If the global economy is an elastic band, what if it snaps?

In its annual report the Bank for International Settlements warns about the dangers of excessive debt in the global economy. " The policy mix has relied too much on measures that, directly or indirectly, have entrenched dependence on the very debt-fuelled growth model that lay at the root of the crisis," the report says. Which means that the extremely loose monetary policies adopted by central banks to boost growth have resulted in excessive debt, which was the cause of the financial crisis in the first place. Central banks have spent $10 trillion to stimulate the global economy so far, but with little success. " The global economy exhibits ' excess financial elasticity '- think of an elastic band that can be stretched out further and further until, eventually, it snaps back more painfully," the BIS report says. If the elastic band snaps back it maybe painful but at least the band still exists. But what if the band breaks? Perhaps that risk is too scary for the BIS to contemplate. As central banks have cut interest rates to zero savers have moved their money into riskier assets, such as emerging markets, which is why the Sensex is so high. Indian companies have borrowed heavily in foreign currencies to take advantage of the low interest rates. Forex loans of Indian firms have increased from 4.9% in December 2008 to 8.3% today, that is from $60 billion to $170 billion, while the amount of debt that is hedged has dropped from 35% to 15%. If interest rates start to go up, along with a fall in the rupee, these companies will be unable to repay their loans. Curiously, although central banks have poured money into banks to increase liquidity markets are still illiquid. This is because of high frequency trading in stocks and investments in bonds, which they are traded in illiquid over the counter markets. The US was first off the block with near 0% interest rate, followed by 3 rounds of quantitative easing but the effect has been less than spectacular because, while the Federal Reserve was easeing monetary policy the Congress was tightening fiscal spending, just to spite Obama. The economy is growing, but exports are being hurt by a strong dollar, and the unemployment rate is down, but many people have dropped out of the job market. There are questions about how strong the growth momentum is and whether the Fed will raise interest rate in September. In India, politicians keep on haranguing the RBI to reduce interest rate while they go on increasing taxes, adding to inflation. No wonder the consumer confidence is low and they are refusing to spend while banks cannot lend until they can wipe out the bad loans on their books. The resources of mother earth are finite so for one country to grow wealthy another must lose. We cannot all become wealthy but we can all collapse together. It may yet happen.