As the Banking Crisis Ends the Economic Crisis Begins

The latest from Ambrose Evans-Pritchard indicates that the banking crisis has been averted but now the economic crisis will begin. Unemployment will increase as consumer spending and international trade continues to decrease. It looks like a weak housing sector may still have a few years to go. The article indicates that the economic recession will last 18 - 24 months. Don't be surprised if this lasts longer. The de-leveraging process that the economy must go through still has a lot of pain left in it.

The issue that historians and the rest of us will discuss for some time to come is how bad could it have been if some of the unprecedented actions were not taken by the European and US governments and central banks. From the UK Telegraph:

Tuesday's sweeping move by US Treasury Secretary Hank Paulson to guarantee financial debt and inject state capital into America's biggest banks brings the US into line with Britain and Europe, where almost $3,000bn (£1.7 trillion) has been vouched in the biggest bail-out of all time.

If the history of financial crises is any guide, the violent credit shock of 2007-2008 has largely run its course. The sovereign states of the US, Britain, France, Germany, Italy, Spain, and Holland have broad enough shoulders to carry their load of fresh liabilities – even if Iceland does not.
We are now moving to the next phase, a grinding slump across the G7 bloc of leading industrial economies as years of excess debt are slowly purged from the system. This is when people start to lose their jobs in earnest.

Professor Nouriel Roubini from New York University, the vindicated prophet of the crisis, says he can at last glimpse light at the end of the tunnel.

"Policy makers peered into the abyss of systemic collapse a few steps in front of them and finally got religion. While the economic damage is already done, and the global economy will not avoid a painful recession, rapid action will prevent a decade-long stagnation like the one in Japan after the bursting of its real estate and equity bubble," he said, predicting a 'U-shaped' slump lasting 18 to 24 months.

World trade has already stalled. The Baltic Dry Index measuring freight rates for shipping has crashed by 82pc since May, touching a five-year low yesterday. Container vessels are leaving Asian ports with 20pc spare capacity. "We're heading into a global recession," said Simon Johnson, the IMF's former chief economist.

The whole OECD bloc of rich economies is crumbling in unison – a rare event. Such is the dark side of globalisation. Asia is deeply linked into the debt bubble through trade effects, which is why Japan and Singapore are contracting as sharply as the West.

Oil-rich Russia had to step in yesterday with a $56bn package to recapitalise banks and cover foreign loans. Brazil has seen a triple rout in its stocks, bonds, and currency. The Gulf states of Qatar and the Emirates have had to support their financial systems. Even Norway needed a $55bn bank rescue over the weekend.

The French economy is officialy shrinking. Germany's exports fell 2.5pc in August, led by the car industry. BMW has begun to idle three plants; Opel has shut a factory in Eisenach for three weeks.

"The eurozone is in recession already," said David Owen from Dresdner Kleinwort. "The consumer downturn has begun, but the cuts in business spending that you see late in the cycle have yet to come. This is going to get a lot worse," he said.

Brussels invoked its "exceptional circumstances" clause yesterday, allowing EU states to breach the budget deficit limit of 3pc of GDP. But leeway for fiscal stimulus is already constrained. Ireland had to raise taxes yesterday to stop borrowing spiralling out of control. Its deficit will reach 6.5pc.

Former Federal Reserve chief Paul Volcker, a harsh critic of the debt bubble, says there is no alternative to the Paulson bail-out measures at this late stage, however "distasteful" they may be. "They will turn an inevitable recession into something more manageable," he said.

Be thankful for small mercies.