'Vicious Cycles' Continue To Go 'Round And 'Round: BIS

Five years into the most significant global financial crisis since the 1930s, the world's leaders have formulated neither the fiscal policies nor the monetary policies required to deal with short-term challenges and long-term dangers, according to the Bank for International Settlements' 82nd Annual Report, which was released Sunday.

The global economy is still unbalanced and seemingly becoming more so as interacting weaknesses continue to amplify each other. The goals of balanced growth, balanced economic policies, and a safe financial system still elude us, reported the BIS, an organization based in Basel, Switzerland, that has been described as the central bank for central banks.

In advanced economies at the center of the financial crisis, high debt loads continue to drag down recovery; monetary and fiscal policies still lack a comprehensive solution to short-term needs and long-term dangers; and, despite the international progress on regulation, the condition of the financial sector still poses a threat to stability, the BIS said.

Because of these and other factors, the BIS reported, Vicious cycles are distorting both advanced and emerging economies.

Due to these vicious cycles, [C]entral banks in the advanced economies have continued or even expanded their purchases of government bonds and their support of liquidity in the banking system. At $18 trillion and counting, the aggregate assets of all central banks now stand at roughly 30 [percent] of global [gross domestic product], double the ratio of a decade ago, the BIS said.

Meanwhile, the BIS reported, [R]eal policy interest rates -- nominal rates minus headline inflation -- remain substantially negative in most major advanced economies.

The Old Cost/Benefit Analysis

The central banks' accommodative moves have had benefits, the BIS said: The global economy is certainly better off today because central banks moved forcefully after the 2008 collapse of Lehman Brothers and in the years since. One of the latest examples of such action was the European Central Bank's offer of three-year loans to banks in late 2011 and again in early 2012. That €1 trillion program, which increased the Eurosystem central-bank balance sheet by roughly €500 billion, was perhaps the single most important factor halting the freeze in banks' funding markets and, indirectly, supporting some euro-area government bond markets.

The central banks' accommodative moves also have had costs, the BIS said: The extraordinary persistence of loose monetary policy is largely the result of insufficient action by governments in addressing structural problems. Simply put: central banks are being cornered into prolonging monetary stimulus as governments drag their feet and adjustment is delayed. ... [A]ny positive effects of such central-bank efforts may be shrinking, whereas the negative ... effects may be growing.

According to the BIS: Both conventionally and unconventionally accommodative monetary policies are palliatives and have their limits. It would be a mistake to think that central bankers can use their balance sheets to solve every economic and financial problem: they cannot induce deleveraging, they cannot correct sectoral imbalances, and they cannot address solvency problems.

Besides describing the mammoth problems still to be solved, the BIS annual report covering the period from April 1 of last year to March 31 of this year also proposes an answer to the question: How can these vicious cycles be turned into virtuous ones? It centers on structural adjustment, monetary policies, fiscal policies, and financial reform.

Because the BIS was founded in 1930, it may be the only international finance organization with extensive experience in each of the last two major global financial crises (i.e., the one first acknowledged in 1929, and the one first acknowledged in 2007). Accordingly, any comprehensive presentation of both its facts and its opinions merits the attention of those interested in the financial markets.