The Bank for International Settlements is an odd organisation. Originally set up in the 1930s to facilitate the payment of First World War reparations by Germany to France, Britain and others, it has since transformed into a club of central bankers.
What’s less well-known that it came within a whisker of being disbanded during the Second World War. It had been tainted by the failure of the reparations policy and by the presence of prominent Nazis on its board. At the Bretton Woods Conference in 1944, the Norwegians lobbied for it to be dissolved – after all, aside from anything else, what purpose did it have any longer? The British argued against this, but were overruled by the Americans* and the conference agreed that the BIS would be shut down.
But in the event, the undertaking was forgotten and the BIS survived. And, many economists would argue, a good thing too. For today, the BIS is renowned for being one of the only international institutions to have warned us of the risks and imbalances which eventually led to the great financial crisis of 2008.
Which is why we should take note, today, that it has issued yet another warning. According to the BIS’s latest Quarterly Review financial markets are starting to behave in some of the ways they behaved before the crash. In particular, investors seem to be chasing riskier and riskier assets, despite the fact that the economic prospects are hardly all that great.
Here’s the key passage from the BIS report:
some asset prices started to appear highly valued in historical terms relative to indicators of their riskiness. For example, global high-yield corporate bond spreads fell to levels comparable to those of late 2007, but with the default rate on these bonds running at around 3%, whereas it was closer to 1% in late 2007.
The same was true of investment grade corporate bond spreads, but with respective default rates of a little over 1% and around 0.5%. Indeed, numerous bond investors said that they felt less well compensated for risk than in the past, but that they had little alternative with rates on many bank deposits close to zero and the supply of other low-risk investments in decline.
Bond yields usually move in line with the wider economy’s growth prospects, but clearly these two lines have started to diverge in recent months. There is something going on.
At least past of the likely explanation – and this is my interpretation rather than the BIS’s – is that the flood of money being set loose by central banks, including the Bank of England and the Federal Reserve, through quantitative easing is pumping asset prices higher.
But either way, it is alarming that the very institution which first warned about the prospects of a crash is issuing a warning again about the same kind of behaviour happening in asset markets.
* After a confrontation about this with Henry Morgenthau, the US Treasury Secretary, John Maynard Keynes actually collapsed and had a heart attack. He was wrongly reported as dead in Europe shortly afterwards. Given that Keynes was arguing against the BIS being shut down, I suppose one could say that Keynes almost died trying to protect it.