BIS Cautiously Optimistic About Global Financial Markets

Jaime Caruana tells IESE MBAs and Alumni that future growth depends on deleveraging and managing systemic risk

08/03/2016 Barcelona

Jaime Caruana

Jaime Caruana, general manager of the Bank for International Settlements, at IESE Barcelona / Photo: Íñigo Alcañiz

What is the new normal in financial markets?

This was the question asked by Jaime Caruana, general manager of the Bank for International Settlements (BIS) – known as the central bank to central banks.

Speaking at IESE Barcelona this week, Caruana rejected the “pessimism” of so-called secular stagnation, but nonetheless called for “caution” in making firm projections about the global economic outlook.

All of the data needs to be appraised, he argued. And risk – systemic risk in particular – must be addressed to undergird sustainable growth.

“As the economist Kenneth Galbraith said: conventional wisdom protects us from the challenge of thinking,” said Caruana. “So it’s incumbent on economists to assess every scenario; and to do so with humbleness – especially given our recent economic history.”

Techno-Pessimism and Demand Deficiency – the New Normal?

The techno-pessimist school of thought has it that gains in global productivity thanks to technology are starting to peter out, said Caruana.

“Robert Gordon and other economists talk about the negative impact of digitization on actual productivity and conclude that we will see growth continue to falter and stagnation take root in the near future.”

Then there is the issue of what Caruana describes as “demand deficiency” – a concept that has gained a great deal of traction with policy makers in central banks. There’s a perception that the “new normal” will be characterized by the likes of quantitative easing and low – even negative –interest rates to boost aggregate demand, said Caruana.

Neither scenario, said Caruana, dovetails entirely with the position of the BIS. “We don’t see the future necessarily being defined by low productivity or by central banks using unconventional monetary policy like negative interest rates to stoke growth. What we see is a ‘balance-sheet recession’ which we believe is not the ‘new normal,’ but rather a transitory phase in the global economy.”

The Need to Reduce Debt

The current recession is the result of too much debt, said Caruana. And the key to strengthening the recovery is in deleveraging – echoing comments to the Financial Times earlier this week, in which he said that while some advanced economies had reduced leverage after the crisis, debt had continued to build up in many emerging economies: a situation that is contributing to global market turmoil and falling commodities prices.

A long-term view, said Caruana, is needed to address the issue of the stock of global debt – short-term measures being “palliative” and only successful at postponing the inevitable.

Part of this, he argued, is tackling systemic risk.

“Finding ways to combat or mitigate of systemic risk is difficult – and ever more pressing. Something the current crisis has taught us is that strong institutions are no protection against a problematic financial system.”

Tackling System Risk

The BIS has issued a call to banks to increase their capacity to reduce risk, says Caruana. A big issue here is the imperative to have larger capital buffers. The derivatives market too should be “much more robust” – something that can be achieved through greater centralization.

Caruana also highlighted the ‘too-big-to-fail’ phenomenon, where banks are bailed out with tax-payers’ money. National governments, he said, need to be more selective about which banks are bolstered by the state, and which ones are not.

“A reliable financial system depends on public confidence and that confidence has been repeatedly dented in the wake of the crisis. Trust needs to be rebuilt if the financial system is to function as it should.”

Anticipating “Morphing” Risks

Although, to a certain extent, Caruana believes all these issues are being addressed, his optimism is tempered with caution.

Additional risks are developing and morphing, even as institutions such as the BIS respond to existing issues. New threats include some aspects of algorithmic trading and the increasing trend for some asset managers to use leveraging tactics.

In the end, says Caruana, the best solution – both at a macro and a micro-economic level – is to reduce debt and ensure that organizations maintain flexibility through liquidity.

“You may think that you’ll be smart enough to cope with market turbulence, but so will everyone else.”