Why wobbly world markets are more worrying than oil: Don Pittis

Bank of Canada governor Stephen Poloz has reassured Canadians that the worst of the oil slowdown is over for the domestic economy, but he and his fellow central bankers are poorly equipped to deal with a bigger problem global markets now hitting dangerous peaks, Don Pittis writes.

Central bankers are out of bullets if 1929-level markets go bust again

World markets are hitting levels similar to those just before previous crashes including 1929, 1999 and 2007. But with liquidity at record highs, central banks will have to think of different strategies to get economies back on track. (Martin Leissl/Bloomberg)

Bank of Canada governor Stephen Poloz says the pain in the Canadian economy caused by the shocking fall in the price of oil is just about over.

But according to some analysts, a more dangerous threat may be connected to an entirely different mineral: mercury.

And if so, central bankers will find themselves helpless to deal with the fallout.

In his news conference Wednesday, it seemed the bank governor's biggest international concern was that the U.S. economy would grow even more quickly than he expected, forcing him to raise interest rates sooner.

Considering how everyone pounced on the his recent description of the Canadian economy as "atrocious," there is little wonder he did not warn of an impending market crash. 

'Atrocious' growth

With growth at zero, using the term "atrocious" was no exaggeration.

However, it just shows that if a staid but influential character like Poloz reminded us that markets — especially at current elevated levels — are mercurial, it could cause some serious fallout. Others are not so shy.

Quicksilver markets can turn from tranquil to turbulent in short order.- Ted Berg

A report out of the U.S. last month titled "Quicksilver Markets," (quicksilver being an older, less frightening word for mercury), contained a far more worrying warning: that global stock markets are now hitting levels seen just before the bursting of previous major market bubbles.

"The highest market peaks (1929, 1999 and 2007) either surpassed or approached this two-sigma level," says the report. "Each of these peaks was followed by a sharp decline in stock prices and adverse consequences for the real economy."

In market terminology "two sigma" means, roughly, twice what you would expect.

Markets like 1929

Perhaps most unsettling is that the report is not based on arcane calculations by some short-seller trying to drive markets lower. It's by Ted Berg, a financial modeller and risk analyst at the U.S. Office of Financial Research.

According to Financial Times markets columnist Gillian Tett, the office was set up after the 2008 financial crisis to "monitor threats to financial stability." 

After Wednesday's speech by Poloz, it's not clear that anyone is listening. 

The focus of Poloz's analysis was domestic economics. He said that the crash in oil prices hit the Canadian economy much harder, or maybe more quickly, than expected.

But after that "atrocious" first part of the year, he expects people thrown out of work in oil and gas to find jobs elsewhere, as a low loonie and cheap fuel spur exports.

According to that way of thinking, the Canadian economy won't need any more interest rate cuts before using up its excess supply of labour and money by the end of 2016.  

But it may turn out that the decision not to cut rates is prescient for a different reason. Contrary to the understanding of many people, markets have not been rising because of economic strength, but perversely, for the opposite reason.

Perverse market reaction

When China's exports plunged 15 per cent this week, markets shot to even higher highs on the expectation that the government would further loosen the purse strings and pour new money into the economy.

When China's exports fell 15 per cent this week, markets shot even higher on the expectation that the government would pump new money into the economy. (Associated Press)
Every time China or Europe or Japan or Canada cuts interest rates or buys more bonds as a stimulus, markets shoot up further into danger territory.

Of course, this is one of the reasons why U.S. central bank chair Janet Yellen has been so reluctant to begin raising rates.

Higher rates may well have the opposite effect, acting as a catalyst for a global market tumble.

As Berg said in his report, when stock bubbles burst, it is not just a market event detached from the real economy. Market crashes have adverse effects. And markets can wobble without warning.

"Quicksilver markets can turn from tranquil to turbulent in short order," says Berg. 

The biggest danger for the global economy if there is another market crash similar to the one that began in 2007 is that the economic doctors at our central banks will be forced to change their prescription.

Then, their solution was to cut interest rates to the bone and flood the banking system with liquidity — cash — by creating money and buying up bonds.

But now, with the world so filled with liquidity, its teeth are floating. It will be a hard trick to repeat. 

Except for a few sophisticated short sellers hoping to feed on the bones of crumbling financial system, no one wants a market crash.

Nearly everyone hopes Poloz is right about the coming recovery.

But while Poloz may have held off on cutting rates for entirely different reasons, eventually, he may be glad that this time, he kept his powder dry.


  • A previous version of this story attributed Stephen Poloz with describing a 'wobble' in the Canadian economy when in fact he was referring to the temporary weakness in the U.S. economy when he used that word.
    Apr 17, 2015 9:48 AM ET


Don Pittis

Business columnist

Don Pittis was a forest firefighter, and a ranger in Canada's High Arctic islands. After moving into journalism, he was principal business reporter for Radio Television Hong Kong before the handover to China. He has produced and reported for the CBC in Saskatchewan and Toronto and the BBC in London. He is currently senior producer at CBC's business unit.


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