This Is The Real Libor Scandal
Amid all of the attention that the Libor rate-fixing scandal has received, the world is completely overlooking a far worse Libor “scandal” that has been occurring right under our noses this entire time. Though the Libor rate-fixing scandal is certainly no trivial matter, the losses caused by it amount to a few tens of billions of dollars, which is ultimately a drop in the bucket compared to the size of the global economy and financial system. In addition, as dramatic as the term “rate-fixing” sounds, the Libor manipulations only moved the Libor rate by a few basis points (basis points are .01 percentage points) for just a few brief moments at a time. The Libor manipulations did not move the rate by significant magnitudes such as from 5 percent to 2 percent, for example.
The vastly worse Libor “scandal” that I am referring to is the fact that the Libor has stayed at record low levels for the past half-decade, which is helping to fuel a massive economic bubble around the entire world that will end in a devastating financial crisis that will be even worse than the Global Financial Crisis. Instead of causing a few tens of billions of dollars worth of losses like the Libor rate-fixing scandal, the “Libor Bubble” will gut the global economy bytrillions of dollars.
The chart below shows the U.S. dollar Libor rates for four common maturities:
Chart source: Mortgage-X.com
The Euro, Japanese yen, British pound, and Swiss franc Libor rates for all maturities have also been at record lows for a record length of time (click on links to see charts). Low interest rate environments create economic bubbles that burst when interest rates eventually normalize. The reason why low interest rate environments inevitably lead to the inflation of bubbles is because low borrowing costs encourage credit booms and discourage saving by reducing the rate of return on savings accounts and fixed income investments.
Prior Libor rate troughs have resulted in bubbles that ended in crises when the rate rose again:
Chart source: Mortgage-X.com
Here are the bubbles and crises of the past three decades that low Libor rates have contributed to:
3) The Dot-com bubble (late-1990s)
5) Post-2009 economic bubbles that have not yet popped (to be discussed in the next section)
To reiterate, the current Libor rate trough that started in 2009 has created another global bubble that is far more extreme than the bubbles created by prior Libor troughs simply due to the fact that rates have never been this low for such a long period of time. Libor rates have been at such unusually low levels because most Libor rate-setting banks are based in the U.K. and U.S., which have both experienced severe credit busts and balance sheet recessionsduring the financial crisis as a result of their large debt and asset bubble overhangs. Economies that experience credit busts are at risk of experiencing deflationary depressions, which central banks try to combat by cutting interest rates as low as possible.
While the U.S., U.K., Japan, and peripheral European nations have suffered with balance sheet recessions and now weak credit growth and recoveries, most other nations escaped from the financial crisis largely unscathed and have been growing at a steady rate. In a normal world, borrowing costs in these faster-growing economies would be in the 4 to 7 percent range, but instead borrowers in these countries are taking advantage of the record-low sub-1 percent Libor rates that are geared for truly sick economies. Today’s Libor rates are simply too low for non-crisis economies, so this cheap credit bonanza is helping to fuel borrowing binges and asset bubbles almost everywhere that is not the U.S., U.K., Japan, and peripheral Europe.
As the world’s most important benchmark interest rate, approximately $10 trillion worth of loans and $350 trillion worth of derivatives use the Libor as a reference rate. Libor-based corporate loans are very prevalent in emerging economies, which is helping to inflate the emerging markets bubble that I am warning about. In Asia, for example, Libor is used as the reference rate for nearly two-thirds of all large-scale corporate borrowings. Considering this fact, it is no surprise that credit and asset bubbles are ballooning throughout Asia, as my report on Southeast Asia’s bubble has shown.