Stanley Fischer, pre-crisis

He writes,

We have a better capitalized and more liquid banking system, less run-prone money markets, and more robust resolution mechanisms for large financial institutions. However, it would be foolish to think we have eliminated all risks. For example, we still have limited insight into parts of the shadow banking system, and–as already mentioned–uncertainty remains about the final configuration of short-term funding markets in the wake of money funds reform.

Debt has been exploding, and folks at the Bank for International Settlements have pointed out that the debt/GDP ratio is higher than it was before the 2008 crisis. If there is another crisis, Fischer will be able to say that he did not claim that all risks were gone. Still, it is a very smug assessment, and if the debt bomb (and I include the government debt bomb) explodes in the next year or two, this will be the sort of speech that will indicate that policy makers were blind.

If it takes longer than a couple years for the debt bomb to explode, then I imagine that there will be other speeches made between now and then that will look worse in hindsight.

14 thoughts on “Stanley Fischer, pre-crisis

  1. And debt service is near the lowest it has ever been. Interest rates don’t move on their own and there is no normal level. Higher rates mean higher inflation or higher growth, neither of which are bad for debt service.

    • It’d not bad for long-term debt. But it is really bad for short-term debt one will need to roll over. US debt held by the public is mostly notes which mature in just a few years, with many of the long term bonds held intergovernmentally. (Actually, that’s a whole ‘nuther problem, because the solvency of many trust funds depends on getting good interest rates from their bond holdings, but lately they’ve been switching out of old high rate bonds into new low rate bonds, and eventually the old high yielding bonds will be gone. Low inflation helps with this problem, but sudden shift to high inflation would accelerate it.)

      The fact remains, the US will have to go to the public for a lot of new debt and rollover debt annually, over $2.5 trillion per year. If interest rates suddenly rise that is more due to inflation than real growth, then it’s not at all clear that the depreciation of old public debt will compensate for increased costs.

    • They likely should be extending maturities. At least I thought that 7 years ago.

  2. Debt service and, more than expected GDP (Nominal or Real), expected debt service is low now but can increase rapidly with higher interest rates.

    I expect to see a debt explosion which results in a money printing explosion to avoid sovereign default, which might result in inflation as high as the 70s — 15% mortgages…

  3. Debt has been exploding, and folks at the Bank for International Settlements have pointed out that the debt/GDP ratio is higher than it was before the 2008 crisis.

    Isn’t Debt exploding more in more in developing nations than developed nations? While the West/Far East have unfortunately reshuffled debt to governments from consumers, it appears the debt levels of developing nations, especially China is climbing the highest in the world. So if China is climbing the highest, don’t they get hit next? It might not be tomorrow as some theorize but they do seem to be following the Japan model of the 1970/1980s.

    Also, isn’t part of the problem Interest Rates are so low that there is tons of savings that can not find productive investments? Considering most of the West is focused on tech growth (where traditional capital investments are not needed), where does all the money go? (And aren’t Entrepeurs focused on tech growth today?)

    • Size really does matter, but it is a weak proxy for the problems arising from debt.

  4. Makes me wonder if Financials are always crisis prone and the incidence is exogenous.

    • So, when the crisis comes, we should be able to lend freely at punitive rates, but either it doesn’t work or there are road blocks to trying. I’d still like to co-author a book on this.

      • Where is the evidence on shadow banking being a causem Now that everyone had been educated on fake news, they should understand my question.

  5. There is supply and demand for debt. Why does everyone assume that rising debt is related to risk seeking and cyclical excess? Debt declines when cyclical contractions happen, but attributing the contraction to debt is circular reasoning. It appears to me that rising debt levels are more reasonably associated with demand for fixed income – with declining sentiment. Reacting to rising debt by tightening monetary policy could be devastatingly pro-cyclical.

    Recently, many people noted that Tesla had a larger market capitalization than Ford. I was pretty amazed by that, so I looked up their financials.

    Ford has a market cap of $46 billion plus $143 billion in debt. Tesla has a market cap of $58 billion and $7 billion in debt.

    Debt isn’t a sign of risk taking. Equity is. The reason Ford has lots of debt isn’t because risk-seeking shareholders demand that they leverage up. Risk-seeking shareholders buy unleveraged Tesla shares. The reason Ford has lots of debt is because a lot of investors want cash flow certainty, and Ford, with a large base of physical assets, can credibly provide it.

    An economy with more debt is, overwhelmingly, the result of an economy with more Fords and less Teslas.

    Until we reverse this backward thinking about debt and business cycles, we will continue to pointlessly force ourselves into these monetary contractions.

    • “Why does everyone assume that rising debt is related to risk seeking and cyclical excess?”
      Minsky’s financial instability hypothesis?

      • Yep. So when there is a massive surge of demand for near-cash and low risk securities, we “solve” it by sucking out the supply of cash, and then when the economy craters, we pat ourselves on the back for being right along, that the economy was destined to collapse under all that debt. Then we bemoan, “If only we hadn’t pulled back on the money supply sooner!”

  6. Debt service is about 20% of the federal budget and the volatility of interest payments are large.
    3% of real GDP goes to pay government interest charges, but growth has been about 1.5%. Interest charges could go up to 3.6% of the economy, but congress shuts down at that level because small states face an existential risk as these interest payments.

    Then we have the problem of all that government debt on the central bank balance sheet with all the member banks piling on the excess reserves. The finance industry has essentially stopped while awaiting the senators decision on what they intend to do with the 2.4T they have in central bank loans.

    We are bankrupt, the rate of innovations in finance is such that we have some 200 years before we get growth up and government bills paid. Millennials never voted for the crud, and are not likely to pay the debt, and certainly not going to condemn their children and grandchildren to a life of debt slavery.

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