Looking beyond the Storm: The Current Economic Crisis Is in a League of Its Own and Few Markets, Emerging and Frontier, Will Escape the Consequences Unscathed. but There Is Light at the End of the Tunnel and the Future May Even Become Sounder

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Financial upheavals have worsened dramatically in recent weeks, biting into the real economy. Although there have been earlier crises in Latin America and South East Asia during the 1980s and 1990s, as well as the 2001 dot.com crash, today's crisis is exceptional.


This time the West's banking system-the engine of economic activity- has been paralysed. In a global village, no country or region can be insulated from exogenous shocks originating in any part of the world.

The world economy is "now entering a major downturn in the face of the most dangerous shock in mature financial markets since the 1930s," says the International Monetary Fund (IMF), the lender of last resort for governments. It expects global output to grow by 3.9% this year (albeit compared with 5% in 2007), led by emerging markets (notably China and India), offsetting sluggish activity in the US, Japan and Western Europe.

Some European countries, namely Britain, Ireland and Spain, have had their own housing and credit booms that are now going into reverse. Many banks in Central and Eastern Europe have borrowed heavily in foreign currencies; as their own currencies carry the weight of high fiscal and external deficits, the cost of servicing debt increases and so does the risk of default. That is why Hungary and Ukraine are in trouble.

Business and consumer confidence indicators for the Organisation for Economic Cooperation and Development (OECD), the club of wealthy nations, are now close to the lows experienced during the 2001-02 recession.

The IMF warns: "When a slowdown or recession is preceded by financial stress and especially when the stress is concentrated in the banking sector, typically it is substantially more severe. Based on a comparison of the current episode of financial stress to previous episodes, there remains a substantial likelihood of a sharp downturn in the US." This year alone, about 750,000 American jobs were lost. The evidence is mounting of a full-blown credit freeze despite the $7-8 trillion of public funds being injected into banks in terms of liquidity, debt guarantees and recapitalisation. JP Morgan remarked: "Every week that credit markets remain dysfunctional is doing unknown damage to the macro-economy."


In fact, many observers--not least Alan Greenspan, the former chairman of the US Federal Reserve--underestimated the depth of financial disorder.

It is shocking how the US's credit debacle, fuelled by 'toxic' assets like collateralised debt obligations and credit default swaps, has rapidly spread from sub-prime to prime mortgages, and from residential mortgages to consumer credit, commercial real estate and now to the corporate sector, which, in turn, are infecting businesses worldwide. The Bank of England estimates that losses on toxic mortgage securities may total $2.8 trillion.

Bubble of fear

Global money markets are showing symptoms of a 'confidence crunch'. There's plenty of liquidity sloshing around the system but very few banks are lending to one another beyond one week, due to the solvency concerns of counterparties. Central banks are trying to restore calm to the interbank market, where rates for longer maturities are still high. When banks curtail lending to smaller-and medium-sized enterprises and home buyers, consumer spending falls and the economy ultimately grinds to a halt. The net result is a deflationary spiral and recession--defined as two or more consecutive quarters of negative growth.

Investors are scared about plunging share prices and the probability of companies, including blue chips, defaulting on their debts. The collapse of Lehman Brothers, the fourth-largest US investment bank, led to panic selling worldwide and a switch to less risky forms of investment, such as US Treasuries and gold. Inflows poured into gold-backed exchangetraded funds and the physical metal itself. …