Grand Central: A Warning From Basel On China’s Debt-Driven Growth – Real Time Economics

The Wall Street Journal’s Daily Report on Global Central Banks for Monday, June 30:

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Check out chapter four of this year’s Bank for International Settlements’ annual report. It presents interesting new research on the elusive threat of financial cycles, with worrying implications for China and other emerging markets.

BIS researchers, who were on to the problem of debt-driven financial crises before most central bankers, use a few simple metrics to model the life of a long-running financial cycle. These cycles are marked by slow-moving debt buildups and property price upturns which suddenly reverse and lead to bank crises and deep recessions. Unlike the typical business cycle, which runs just a few years, the financial cycle plays out over 15 to 20 years and often ends badly, the BIS finds.

The BIS tracks the financial cycle with gauges of private sector debt as a percentage of gross domestic product,  and measures of national property price gains. While the U.S. is in the healing phase of the financial cycle and Europe is in the correction phase, the BIS debt metric for China is now flashing red. The measure of private sector debt to GDP is running 23.6% above its long-run norm in China, the highest level among the countries it tracked. Brazil, Turkey, emerging Asia and Switzerland are also flashing red on this measure.

The report’s release coincides with the annual meeting of the BIS in Basel, Switzerland, where the world’s leading central bankers are now gathering. It is the handiwork of Claudio Borio and Hyun Song Shin, two first rate economists on the interplay of the financial cycle and the economy.

“In many cases, the surge in credit and asset prices slowed in 2008 and 2009 but resumed full force in 2010. Since then, credit to the private sector has expanded by an average of about 10% per year. In China, this growth was mainly driven by non-banks, whereas banks financed the expansion in Turkey. At present, there are signs that some of these booms are stalling. For example, property price growth in Brazil has weakened, which is typical of the later stages of the financial cycle. Rising defaults in the property sector in China also point in this direction,” the BIS finds.

It continues with a discussion of the large capital inflows into emerging economies through new channels like global bond markets, over $2 trillion in all since 2008.

“The position in the financial cycle identified above, as well as high levels of private sector debt, pose challenges for the years to come,” the BIS concludes. “There is obviously a risk that many of the more recent booms will end in a crisis or at least in severe financial stress, just as many have before.”

-By Jon Hilsenrath


Fed’s Bullard: Markets Right to Play Down Gloomy GDP Report. Federal Reserve Bank of St. Louis President James Bullard said markets are correct in looking past the “shockingly negative” estimate of first-quarter economic growth reported this past week amid other signs that the economy is improving.

Security Detail for Fed Chairwoman Irks Neighbors. In the Georgetown gated community of Hillandale, residents live in secluded calm governed by some 50 pages of rules banning fences, motorcycles, certain paint colors, tree species and excess dogs and cats (no more than two total per household). Then one of the most powerful economic policy makers in the world moved in and, in the words of some here, ruined the neighborhood.

Zients Says Obama Plans Fed Nominations ‘Soon’ –Bloomberg. President Barack Obama will nominate people to fill two vacant seats on the Federal Reserve’s board of governors soon, said Jeffrey Zients, director of the White House’s National Economic Council. “We will nominate folks soon. This is a high priority and we’re working on it,” Mr. Zients said on Bloomberg Television’s “Political Capital with Al Hunt.”

Euro-Zone Inflation Rate Stays at Lowest Level in Over Four Years. The euro zone’s annual rate of inflation was unchanged at its lowest level in more than four years in June, while bank lending to households and businesses declined in May.

ECB’s Mersch Currently Sees No Deflationary Pressure in Euro Zone. The European Central Bank currently perceives a period of extreme low inflation in the euro zone, but no deflationary pressure, ECB executive board member Yves Mersch said Sunday.

Global Markets’ Strength Doesn’t Reflect Economic Outlook, Central Banks Say. Buoyant financial markets are out of sync with the shaky global economic and geopolitical outlook, the Bank for International Settlements said in its annual report published Sunday.

China FX Regulator Bracing for End of QE. China’s foreign exchange regulator said Monday it was preparing to deal with the possibility of excessive capital flows as the U.S. withdraws from its quantitative easing program – Dow Jones Newswires.

BOJ Beat: What Central Bankers Will Watch in the Tankan Business Survey.  When the Bank of Japan releases its latest Tankan corporate survey Tuesday, there will be a flurry of media coverage of the main sentiment indexes of big companies–figures that many watchers use to measure the health of the world’s third-largest economy.

EU Approves Bulgarian Bank Aid. The European Commission on Monday approved an emergency request by Bulgaria to grant a credit line of 3.3 billion levs ($2.3 billion) to its lenders, after the country suffered a run on two banks.

BOC’s Schembri Wants Exports, Investments to Boost Growth. Exports and business investment must play a bigger part in boosting Canadian economic growth, Bank of Canada deputy governor Lawrence Schembri said on Friday. He suggested that lower costs for cross-border payments could help drive a trade-driven expansion.

India’s RBI Says State Banks Still ‘High’ Risk. India’s central bank last week said it is concerned about the asset quality at state-run lenders as the amount of bad loans on their books remains significantly higher than their private-sector peers. Industries such as infrastructure, iron and steel, mining and aviation account for a significant share of the troubled loans at state-owned banks, putting them in the “high” risk category, the Reserve Bank of India said in its semiannual Financial Stability Report.

Poland’s Rate Meeting in Focus This Week. The first meeting of Polish monetary policy makers since the leaking last week of illegal recordings of comments made by the central bank governor about certain members of the panel is scheduled for Tuesday and Wednesday. The rate meeting will also be eyed for its update to the central bank’s economic forecasts. –Dow Jones Newswires


Japanese private consumption showed signs of recovery in May after it plunged on April’s sales-tax rise, an encouraging sign for Prime Minister Shinzo Abe’s push to lift the economy out of its long funk. Retail sales rose 4.6% on-month in May, the Ministry of Economy, Trade and Industry said. Compared to a year earlier, sales were down 0.4%.



-San Francisco Fed’s Williams will speak at 12:10 p.m. EDT in Sun Valley, Idaho


-Reserve Bank of Australia issues a policy statement at 2:30 p.m. local time

-ECB’s Noyer speaks on fighting credit-card fraud at 0830 GMT in Paris

-Romania’s central bank issues a policy statement


-Fed Chairwoman Yellen will speak on financial stability at 11 a.m. EDT at the International Monetary Fund in Washington, and take questions from IMF Managing Director Christine Lagarde

-BOE’s Haldane speaks on a panel at 1600 GMT in London

-Poland’s central bank issues a policy statement


-Sweden’s central bank will issue a policy statement at 0730 GMT

-BOE’s Cunliffe speaks at 1100 GMT in Liverpool

-ECB issues a policy statement at 1145 GMT, followed by President Draghi’s press conference at 1230 GMT

-ECB’s Draghi and Weidmann speak at 1715 GMT in Berlin


-U.S. markets are closed for Independence Day


Can China Fix Its Financial System Without Derailing Its Economy? Yes, says Paul Gruenwald, chief economist of Standard & Poor’s Rating Services’ Asia Pacific region. China has built up sufficient buffers to protect against a collapse in the country’s financial system, he said, pointing to the $4 trillion in foreign-exchange reserves and the big banks’ cash stockpiles.

Baby Boomers Aren’t (Yet) Downsizing in Droves. There’s a popular perception that housing inventory could surge in the coming years as the Baby Boom generation — those born between 1946 and 1964 — downsizes, trading in larger single-family homes for urban condos. But two reports suggest that such downsizing has yet to materialize and that it may not happen, at least not to the extent that many have assumed.


The Fed should adopt a rules-based approach to monetary policy, and soon, writes John Taylor (namesake of the Taylor rule) for the Journal. “Fed Chair Janet Yellen has expressed agreement that the Fed should eventually ‘adopt such a rule as a guidepost to policy,’ though she adds that the time is not yet ripe because the economy is not yet back to normal. So the main debate now is about when, not whether, a rules-based policy should be adopted. Based on recent research, the sooner the better.”

The Fed should be worrying about the “awful” U.S. growth numbers, not its exit strategy or inflation, writes John Makin of the American Enterprise Institute. “At the very least, the Fed needs to stop talking about its exit strategy and when it will start raising interest rates and perhaps start talking about things it might do to boost weak growth. … But before that happens, the Fed will have to stop dreaming about 3 percent growth and wake up to the reality that 2014 will be a slow growth year wherein a resumption of inflation is not a risk.”

The ECB “has an uncomfortable wait ahead,” Alen Mattich writes for the Journal. “The central bank launched a raft of new monetary measures earlier this month, designed to end the single currency region’s deflation risk and get the region growing. But monetary policy works with a lag. It would seem rash if the ECB were to do yet more before seeing whether these most recent policies work.”

With the center of gravity in the world economy having moved 5,000 kilometers east over the last three decades, London School of Economics Professor Danny Quah examines recent controversies over the degree to which U.S. monetary policy should take account of its international impact, and asks whether “we looking for our hero where we should or just where we’ve come to out of laziness and habit?  When will we need to agree the US can no longer be global hegemon?”


– Hungary’s government on Friday submitted a draft bill to parliament that widens the scope of its original plan to ease pressure on holders of foreign-currency loans by extending the proposal to holders of local-currency loans.

-North Korea’s economy grew last year, but more slowly than a year earlier. Perhaps.

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