shock
William Keegan
According to the Bank of International Settlements (BIS): “A general resurgence of inflation seems less likely than further disinflation or even deflation.”
This may seem a dry, even unremarkable, assertion until you consider who made it. The BIS is one of the world’s most prestigious financial institutions, the “central bankers’ bank” based in Basle. It hosts monthly meetings of the leading central bankers, and has privileged access to key financial information. Coming from central bankers, who are normally assumed to see an inflationary threat under every carpet, it is a truly remarkable admission.
At a time when influential voices have criticised Italy’s relaxation of budget deficit targets, the BIS states: “One cannot rule out the possibility of a situation arising in Europe in which fiscal stimulus may once again be an appropriate policy response.”
These observations are made in the BIS’s 69th annual report, published in Basle earlier this month. It received little media attention amid the peace talks in Kosovo and the gyrations of the euro. The BIS was one of the few institutions to alert the world in 1997 to the possibility of an Asian financial crisis. It is closely involved in discussions about international financial and banking supervision. But throughout its report there are strong hints that not enough is being done to prevent a serious international disaster.
After analysing the events surrounding the threat to the system that followed last August’s Russian debt default and the rescue of the Long-Term Capital Management hedge fund, the BIS indicates that the system remains highly exposed.
It thinks the world economy is vulnerable to the possibility of a Wall Street crash, and warns that “a lack of stability in one area [macro-economic policies] commonly contributes to instability in the other [policies for financial stability].
“Record trade imbalances must at some point imply a lower dollar and an appreciation of the yen and the euro. Should this happen before the economies of Japan and continental Europe are growing healthily again, the downside potential … is obvious.”
The BIS connects the deflationary threat with “the overhang of productive capacity in traded goods”. It says this is already putting downward pressure on prices in industrial countries “even though export volumes from Asia have not yet fully responded to earlier depreciations”.
The BIS notes that protectionist pressures are rising in the United States “even as the unemployment rate keeps falling”.
One route to a stock market correction it envisages is “the intensification of price competition [which] makes firms vulnerable to any significant acceleration of costs”. It goes on to warn: “Should profits come under further pressure in the US, the effect on equity prices could be significant, and this would in turn be expected to have an impact on consumption.”
Even though the Japanese economy recorded an unexpected rise of 1,9% in gross domestic product during the first quarter, the BIS is gloomy about Japan’s immediate prospects. It says last year’s appreciation of the yen was unwelcome, and hints that a competitive exchange rate is vital if Japan is really to emerge from its recession.