Central bank body warns of Great Depression

The Bank for International Settlements (BIS), the organisation that fosters cooperation between central banks, has warned that the credit crisis could lead world economies into a crash on a scale not seen since the 1930s.

In its latest quarterly report, the body points out that the Great Depression of the 1930s was not foreseen and that commentators on the financial turmoil, instigated by the US sub-prime mortgage crisis, may not have grasped the level of exposure that lies at its heart.

According to the BIS, complex credit instruments, a strong appetite for risk, rising levels of household debt and long-term imbalances in the world currency system, all form part of the loose monetarist policy that could result in another Great Depression.

The report points out that between March and May of this year, interbank lending continued to show signs of extreme stress and that this could be set to continue well into the future.

It also raises concerns about the Chinese economy and questions whether China may be repeating mistakes made by Japan, with its so called bubble economy of the late 1980s.

EDITORS NOTE: Quite a few comments have been made that there is no direct reference to the Great Depression in this month’s BIS report.

While this is strictly true, BIS warned in June 2007 - just before the Credit Crunch really hit - that the global economy was vulnerable to a major economic set-back because of extraordinary exposure to collateralized credit.

BIS directly made references to the 1930’s as an example of a similarly serious credit bubble, and this month’s BIS report describes the conditions of this being lived out.

So, to be pedantic, the warning “BIS warns of Great Depression” is actually a year old already. What BIS discusses now is the fragility of existing conditions of the fall-out from a massive credit bubble bursting - which has already been made clear across their reports historically can be similarly referenced to the 1930’s, though stated in a typically conservative and non-alarmist language.

Even what optimism BIS had about a weak recovery to the end of May 2008 have been dashed by extreme shorting of financial stocks across the US and UK - Lehman Brothers, HBOS, and property developers such as Barratts, have all taken extreme beatings in June 2008.

So back to the headline - BIS have indeed already warned of repeat of conditions that could be as extreme as the Great Depression, and are now describing that process as we move through it.

In the meantime, unemployment is already on the rise on both sides of the pond, and the analogy some people have concerns about I’m afraid is still salient.