How to stop the Great Crash of ’08
According to an item published today by Asia Times, the chain-reaction of high oil prices will cause a catastrophic breakdown that will include the decline of world economic growth. Spengler believes several scenarios will play out as the U.S. economy crumbles. First, he predicts that markets will expect economic growth to decline as oil prices rise. American financial institutions, whose market capitalization has fallen by almost half in the past year, he says, sustain higher default rates from households and firms, leading to some failures.
Credit availability will shrink as banks come under pressure, raising the default rate. Meanwhile, the price of household assets (real estate and stocks) will continue to decline, destroying their creditworthiness. According to Spengler, markets will expect the Fed to continue to ease monetary policy and offer unlimited liquidity to all comers, as it did with the mid-March bailout of Bear Stearns. But instead, he believes, investors will turn away from falling equity markets and buy inflation hedges, pushing oil and commodity prices up further.
The position of American households is so fragile that major institutions might fail. Washington Mutual, America’s largest thrift institution, is now trading at a tenth of its 2007 stock price. It is not clear whether any other institution is willing, or indeed able, to take it over.
Federal Reserve chairman Ben Bernanke knows that something has gone dreadfully wrong. He spent the month of June threatening to do something about the sagging dollar and soaring commodity prices, until the market concluded last week that he was bluffing. Bernanke simply doesn’t have the nerve to raise interest rates into a weakening economy.
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