RBI’s Rajan Sees Risk of Financial Markets Crash

• August 6, 2014, 7:12 AM ET

RBI’s Rajan Sees Risk of Financial Markets Crash

ByGabriele Parussini

Reserve Bank of India Governor Raghuram Rajan warned Wednesday that the global economy bears an increasing resemblance to its condition in the 1930s, with advanced economies trying to pull out of the Great Recession at each other’s expense.

The difference: competitive monetary policy easing has now taken the place of competitive currency devaluations as the favored tool for playing a zero-sum game that is bound to end in disaster. Now, as then, “demand shifting” has taken the place of “demand creation,” the Indian policymaker said.

As was the case in the 1930s, the lack of coordination between policymakers is producing spillovers that may be difficult to control, and the world’s financial system may soon face fresh turbulence at a time when central banks have yet to repair the damage that the 2008 financial crisis caused to developed economies.

“We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost,” said Mr. Rajan in an interview with the Central Banking Journal.

A sudden shift in asset prices could happen in a variety of ways, Mr. Rajan said. The most obvious route would be as a result of investors chasing higher yields at a time when they believe central bank policies will protect them against a fall in prices.

“They put the trades on even though they know what will happen as everyone attempt to exit positions at the same time – there will be major market volatility,” said Mr. Rajan.

A clear symptom of the major imbalances crippling the world’s financial market is the over valuation of the euro, Mr. Rajan said.

The euro-zone economy faces problems similar to those faced by developing economies, with the European Central Bank’s “very, very accommodative stance” having a reduced impact due to the ultra-loose monetary policies being pursued by other central banks, including the Federal Reserve, the Bank of Japan and the Bank of England.

“The exchange rate is too strong given the euro area’s economic standing,” said Mr. Rajan, who took over the RBI in September.

Mr. Rajan said economists still disregard the central role of financial systems in the economy and believe they can predict upcoming disruptions.

“They still do not pay enough attention–en passant–to the financial sector,” Mr. Rajan said. “Financial sector crises are not as predictable. The risks build up until, wham, it hits you.”

...........will eventually end in disaster

For the past few years, a number of prominent hedge fund managers, Jones included, have warned that the Federal Reserve’s efforts to push down interest rates and stimulate the economy will eventually end in disaster–a calamity that will prove more damaging than the financial crisis.

That may explain why prominent hedge fund manager Paul Singer last May wrote that the Fed’s bond buying program would “ultimately destroy the value of money and savings while uprooting the basic stability of their societies.” Scared yet? Jones himself has called the Fed’s policies misguided.

 

The five most worrisome charts in the global economy

There are plenty of reasons to think that the global economy could continue to power forward.

The US economy seems to be emerging from its winter’s nap. China’s economic managers look ready to embark on a mini-stimulus push. German industrial production continues to push forward. Japan’s manufacturers are feeling better than they have in years.

But there are also reasons to worry about what economists politely call “downside risks.” Here are some that everyone should have on their radar screen.

European disinflation

European prices are climbing at their slowest pace since the worst of the financial crisis, when prices actually fell. Deflation is a dangerous place for an economy to be, as declining prices act as a persistent headwind to economic growth. What’s more, there’s no clear cure to deflation once it sets in. (Just ask Japan.)

1

After the “taper”

Lending is the lifeblood of any large, advanced economy. And a recovery in demand for loans—specifically mortgages—has been an important part of the of the US recovery over the last couple years. The Fed’s survey of senior lending officers showed a sharp downturn in demand for mortgages during the first quarter. Let’s hope it was just the weather.

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China’s credit conundrum

There’ve been plenty of rumblings that China could be about to experience a Bear Stearns-style “Minsky moment” when investors suddenly perceive risks where they previously only saw profits. Given the fact that the financial system is already largely backed by the government, we can’t see an outright financial crisis as being in the cards. Rather, as the credit cycle turns in China, the risks seem tilted toward a Japanese-style system of unhealthy zombie banks that sap growth. Such a scenario would prompt economic forecasters to rapidly rethink the prospects for global growth.

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Brazil’s ballooning current-account deficit 

China’s slowdown could endanger the growth model of other giant emerging markets. For instance, as commodity prices have fallen, Brazil’s current-account gap has gotten much worse. (Essentially, this is the best measure of how much a country has to borrow from abroad.) So far, investors in Brazil have been more than willing to continue to finance the South American giant. But with ongoing unrest and elections in the offing, it’s not too hard to imagine a destabilizing outflow of capital.

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Japan’s shift from creditor to debtor

Speaking of current-account deficits, in recent months Japan notched some of the biggest on record, meaning it was becoming an importer of capital instead of a lender to the world. (Japan’s government has a lot of debt, but the economy as a whole has long run current-account surpluses.) Plainly put, if Japan ran persistent current-account deficits, it would need foreign investors to buy its government bonds. They’d likely demand higher interest rates. Those higher rates would make the debt, already nearing 230% of GDP and predicted to keep growing under Japan’s economic stimulus program, pile up even faster. That could set off the kind of negative debt dynamics that we’ve seen drive once rock-solid creditors—like Italy—to the brink in recent years. And because Japanese government bonds—like US Treasurys—are a bedrock of the global financial system, that would be a terrible thing for global growth.

Developed country debts hit WWII high at $39.8tn by the end of this year

Developed country debts hit WWII high at $39.8tn by the end of this year

28 March 2014 - 16:05 pm

The developed world’s borrowing binge peaked in 2012, but overall debts are still climbing and are expected to reach the highest since World War II for a slew of big countries.

The Organisation for Economic Co-operation and Development, a club of 34 rich countries estimates that member governments borrowed about $10.8tn last year, down from a peak of $11tn in 2012, and forecast the total would slip further to $10.6tn in 2014.

However, the OECD noted that the overall debt burden is still climbing sharply – to an estimated $39.8tn by the end of this year – which will pose a “significant challenge” to refinance in the coming years.

Government debt ratios are expected to further increase and remain at elevated levels in the near future. In fact, general government debt as a percentage of GDP is projected to surpass the World War II peak.

The OECD has included a striking chart in its latest report on government borrowing that underscores this point, seen below.

Low interest rates mean that the net interest payments as a percentage of economic outlput has remained relatively stable, but that could be reversed by the US Federal Reserve’s ongoing “tapering” of its quantitative easing programme and possibility of rate hikes in 2015.

The Fed is the world’s most powerful central bank, and shifts in its monetary policy have major knock-on effects elsewhere. The OECD duly noted a wide range of risks:

In sum, OECD debt managers continue to face continued sizeable borrowing operations amid a still fairly challenging environment with headwinds to global economic growth, heightened concerns about market and liquidity risk, higher long-term borrowing rates, the high uncertainty of the exact timing of the exit and tapering plans regarding asset purchase programmes by central banks, legacy risks related to incomplete financial sector reforms, the possible adverse impact on market liquidity of new regulations, reducing leverage and increasing capital cushions of banks in particular in the euro area, and downside risks with a build-up of imbalances in a wide range of emerging markets.

Agricultural Sector ........long term story

• Agriculture is an inelastic sector.
• 30% of the house-hold income has to go into food.
• Walmart, ITC, Tesco, RIL , Bharati to make an imminent entry into corporate farming.
• Scarce land supply competing with urbanization
• Poor productivity in farming due to an avg age greater than 50 yrs
• Food supply unable to keep pace with a global pop. to explode to 9 billn. by 2050.
• Global warming depleting current agri. output.
• Massive farm to fuel programme
• Increasing intake of food per capita due to rising discretionary income

Foreign Grip Loosens on Treasuries as U.S. Investors Buy..........Bloomberg

http://www.bloomberg.com/news/2014-03-23/foreign-grip-loosens-on-treasuries-as-u-s-buyers-bolster-demand.html

Overseas creditors such as China and Japan enabled the U.S. to spend its way out of the recession as they gobbled up 80 percent of the nation’s Treasuries. Now, their holdings are dropping toward the lowest level in a decade, while homegrown investors have picked up the slack.

Foreigners are slowing their purchases of U.S. government debt as central banks and reserve managers tried to diversify away from dollar-based assets on speculation the Fed’s policy of printing money by buying bonds would debase the greenback

With the Fed moving to end its own debt purchases this year, the willingness of U.S. investors to finance a greater share of America’s $12 trillion in marketable debt securities is now providing a crucial source of demand.

Becoming less beholden to foreign creditors also means the U.S. can limit the risk any reduction in their buying will trigger a sudden surge in borrowing costs for the government, companies and consumers.

Yields (USGG10YR) on 10-year Treasuries, a benchmark for everything from mortgages to car loans and corporate bonds, have confounded forecasters by falling this year as an economic slowdown in China and political crises from Thailand to Ukraine helped fuel demand for the safest assets among U.S. investors.

After reaching a 29-month high of 3.05 percent at the start of the year, yields on the benchmark 10-year note ended at 2.74 percent last week. That compares with an average of 4.7 percent in the past two decades and 5.84 percent for past 30 years. 

The yield was 2.77 percent as of 7:21 a.m. in New York.

Foreign Holdings

Of the $8.1 trillion in U.S. government notes and bonds not held by the Fed, overseas investors owned $5.4 trillion as of January, data from the Treasury department and the central bank compiled by Bloomberg show. The figures exclude Treasury bills, which have maturities of one year or less.

The total is equal to about 67 percent, approaching the lowest level since the government began releasing the data in 2000. Overseas investors scaled back their pace of U.S. debt purchases last year, increasing their holdings by $228.2 billion, or 4.1 percent, the least in seven years.

China, the largest foreign creditor with $1.27 trillion of Treasuries as of January, has slowed its accumulation to about 3.1 percent annually since 2010. That compares with an average yearly increase of 34 percent in the 10 years before.

me - Japan like situation; lost decade; lower yields for many years ???

benchmark Philadelphia Gold & Silver Index in December traded at the cheapest ever relative to the price of bullion

The ratio of the Philadelphia Gold & Silver Index to gold futures reached 0.066 on Dec. 5, the lowest since the data begins in 1983. The measure was at 0.075 yesterday, and averaged 0.16 in the past 10 years

me : when shares of gold mining companies are trading at about historic lows; bubble in gold prices are far away.