US stock market

It has been a very volatile few years for the global economy, geopolitics, and, of course, world health in recent years, what with recessions, wars, and pandemics. This period has seen governments forced to increase spending dramatically, while central banks have both eased policy dramatically after the pandemic struck and then tightened substantially when inflation took hold. And yet, despite all this upheaval, we’ve not seen a significant financial crisis. Is this just luck or something else?

This question is given because, as usual, there are doom-mongers out there that say the next financial crisis is just around the corner. Their favourite claim seems to be that the USD 1.5 trillion refinancing need in the US commercial real estate market over the next two years, or the USD38bn need in Germany, will catapult not just these sectors but banking as a whole into a crisis. It might not be unreasonable, although it is worth noting that policymakers have quickly and successfully doused the fires of financial tension in recent years. In fact, it seems to have been quite easy.

For instance, the US regional bank ‘crisis’ of March last year was soon doused by a combination of support from large commercial banks and policies from the Fed. In fact, the Fed has just announced that the tool it invented last March to give quick liquidity to banks, the Bank Term Funding Plan (BTPF) can now come to an end as it is not needed anymore. In fact, it was probably not needed within weeks of it being introduced, as tensions quickly evaporated.

In the UK, the strains in the non-bank financial sector, long thought to be a hot-bed of financial risk, were quickly doused by BoE gilt purchases when defined-benefit pension schemes blew up the gilt market following former PM Liz Truss’s disastrous fiscal experiment. Here too, the BoE was quickly able to sell back the gilts that it had bought to ease the crisis. We could name other potential financial flashpoints in recent years, not least the demise of CSFB in Switzerland.

These ‘crises’ might have had different origins, but they share one outcome, which was that the tensions were eased quickly, with no discernible contagion. They did not, for instance, create a re-run of the global financial crisis or the euro zone debt crisis. Why not?

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said policymakers might like to think that their quick and decisive action was the reason, and we don’t doubt that it played a part. However, there’s another, more sinister argument, which is simply that there’s so much liquidity sloshing around because of the huge balance sheet expansion undertaken by central banks that a major new crisis is not only easily avoided but almost impossible.

A recent commentary from former Bundesbank president Weidmann highlights the issue. He argues that these days of massive excess reserves in the banking system mean that banks no longer borrow and lend these reserves to one another in the way that they used to. In essence, it creates zombie banks that are insulated from the financial strains that occasionally blow up in the market. Quantitative easing acts like a huge anaesthetic, not just for banks but for customers of banks, like non-bank financial firms and non-financial companies. This might also help explain why central banks appear to have been able to get inflation back down without provoking the sort of deep recessions that many had feared. If we accept this view, then what happens as central bank balance sheets are reduced and excess reserves depleted?

Mr. Steve Barrow suspects not very much, in large part because these balance sheets will not be scaled back very significantly. Of course, we could run into tensions as central banks try to find the ‘new normal’ level of reserves, as we saw with the Fed a few years ago, but our best guess is that, when it comes to the possibility of a destabilising financial crisis, policymakers—and the global economy—will stay lucky.