We face another crisis – listen to those who got it right last time

Allister Heath

MOST international economic agencies are pretty useless sinecures for people more interested in climbing the greasy pole of the global establishment than in thinking for themselves. One of the few exceptions is the Bank for International Settlements (BIS), the central banks’ very own bank and a superb organisation which has spent the past few years rejecting groupthink.

Thanks in part to its then chief economist William R White, it was the only global body of its kind to warn that loose monetary policy and a fixation with targeting consumer price indices had allowed a massive, near-lethal bubble to develop in asset markets. Meanwhile, the likes of the IMF and the OECD thought that all was well, probably because their army of analysts used models that were simply not good enough.

The truth, of course, is that White wasn’t alone. More economists predicted the bubble and bust than is usually understood – in the UK, some of these include the monetarist-leaning David B Smith (then at Williams de Broe), Tim Congdon (now at International Monetary Research), Peter Warburton (Economic Perspectives), John Greenwood (Invesco), Gordon Pepper (Lombard Street Research) and Andrew Lilico. It is at best a myth and at worst a convenient lie to claim that nobody saw the crisis coming. All of those mentioned are members of the Institute of Economic Affairs’ shadow monetary policy committee; I used to talk to all of them in the run-up to the crisis, in Smith’s case every single week, and remember how worried they were.

Others who forecast the bubble in Britain included members of the Austrian school of economics; their analysis differed from that of the monetarists but they too realised that the amount of money and credit in circulation was exploding and that the Bank of England and the Fed, among others, were encouraging the party.

But while White was far from alone, he was the only one at a major international body. His own analysis was drawn heavily from the Austrian school; remarkably, even though he retired from the BIS a few years ago, his legacy and influence lives on.

In its annual report published yesterday, the BIS has it right. It explains how quantitative easing and ultra-low rates were meant to create time for public and private balance sheet repair, reducing budget deficits, and radical supply-side reforms to bolster productivity growth. But the opportunity has been squandered, with politicians and many private individuals failing to act: as the BIS put it, “cheap money makes it easier to borrow than to save, easier to spend than to tax, easier to remain the same than to change.” Instead of reducing risks, loose money has added to them.

Among the explosive facts in the report is that the debt of households, non-financial corporations and governments has increased as share of GDP in most large advanced and emerging countries since the crisis. In a sample of 18 countries – including the US, UK, China, India, Japan and the big Eurozone nations – this debt surged by $33 trillion between 2007 and 2012, up 20 per cent of GDP. Most if this was caused by extra government debt; with populations ageing, maintaining long-term fiscal sustainability will increasingly be difficult. Another major problem is that thanks to QE rich countries’ central banks now own assets worth 25 per cent of GDP and emerging economies’ 40 per cent – from $10.4 trillion in 2007 to $20.5 trillion and rising. The problem is that when bond yields eventually shoot up, the value of all of these assets will collapse. As ever, BIS’s recommendations will be derided and rejected – it is calling for fiscal and monetary tightening, which is anathema to most economists. But when the next crisis engulfs us, at least nobody will be able to claim that we weren’t warned.

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