SCC Chartered Accountants

   

The World Economy

The global economy is facing a financial crisis of historic dimensions.  The bursting of the housing and credit bubble has seen investors retreat from markets around the world.

It started more than a year ago as declining home prices in the United States starting creating losses on investments underpinned by the value of these homes.

Similar problems were evident in other countries, this had been simmering for some time and it boiled over these last few months as many financial institutions faced increased difficulties obtaining credit and getting access to new capital.  The appetite for risk has virtually dissolved, driving large parts of the financial system to the brink of shutting down and threatening to grind the wheels of credit that keep the economy rolling to a halt.

In response, governments have stepped in aggressively, taking some unprecedented actions.

In addition to conventional easing of monetary policy around the world, many central banks have gone above and beyond in their attempts to assist with the current turmoil.  Governments have expanded deposit insurance, temporarily guaranteed bank debt and set up plans to buy up the illiquid investments that show as debt on the balance sheets of global investment houses.  The intention being that these market participants are then able to raise fresh private capital. Governments have also proposed taking a direct public capital position in the banks so that they can get back into the business of channelling credit to the economy.

Over time, these steps should help break the vicious cycle and get credit flowing again. But it will take time. Confidence has been shattered and will not likely re-emerge quickly. And credit is not apt to start flowing normally again until the root cause of the problem – the surplus of homes built during the boom on dubious credit and the associated bubble in home prices – are unwound.

There are some glimmers of hope, though. Policymakers have shown that they will do whatever it takes, and they have considerable ammunition left in the form of central bank liquidity and public funds to deploy.

Still, even in the best-case scenario, economic activity is likely to remain decidedly sub-par over the balance of this year and through much of 2009. Though the advanced economies most exposed to the housing and credit shocks may suffer the worst, even emerging economies will not escape unscathed, damaged by weaker export demand and by reduced capital inflows.

There’s a considerable risk, moreover, that the housing and credit shocks last longer and cut deeper, perhaps because sentiment deteriorates further and pushes house prices below fundamentals, exacerbating the credit crunch and economic weakness.