How many more shoes to drop in the global economy?

You have to wonder what is going on when Citi announces a $12 billion write-off in Q1 and the market responds favorably. How long is it since the previous write-down and the optimistic noises about the future then? Meanwhile, global credit markets remain grid-locked and even in the Middle East Islamic sukuks, or bond issues, fell by half in Q1 against Q1 2007.

The assumption is that what has gone down will come back up, and fairly quickly, or at least in time for the US presidential election this autumn.

Recovery?

It would be surprising indeed if the Washington machine did not manage to engineer a short-term upward blip in economic fortunes for the election. However, it is also most likely its last hurrah before being booted out and replaced by a new team of naïve and optimistic election winners.

Will the patch-and-mend of the old team be enough to carry the new team forward? Or will Wall Street take fright at the thought of high-tax and big government?

Most likely yes but fundamentals are the real problem. The economic problems caused by falling US house prices are not going to vanish due to the appointment of a new president, whoever she or he might be. US house prices are not expected to bottom out until the middle of 2009, and that is going to mean further pressure on the financial system as it comes to terms with negative equity and housing repossessions.

So even if the US economy is dragged out of recession later this year, it could well plunge back next year, perhaps accompanied by a far more significant exit from stock markets and a bigger run on the US dollar.

But we have also only just begun to feel the spill-over of the sub-prime lending crisis into the real economy with thousands of redundancies at the big banks. Is this going to end anytime soon? And what will be the impact of reduced activity on the ongoing business of the financial sector? This is hardly good news is it?

2009 disaster

A further contraction in the US economy in 2009 would almost certainly result in real damage to other global economies and drag the rest of the world into a global recession. That would mean commodity price deflation, and a major slowdown in trade flows, as well as considerable disruption again in capital markets.

Is this not a more likely scenario than the optimistic hope of a quick bounce? I love the journalists who argue that everything would all be right if only we stopped being so negative about the future. It gives the media credit for far more power than it actually holds; a bit like politicians who pontificate on matters they are powerless to control like the economy.