BORDEAUX, France:
I'd have hoped that the salubrious setting of a café in the south of France might have provided me with some respite from the storm engulfing global markets. But, everywhere I turn, the newspapers and televisions all shout the same news. The world is skirting a crisis of proportions not seen since, perhaps, the great crash of 1929.
Practically, nowhere is immune. A storm that started brewing in the United States has spread across the planet. It is affecting all asset classes, from real estate to stocks to bonds.
Credit is drying up as banks, their balance sheets eroding, stop lending. With lending curtailed, there is less money to spend and invest. So, the spiral continues downwards.
Globalisation made it possible for the world economy to rise in one tide. Liberalised capital markets enabled firms and investors to diversify their assets globally, creating a vast and highly inter-connected economy.
What few anticipated was that sudden falls in the US housing market would eventually drag asset values down across the planet. Everyone was exposed to what happened in the world's largest economy.
Mortgages bundled into large pools
The American financial sector had found a way to bundle mortgages into large pools, then selling bonds against their value. By spreading risk, this kept interest rates low in the US. This enabled millions of Americans to buy homes. This, in turn, kept house prices rising, which further swelled demand for these complex securities.
So, when American house prices started falling, bond values fell sharply. Banks and investors around the world saw their balance sheets erode. To make up for their losses, they sold assets. This rush to market drove prices further down.
Last week, this rush for the exits turned into an outright panic. Vicious cycles had taken hold. As prices fell and firms unloaded assets, nobody would buy, fearing the prices on those assets would fall yet further.
Authorities have struggled to stay cool. In the US, the government bailed out several entities, then drew a line. When Lehman Brothers began collapsing, the government left it to fail. But then this week, the government reversed itself when the major insurer, AIG, also began to run into problems.
The world's markets are more exposed to AIG than they were to Lehman. Washington judged, perhaps correctly, that Lehman's collapse would be contained, whereas that of AIG would have induced another 1929-style global crash. The Federal Reserve and Treasury Department felt they had no choice but to step in.
New confusion, uncertainty
Markets got to breathe for another day. But, in the midst of it all, a new confusion and uncertainty entered the market. Traders are now left guessing which banks the government will save, and which it won't.
In the meantime, the American Government is profoundly redefining its role in the economy. The free market has been exposed as something of a smokescreen. Markets boomed in the US because government guarantees of real-estate markets drove them high.
Now, with markets falling, Washington has got drawn into the game of picking winners and losers, of micromanaging the economy as it decides who it will assist, and who it won't.
When the dust settles, all of this will have to be formalised. But it is clear that the next US government will find itself more deeply involved in the economy's management than it had ever expected.
The warm sunlight of Bordeaux in the autumn seems such a contrast to the gloomy mood in the world's financial capitals. But, there is almost nowhere on the planet where one can go to escape the storm. And, if today seems calm on global markets, it may be only because we're in the storm's eye.
John Rapley is president of Caribbean Research Institute(CaPRI) an independent think tank affliated to UWI, Mona.
