In what seems to be a case of deja vu, the IMF has warned of major risks to the global economy. To no one’s surprise, at least to the ones who pay attention, the $135 trillion debt pile in the G20 nations is masking irrational exuberance. Businesses and nations are beginning to have problems servicing the debt payments. A past article regarding the debt-to-GDP at 327% shows that the folly of markets will be understood when it is too late. Financial markets continue to churn higher week after week, as investors are left with no other alternative for yield. Bank accounts yield next to nothing and the base currency units in the global market leads to asset price inflation.
The cycle is quite comical, as the IMF comes out with higher GDP forecasts and revises them down each time. Then they warn of structural issues to the economy, and then repeat it while markets go higher. In the latest report, the IMF said nine of the world’s largest financial institutions will struggle in the new global economy. The banks include Citigroup, Societe Generale, UniCredit Group, Deutsche Bank, Barclays, Standard Chartered, Sumitomo Mitsui Financial Group, Mizuho Financial Group, and Mitsubishi UFJ Financial Group. Essentially, these banks need to increase their capital reserves for future regulatory requirements. They would like these institutions to build reserves over the next few years. IMF buzzwords like this make me think that the next crisis or recession is close. Future regulatory measures mean that interest rates are going lower much faster than people believe, and legacy banking business models will be outdated. Banks will need much higher interest rates to grow their capital, and that scenario seems unlikely over the longer-term. The FED will lower rates, and these institutions still haven’t recovered from the last crisis, meaning these behemoths have post-systematic risk on an exponential scale. “Problems in even a single one of these global systemically important banks could generate systemic stress,” the IMF said. Systematic risk is something that shouldn’t be taken lightly, as we know what happened the last time the system scale grew faster than the ability for humans to maintain it. I can’t remember a time where I haven’t heard about Six Sigma or Ten Sigma events happening in the market. The reason for these events is that the function of scale has become so great that anomalies before are not anomalies now. When you look at exponential system growth, exponential debt growth, and exponential interconnectedness, the chances of “phase transitions” (black swans) is increasingly more likely. Normal statistics show you that our normal bell curve will be within one standard deviation of the mean 68% of the time, two standard deviations of the mean 95% of the time, and three standard deviations 99.7% of the time. If you look at the table below, the number of significant Six Sigma events has increased as we’ve moved into the 2000s.
Although volatility has been subdued lately due to central bank intervention, the risk remains for increased 6+ Sigma events. Blockchain digitation of assets could make this more efficient, but in the meantime, the old legacy system is at risk.