U.S. risks stagflation, says BIS chief

BASEL, Switzerland, April 29 (Reuters) – Stagflation is an increasingly plausible prospect in the United States and weak economic growth could last well into 2009, if not longer, the head of the Bank for International Settlements says.

That does not herald a rerun of the economic stagnation and rampant inflation that ran riot during the 1970s when oil prices last soared to unprecedented levels, Malcolm Knight, BIS general manager, said in an interview.

But it does cast some doubt on the White House’s thesis that the economy will rebound in the second half of 2008 in response to the tens of billions of dollars of tax rebates the government will be delivering to U.S. households in the coming weeks.

“I see a certain amount of scope for stagflation in a number of economies and that usually tends to result in subpar economic growth performance for an extended period of time, which could go well into 2009 or even longer,” said Knight, a Canadian who worked for more than 20 years at the International Monetary Fund.

“I think the U.S. economy is likely to experience weakness this year and in much of 2009,” said Knight, speaking to Reuters at BIS headquarters in Basel, Switzerland.

“Stagflation is a definite risk.”

U.S. Treasury Secretary Henry Paulson said on Tuesday that the aim of a $152-billion stimulus plan, mostly comprised of tax rebates, was to give the economy a new lease of life that would show through already this year.

His reassurances on Fox TV coincided with more bad news on inflation — that retail petrol prices rose nearly 10 cents in just one week to hit a high of $3.60 a gallon, driven by record world oil prices of close to $120 per barrel.

Knight said the recent acceleration in food prices across the globe had been a suprise but nonetheless appeared to be driven by fundamental forces such as surging demand. While Europe was in a stronger position than the United States, there were signs of weakness there too of late, Knight said.

“The emerging market economies are still growing very rapidly and probably see the main challenge as the recent increases in their inflation rates,” he said.

POOR VISIBILITY

From his 17th-floor office Knight’s view stretches into France and Germany, on a clear day.

Little else is clear since the downturn in U.S. housing and the collapse of the subprime mortgage market triggered a global financial markets crisis last August which has forced banks to report well over $200 billion in losses and writedowns, so far.

“I think it’s really not possible to predict exactly where we are in the deleveraging process,” he said. “I’d certainly hope that we’re half-way through it.”

Knight, in his current post for five years now, said the crisis was trickling through to the rest of the economy.

“It’s a significant factor that will tend to slow activity in other sectors going forward,” he said, noting the contagion was mainly happening through tighter credit standards.

The crisis, the worst since World War Two in Knight’s view, has thrust the BIS into the spotlight as a sort of nerve-centre of policy cooperation among central banks and regulators of the private-sector banks and financial institutions.

Often described as the central banks’ central bank, the BIS is the oldest international financial institution in the world, created in 1930 to oversee reparation payments imposed on Germany in the wake of World War One.

BIS staff and the Basel Committee on Banking Supervision are working on making the modern financial system safer, including demanding higher capital provision by banks for the more risky and exotic types of investment products developed in recent years.

But Knight is keen to reassure banks that despite the excesses that caused the current credit crisis, regulators are not bent on unlimited regulatory retaliation.

“The job is to protect the core of the financial system. What’s really needed is not to regulate everythying…but to have a better dialogue,” he says.

That dialogue needs to improve both among the supervisory agencies and between them and the private-sector.

“Both sides have an interest”.

Like many others on the regulatory and supervisory side of the fence, Knight is wary of the dangers of smothering innovation.

“There’s going to be more regulation and supervision in areas where there were unintended holes. But it’s very important to continue to encourage innovation,” he says.

04.29.08, 8:30 AM ET
By Brian Love, European Economics Correspondent

Source: Reuters

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