The imploding of the US housing market bubble has resulted in one of the worst credit crunch crises yet with well over $500bn already written off by financial institutions thus far. How much more will the crisis cost investors? Well, analysts predict at least another $500bn, but more likely double that, are to be written off in the near future. We have already seen the demise and bailout of financial giants such as Bear Stearns, Freddie Mac and Fannie Mae and lately the bankruptcy filing of one of the largest investment banks, Lehman Brothers while Merrill Lynch has agreed to be taken over by Bank of America.
Surprisingly, the economies of the US and the Euro zone have shown some resilience thus far. Although most commentators are expecting recessionary economic conditions in these regions, unemployment figures have not risen dramatically, nor have economic output dramatically declined.
However, which events could cause a deep economic recession, especially among the major economic forces of the world? First, it is of course a global financial meltdown, which the US Federal Reserve is trying to prevent at all costs. Wolfgang Munchau, columnist of the Financial Times, reckons that the $6,000 bn credit default swap market, for example, poses huge risks as non-payments by counterparties would lead to enormous uncovered exposures by supposedly insured parties.
The second possibility is a dollar crisis. At the moment interest rates are kept low by the Fed to stimulate economic growth in the midst of the credit crisis and will probably be maintained at those levels for some time. What will happen if US inflationary expectations will rise significantly above the prevailing interest rates? Despite the prominent role of the US dollar in global financial affairs or its dominant position in countries’ foreign reserves, it is not unlikely that a flight of global investors from the US will result in vicious circle of a falling US dollar, rising US inflation and interest rates, bank failures and a deep recession (depression?).
The materialising of either scenarios seems rather unlikely at the moment. In fact, the dollar has strengthened considerably against the euro in recent months as investors globally have increased their allocations to ‘flight-to-quality’ investments, like US treasury bonds. But then, not even a year ago, very few commentators, if any, would have predicted that stalwarts such as Bear Stearns and Lehman Brothers (and Merrill Lynch) would have ceased to exist by today.
Surprisingly, the economies of the US and the Euro zone have shown some resilience thus far. Although most commentators are expecting recessionary economic conditions in these regions, unemployment figures have not risen dramatically, nor have economic output dramatically declined.
However, which events could cause a deep economic recession, especially among the major economic forces of the world? First, it is of course a global financial meltdown, which the US Federal Reserve is trying to prevent at all costs. Wolfgang Munchau, columnist of the Financial Times, reckons that the $6,000 bn credit default swap market, for example, poses huge risks as non-payments by counterparties would lead to enormous uncovered exposures by supposedly insured parties.
The second possibility is a dollar crisis. At the moment interest rates are kept low by the Fed to stimulate economic growth in the midst of the credit crisis and will probably be maintained at those levels for some time. What will happen if US inflationary expectations will rise significantly above the prevailing interest rates? Despite the prominent role of the US dollar in global financial affairs or its dominant position in countries’ foreign reserves, it is not unlikely that a flight of global investors from the US will result in vicious circle of a falling US dollar, rising US inflation and interest rates, bank failures and a deep recession (depression?).
The materialising of either scenarios seems rather unlikely at the moment. In fact, the dollar has strengthened considerably against the euro in recent months as investors globally have increased their allocations to ‘flight-to-quality’ investments, like US treasury bonds. But then, not even a year ago, very few commentators, if any, would have predicted that stalwarts such as Bear Stearns and Lehman Brothers (and Merrill Lynch) would have ceased to exist by today.
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