BIS warns the worst is far from over - The Age 1-7-08
A YEAR ago, the Bank for International Settlements startled the financial world by warning that we might soon face challenges last seen during the onset of the Great Depression. This has proved frighteningly accurate.
The venerable body, the ultimate bank of central bankers, said years of loose monetary policy had fuelled a dangerous credit bubble that would entail "much higher costs than is commonly supposed".
In a pointed attack on the US Federal Reserve, it said central banks would not find it easy to "clean up" once property bubbles had burst.
If only we had all listened to the BIS a long time ago. Ensconced in its Swiss lair, it has fired off anathemas for years, struggling to uphold orthodoxy against the follies of modern central banking.
Bill White, the departing chief economist, has now penned his swansong, the BIS's 78th annual report, released yesterday. It is a disconcerting read for those hoping the global crisis is over.
"The current market turmoil is without precedent in the postwar period," it said. "With a significant risk of recession in the US, compounded by sharply rising inflation in many countries, fears are building that the global economy might be at some kind of tipping point.
"These fears are not groundless. The magnitude of the problems yet to be faced could be much greater than many now perceive.
"It is not impossible that the unwinding of the credit bubble could, after a temporary period of higher inflation, culminate in a deflation that might be hard to manage, all the more so given the high debt levels."
Given the constraints under which the BIS must operate, this amounts to a warning that monetary overkill by the Fed, the Bank of England, and above all the European Central Bank, could prove dangerous at this juncture.
European banks have suffered worse losses on US property than American banks. Their net dollar liabilities are $US900 billion ($A931.4 billion), mostly short-term loans that have to be rolled over, a costly business with spreads still near panic levels. Mortgage and consumer credit has "demonstrably worsened".
The BIS cautions the ECB to handle its lending data with great care. "The statistics may understate the contraction in the supply of credit," it said.
The death of securitisation has forced banks to bring portfolios back on to their balance sheets, while companies in need are drawing down pre-arranged credit lines. This is a far cry from a lending recovery.
Warning signs are flashing across Eastern Europe, where short-term foreign debt is 120% of reserves.
China is not immune, although the BIS has dropped last year's comment that growth is "unstable, unbalanced, unco-ordinated and unsustainable".
Global banks — with loans of $US37 trillion in 2007, or 70% of world gross domestic product — are still in the eye of the storm. "Inter-bank money markets have failed to recover," BIS said. "Of greatest concern at the moment is that still tighter credit conditions will be imposed on non-financial borrowers. Do not count on a fiscal rescue. Explicit and implicit debts of governments are already so high as to raise doubts about whether all non-contractual commitments will be fully honoured."
Dr White says the US subprime crisis was the "trigger", not the cause of the disaster. "Should governments feel it necessary to take direct actions to alleviate debt burdens, it is crucial that they understand one thing beforehand," he said. "If asset prices are unrealistically high, they must fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off. To deny this through the use of gimmicks and palliatives will only make things worse in the end."
Let us all cheer Dr White off the stage.
