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Global economy faces deep slowdown and deflation threat, BIS warns

By Edmund Conway, Economics Editor

Last Updated: 6:19am BST 30/06/2008

The global economy may be heading for a far deeper crisis than is expected and a bout of deflation in the world’s biggest economies is now a possibility, according to one of the world’s most highly regarded economic institutions.

The Bank for International Settlements has warned that many in the City and elsewhere may have underestimated the scale of the coming economic downturn in one of its most sombre portraits yet of the international financial system.

The Swiss institution – known as the central bankers’ bank – issued the alert in its annual report, released today.

It warned that the sub-prime crisis in financial markets was merely a reflection of growing debt burdens in the developed world, which could soon contribute to a deep slowdown.

  • Barclays warns of financial storm
  • More on the credit crisis
  • “The difficulties in the sub-prime market were a trigger for, rather than a cause of, all the disruptive events that have followed,” it said. “Moreover… the magnitude of the problems yet to be faced could be much greater than many now perceive.”

    The warning will cause particular concern among participants in the financial sector, as the BIS was among the earliest major institutions to warn that the world could face a credit crisis and financial slump.

    The report draws stark comparisons between the current crisis and a variety of others including the Great Depression.

    It said: “Historians would recall the long recession beginning in 1873, the global downturn that began in the late 1920s, and the Japanese and Asian crises of the early and late 1990s respectively.

    ” In each episode, a long period of strong credit growth coincided with an increasingly euphoric upturn in both the real economy and financial markets, followed by an unexpected crisis and extended downturn.

    “In virtually every instance, some form of new economic discovery or new financial development provided a further ‘new era’ justification for rapid credit expansion, and predictably became a focus for blame in the downturn.”

  • More on economics
  • Does a UK recession loom?
  • Most sobering is the report’s warning that developed economies including the US and Britain could face deflation.

    It said: “The eventual global slowdown could prove to be much greater and longer lasting than would be required to keep inflation under control. This could potentially even lead to deflation, which would evidently be less welcome.”

    •Profitability in financial services is falling at its fastest rate in at least 19 years as the credit crisis continues to hurt, a new study indicates. A balance of 44pc of firms have reported a fall in profits in the quarterly financial services survey released today by the CBI and PricewaterhouseCoopers. It is the worst result since the survey began in 1989.

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