BIS: Risk of global depression

The Telegraph reports the Bank of international Settlements (BIS), "the world's most prestigious financial body", is warning of a global depression caused by the credit bubble of recent years.

Individuals and businesses are borrowing far too much money and taking too much risk. A system already at risk of further major default is thus close to a situation where the last straw, a "tail event", might break the camel's back.

Of particular concern is what has been going on in China. I have to admit that I have not followed financial events there closely. The BIS says:

"The Chinese economy seems to be demonstrating very similar, disquieting symptoms," it said, citing ballooning credit, an asset boom, and "massive investments" in heavy industry.

Some 40pc of China's state-owned enterprises are loss-making, exposing the banking system to likely stress in a downturn.

It said China's growth was "unstable, unbalanced, uncoordinated and unsustainable", borrowing a line from Chinese premier Wen Jiabao

That doesn't sound too good at all. Clearly the situation as described is not sustainable should it remain that way.

The US Federal Reserve, (the US central banker), in particular, gets a whack:

In a thinly-veiled rebuke to the US Federal Reserve, the BIS said central banks were starting to doubt the wisdom of letting asset bubbles build up on the assumption that they could safely be "cleaned up" afterwards - which was more or less the strategy pursued by former Fed chief Alan Greenspan after the dotcom bust.

It said this approach had failed in the US in 1930 and in Japan in 1991 because excess debt and investment built up in the boom years had suffocating effects.

While cutting interest rates in such a crisis may help, it has the effect of transferring wealth from creditors to debtors and "sowing the seeds for more serious problems further ahead."

The BIS says the trading position of the United States is also perilous with a huge current account deficit equivalent to 6.5% of GDP

a rise in US external liabilities by over $4 trillion from 2001 to 2005, and an unpredented drop in the savings rate. "The dollar clearly remains vulnerable to a sudden loss of private sector confidence," it said.

Is money hard to get? Apparently not. Bankers have found new ways to get around credit risk by passing it off to third parties who may or may not realise the level of risk involved:

The BIS said last year's record issuance of $470bn in collateralized debt obligations (CDO), and a further $524bn in "synthetic" CDOs had effectively opened the lending taps even further. "Mortgage credit has become more available and on easier terms to borrowers almost everywhere. Only in recent months has the downside become more apparent," it said.

That last comment must mean one of the monkeys removed the hands from their eyes long enough to accidentally see some evil.

With that in mind, where is it all heading? The BIS looks at how sustainable many of the private equity transactions / mergers are given they levels of debt taken on assumed credit would remain cheap.

Mergers and takeovers reached $4.1 trillion worldwide last year.

Leveraged buy-outs touched $753bn, with an average debt/cash flow ratio hitting a record 5:4.

"Sooner or later the credit cycle will turn and default rates will begin to rise," said the bank.

"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," it said.

That may not last much longer.

That's the bad news......and there is nothing any political party in New Zealand can do about it, whatever way it goes. Increasingly, this looks like a dumb time for tax cuts.