The Global Financial Crisis was the greatest upheaval to the world’s economies experienced since The Great Depression of the inter-war years. Whilst most of the major economies have long since left since left the recessionary cycle triggered by the crisis, the global recovery remains weak and lending to businesses (which should spark real growth) remains anaemic. Against this backdrop, major central banks are still operating in a highly accommodative monetary stance with interest rates at or near historic low values in many cases and stimulus packages being applied to economies around the world.
The IMF has cautioned that prolonged low interest rates could pose a risk to the global economy. At first, this may seem counter-intuitive, but the reasoning is logical. Investors want to see a decent return on their investments or from surplus cash (what a lovely term!) that they may hold. With central bank interest rates close to zero, many commercial banks are offering very low returns on deposit accounts. Therefore, it is argued, some investors are turning to higher risk investment vehicles in order to secure a more attractive return. In a recent report, the IMF argues that the accommodative monetary policies have not been effective in promoting lending to businesses, but that much of the money has ended up being used for speculation. This, they say, has inflated asset prices and (perversely) driven down the yield on riskier assets.
The IMF report suggests that financial risk has moved from the traditional financial sector (banks and financial institutions) to the so-called shadow banking system; hedge funds, money market funds and investment banks which do not take deposits from the general public. By their very nature, shadow banks are much less regulated than their more traditional counterparts.
The report notes that some investments in emerging markets, which have driven assets prices there, would be subject to significant downside risks if, for instance, US interest rates rise as investors move out of such riskier assets to take advantage of a secure, traditional refuge. This could cause such asset prices to crash – this has been foreshadowed in such markets by Bear Runs when the market has imagined that the Federal Reserve might have been acting to rein-in its QE programme. The Fed was at pains to make sure that the Taper, when it started, was taken in measured steps and has been equally clear that interest rates will rise slowly and not in the immediate future.