Time running out for rescue

Article source: David Smith - business.timesonline.co.uk

Time running out for rescue

Following huge falls in Asia, Europe and London, it seemed that Wall Street which led the panic with a tremendous fall in the last trading hour on Thursday was crumbling to dust. By Friday, one would have assumed that the world wide financial system would reach the end of the road.

It is however believed that the crisis rocking the financial empire worldwide will not end in the near future. That is why the G7 finance ministers and central bankers issued a statement promising to take all measures to stabilise the situation. Some of these measures include a vow to stop key banks collapsing, an increment to money market liquidity, putting taxpayer’s money directly into the banks as capital, protecting the deposits of savers and forcing banks to indicate the scale of their losses.

The G7 recognises that this catastrophe has reached a level at which simple statements are not enough. That is why the US Treasury Secretary, Henry Paulson pledged to inject capital directly into US banks, a decision likely to be emulated by Germany.

It is easy to see that economists are poor at foretelling stock market crashes, and those crashes offer little indication of what will happen to the economy. These crashes have diverse causes and very dissimilar effects.

Black Monday (October 19, 1987) is ranking as the worst day on the market to date when Wall Street slumped by more than 20 percent. It resulted from international economic tensions, mostly in the foreign exchange markets. A number of economists made comparisons with 1929 and expected a repeat of the Great Depression when the Black Monday tensions terrified investors and led to an abrupt collapse in share prices.

As a matter of fact, the result of the 1987 crash was more like the great inflation. Central banks cut interest rates in response to the nose-diving stock market. The outcome was the boom of the late 1980s, which worsened in the early 1900s when interest rates had to be hiked to fight the inflammatory boom. In that case, the recent stock market crash may be no more an indicator of depression than 1987 was, only that the circumstances were different.

According to Nick Bloom the Stanford University economist, the recent volatility of the stock market is similar to the 1929 crash and subsequent episodes in that period when the Depression dominated. Bloom is among a number of economists who think it is not the level of the stock market that counts but the extent to which it fluctuates.

He thinks that the downturn is on its way following the shocking fluctuations that have been witnessed in the recent days. Mr Bloom says that Britain could experience a 3 percent contraction in the economy in the coming year which may not sound much though if it occurs it will count as the worst year since the 1930s.

Why it is different this time round is because the stock market crash last week was a warning sign of the wider credit crunch of the past 14 months. The evident effect of the crunch on the British economy has been a mortgage deprivation and a sharp fall in house prices.

Stock markets fear that nothing governments or central banks do will prevent the banking crisis from getting worse and the credit crunch from sending the world into a slump. That coupled with a mad scramble by investors under pressure to liquidate all their assets including commodity investments led to the crash.