxed monetary policies. Yet this is something that has to be settled sometime in the immediate future, because the bomb may be set off any time. Obviously this time bomb is the part of the American banks’ total assets, estimated at a bit less than $30 trillion, which is toxic. A crisis is the worst way to discover that.

The Eurozone banks

A similar amount of money is nesting in Eurozone banks’ balance sheets. It is around three times the euro area’s GDP that is €30 trillion. The banks call them assets and assets should have been if all those loans were accorded to trustworthy borrowers. It’s not like that. South Eurozone’s over indebted governments and households are not the best debtors of the world. Even the Dutch families cannot serve the mortgages for expensive homes they bought in the good times.

As for the developing world it’s only China that still continues to grow with breath-taking rates. Tigers like Turkey and Brazil are now confronted with winds coming from everywhere. Unfortunately the western financial system, meaning US and Eurozone banks, have not lent money to China but to governments and households in Greece, Spain, Italy, Turkey and Brazil and elsewhere. In short the sustainability of the western financial system depends on the ability of all those borrowers to continue paying their debts.

In the low growth period however that lies ahead this will prove increasingly difficult and for this reason the two major western central banks don’t even think any more of stopping being generous. Actually the European Central Bank came out this summer and advertised that it will continue its fully accommodative monetary policy for as long as it is needed. This means the ECB will continue supplying the banks with all the cash they want at almost zero interest rates. Actually there is no other option than continue filling the gap with newly printed money.

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