Reply #23: The US economy is about to suffer a painful dose of reality. About time, too

[Ghost Dog]

The Bear Stearns collapse heralds the end of the culture of easy lending - and it won't be just America feeling the heat

* Bill Emmott
* The Guardian,
* Tuesday March 18 2008

The collapse and fire sale of Bear Stearns, the fifth-largest US investment bank, may seem bad news, but it is actually good. The excesses of Wall Street firms in recent years were so egregious that a shake-out simply had to happen. Since the credit crunch became manifest last August, we have in effect been waiting to see some blood spattering on to those broad investment-banking braces. It would have been a travesty - and rather surreal - if we had had to wait much longer.

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What that means is that America - the world's biggest economy, accounting for more than a quarter of world output - should be bracing itself for a pretty nasty recession. Worries about inflation, through high food, oil and commodity prices, are keeping long-term interest rates high in any case. Now lending practices are going to add to the squeeze. Unemployment has begun to rise, though it remains low at 4.8% of the workforce, which is probably why economic troubles are still not yet the dominant issue in the presidential election. By the summer, when the election proper begins and the candidates have (at last) been chosen, the economic pain could well be severe.

For that reason, the main risk for the rest of the world from America's financial crisis is that, as well as blaming Wall Street, American politicians will start to blame foreigners. There has already been some anti-trade rhetoric in the Democratic primaries; given that John McCain, the Republican candidate, is a committed free trader it must be likely that whoever is his Democratic opponent will bang the trade drum loudly, attacking principally China (an easier target following the crackdown in Tibet) but also other big trading partners, including Europe. If a Democrat wins in November, and enters office with the Democrats also controlling Congress, the likelihood of protectionist legislation next spring will be high.

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The most intriguing question, though, is what will be the effect in the fast-growing economies of China and India - economies that optimists are relying on to keep the world economy spinning. Their high savings rates mean that they will not face the same credit crunch as America. But China in particular is facing a worryingly high inflation rate - 8.7% in the year to February - for which its only real solution can be a risky and potentially painful revaluation of its currency against the dollar.

When that happens, some will wail about the dollar's final collapse. But actually, like the fall of Bear Stearns, this will be a welcome acceptance of reality. Faced by huge capital imbalances, reckless lending and vast trade deficits, the world has long needed a shake-out on Wall Street as well as a rebalancing between the dollar and the Asian currencies. The first of those has now begun. The second still lies ahead.

/article & comments... http://www.guardian.co.uk/commentisfree/2008/mar/18/useconomy.marketturmoil