The scariest aspect of the current financial crisis

Greece is a comparatively small economy, so the economic crisis there ought to be manageable.  But there is something far more worrisome on the horizon, and the Bank for International Settlements in Basel, Switzerland is ringing the alarm bell.

To employ a common metaphor, interest rate cuts are the penicillin of financial crisis infections – the go-to solution that usually combats an economic downturn by making it cheaper to borrow money to spend and invest. But just as overuse of penicillin has bred antibiotic-resistant bacteria, so has overuse of interest rate cuts left central banks in a tough situation: interest rates are so low that there is no further cutting practical – unless you actually pay people to borrow money. The UK Telegraph reports:

The world will be unable to fight the next global financial crash as central banks have used up their ammunition trying to tackle the last crises, the Bank of International Settlements has warned.

The so-called central bank of central banks launched a scatching critique of global monetary policy in its annual report. The BIS claimed that central banks have backed themselves into a corner after repeatedly cutting interest rates to shore up their economies.

These low interest rates have in turn fuelled economic booms, encouraging excessive risk taking. Booms have then turned to busts, which policymakers have responded to with even lower rates.

Claudio Borio, head of the organisation’s monetary and economic department, said: “Persistent exceptionally low rates reflect the central banks’ and market participants’ response to the unusually weak post-crisis recovery as they fumble in the dark in search of new certainties.” (snip)

The BIS report described the threat of a new bust in advanced economies as a “main risk”, with many reaching the top of the economic cycle.

The economies worst hit by the last crisis are now suffering the costs of persistent ultra-low rates, the organisation said, which could “inflict serious damage on the financial system”, sapping banks and weakening their balance sheets and their ability to lend.

Comparatively few people know much about the BIS, but in many ways it is the most significant financial institution in the world.  It is where central banks meet to balance their accounts out.  As such, it is the closest thing we have to a universal financial institution, one where North Korean and Japanese (for instance) central banks settle their accounts.  I doubt that ISIS is yet represented there, but the BIS will be the first international institution it joins.  Because it is composed of central banks, it is insulated from political pressure and free to tell the truth about the world economy.  This is a clear warning that a global financial crisis of crippling nature could be ahead.