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Wednesday, October 08, 2014 2:19 PM

IMF Warns of Financial Crisis, Admits Low Interest Rates Spurred Asset Speculation Not Investment

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The IMF finally had a "duh" moment in what should have been obvious years ago. The IMF finally realizes that almost zero borrowing costs has encouraged speculation rather than  a hoped-for pick up in investment.

Now, the IMF warns period of ultra-low interest rates poses fresh financial crisis threat.

The Washington-based IMF said that more than half a decade in which official borrowing costs have been close to zero had encouraged speculation rather than the hoped-for pick up in investment.

In its half-yearly global financial stability report, it said the risks to stability no longer came from the traditional banks but from the so-called shadow banking system – institutions such as hedge funds, money market funds and investment banks that do not take deposits from the public.

José Viñals, the IMF’s financial counsellor, said: “Policymakers are facing a new global imbalance: not enough economic risk-taking in support of growth, but increasing excesses in financial risk-taking posing stability challenges.”

Viñals said the IMF had analysed 300 large banks in advanced economies, making up the bulk of their banking system. It found that institutions representing almost 40% of total assets lacked the financial muscle to supply adequate credit in support of the recovery. In the eurozone, this proportion rose to about 70%.

“And risks are shifting to the shadow banking system in the form of rising market and liquidity risks,” Viñals said. “If left unaddressed, these risks could compromise global financial stability.”
IMF Wants More Regulation

Amusingly, the IMF concludes "The best way to safeguard financial stability and improve the balance between economic and financial risk taking is to put in place policies that enhance the transmission of monetary policy to the real economy – thus promoting economic risk taking – and address financial excesses through well-designed macroprudential measures."

The IMF wants tougher supervision of banks, requirements on them to hold more capital, and curbs on lending to specific sectors such as housing.

Curiously, low interest rates were the problem but the solution is low interest rates and more macro controls including "policies that enhance the transmission of monetary policy to the real economy – thus promoting economic risk taking".

It's a financial axiom that central banks can make money available and set the rates, but they cannot dictate were it goes. Yet, the IMF just now seems to be figuring that out.

As for central bank sponsored "risk taking", haven't we seen enough already?

Where the Money Went

  1. Junk bond speculation
  2. Stock market speculation
  3. Stock market buybacks at ludicrous prices
  4. Robots in lieu of hiring
  5. Free profit for banks thanks to interest on "excess reserves"
  6. Private equity firms buying up houses
  7. In Europe, banks loaded up on their own allegedly risk-free bonds
  8. In China, property bubbles and profitless SOEs

Where the Money Didn't Go

  1. Higher wages
  2. Infrastructure
  3. Investment

What Now?

Not only was the IMF late in figuring out central banks did little but encourage asset speculation, it remains clueless in regards to what to do about it.

Curiously, the IMF argues for raising the VAT in Europe which will take money out of the hands of people who will spend it. The IMF also has concerns about price deflation when the whole world could use lower prices.

The IMF still has not figured out it is asset deflation and speculative loans made on assets that is the problem, not price deflation on consumer goods.

To get money to flow where it perceives best, the IMF wants more regulation over what projects banks can or cannot lend to.

Want efficient allocation of capital? Then how about trying a free market in goods and services with a free market in interest rates as well?

Instead, the IMF proposes more central intervention as the solution. The IMF's proposal is economic stupidity at its finest.

Mike "Mish" Shedlock

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