The Bank of International Settlements (BIS) is warning that the global economy could be on the brink of a major depression similar to the one that passed in the 1930s.
The BIS said that years of loose monetary policy have fueled a dangerous credit bubble leaving the global economy more vulnerable to an economic catastrophe than is generally understood.
In its 77th Annual Report for the financial year April 1, 2006-March 31, 2007 that was submitted to the BIS’ annual general meeting held in Basel on June 24, the BIS – which one source described as “the ultimate bank of central bankers” – noted that the Great Depression that began in 1929 caught many off guard and unprepared.
“Virtually nobody foresaw the Great Depression of the 1930s, or the crises which affected Japan and southeast Asia in the early and late 1990s. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a ‘new era’ had arrived”, said the bank.
Several worrying signs, including mass issuance of new types of credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors and entrenched imbalances in the world currency system, have all made the Bank wary the global economy is at serious risk.
The BIS pointed to China as a possible spark that could cause a sudden global downturn.
The BIS said “China may have repeated the disastrous errors made by Japan in the 1980s when Tokyo let rip with excess liquidity.” “The Chinese economy seems to be demonstrating very similar, disquieting symptoms,” the BIS claimed, noting China’s credit and asset boom.
The Bank described China’s booming economy as “unstable, unbalanced, uncoordinated and unsustainable” — a comment apparently made by Chinese premier Wen Jiabao.
The BIS also took a swipe at the U.S. Federal Reserve, noting that the central bank was rethinking the easy credit policies of former Fed chief Alan Greenspan.
The BIS was not sanguine about the dollar, citing America’s huge trade and deficit imbalances with US external liabilities growing to over $4 trillion from 2001 to 2005.
“The dollar clearly remains vulnerable to a sudden loss of private sector confidence,” the BIS report stated.
Worrisome too is the bubble created by private equity deals and hedge fund activity.
“Sooner or later the credit cycle will turn and default rates will begin to rise,” the BIS said.
“The levels of leverage employed in private equity transactions have raised questions about their longer-term sustainability. The strategy depends on the availability of cheap funding,”
The BIS’ report cited several worrying signs, including mass issuance of new types of credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors and entrenched imbalances in the world currency system.