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Staring at 'economic calamity'

The world’s financial ministers are all in a dither, and it is not surprising. At the weekend meeting of the G7 – the world’s richest economies – ministers took a few steps towards acknowledging the scale of the economic unravelling that is both cause and consequence of the global credit crunch. Then most did a sharp about turn, rejecting America’s call for a global reflationary package and claiming things could be contained.

New Labour’s chancellor, Alistair Darling admitted: “It is undoubtedly the case following the problems that arose in the US housing market last summer that the world is facing a turbulent time.” Hank Paulson, the US treasury secretary acknowledged that “the current financial turmoil is serious, and persisting”. They were responding to an understated report from the Financial Stability Forum (FSF), a study group drawn from the world’s central bankers and financial regulators which warned: "It is likely that we face a prolonged adjustment, which could be difficult".

Financial Times columnist Wolfgang Munchau is even more downbeat – at least for the US and the UK - in what tries to be an assessment of the risk of global deflation, a repeat of the Great Depression – “the ultimate economic calamity” as he puts it. Munchau says there is one scenario that could produce a 1930s-style deflationary depression in the US: a large-scale financial meltdown, adding; “By that I mean a situation in which the financial sector would cease to fulfil one of its basic functions: to provide liquidity to the real economy.”

But those who’ve been paying attention know that the problem with Northern Rock was exactly that. The wholesale credit markets seized up – liquidity disappeared – following revelations about the repackaging and reselling of unrepayable debts. So Munchau’s assessment becomes particularly chilling when you read what another G7 Minister had to say. According to Peer Steinbrück, German finance minister, the G7 now feared that write-offs of losses on securities linked to US sub prime mortgages could reach $400 billion. This is sharply higher than the $120 billion credit losses that Wall Street banks and other institutions have revealed in recent weeks – and also far bigger than the US Federal Reserve’s estimates.

Which all helps us to put Munchau’s assessment of the UK’s prospects in perspective. He says “The UK is perhaps more vulnerable, because of the relatively large size of the financial sector in the economy, an over-reliance on a property market that is about to deflate, and chronically low productivity growth in non-financial sectors. There is now clearly the possibility of a severe and prolonged recession, followed by a long period of low growth.”

The FSF puts forward a raft of regulatory measures aimed at strengthening the resilience of key elements of the financial system. These however, are targeted at some of the many consequences rather than the underlying cause: 30 years of credit-induced transformation of the world economy has failed to reverse the underlying trend of a continuous decline in the rate of global growth per head.

None of this is really in line with Darling’s insistence that the UK has “good reasons to be confident” about its ability to withstand a slowdown in the global economy, is it? Just before the G7 met, figures released in Britain showed that home repossessions soared by 21% in 2007 as the credit crisis began to bite into people’s ability to repay their mortgages, let alone second mortgages used to buy expensive consumer goods. Meanwhile, business confidence in Britain is at an all-time low, according to a survey by the Institute of Chartered Accountants in England Wales. The banking, finance and insurance sector showed the lowest confidence. But there will be no recession, the institute says. So that’s alright then.

Gerry Gold, economics editor
11 February 2008

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