Massive injections of liquidity, the latest being $540 billion offered to US money market funds by the Federal authorities, plus the $2.5 trillion in bank bail out programmes, are gradually bringing down interbank lending (libor) rates. As the graph below shows 3 month dollar libor has dropped from a peak of 4.82 per cent on 10 October to 3.83 per cent on 21 October. The immediate threat of a cessation of interbank lending, which would in fact mean the disintegration of the financial system, is slowly receding at least at present.
Although this is very early days in the economic downturn that is to come this trend so far confirms the analysis in SEB that the likely outcome of this financial crisis is a major recession, accompanied by a significant realignment of the weights of different economies internationally, rather than a real long term economic depression of the 1930s type.
If financial disintegration can be avoided then the centre of attention will shift to who will pay for the huge bailout packages that have been used to stabilise the financial system. The present trajectory is that the cost of the financial crisis will be born by the majority of the population. Increased unemployment, stagnant or declining wages, and possible losses in the direct bank bail out programmes themselves, will transfer income away from the population to recreate profitability in the banks. Financial stabilisation will be gained at the expense of economic and social hardship for the population and political discontent. Unnecessary luxury consumption and military expenditure will remain at high levels while the population suffers. The possibility of socialists in the economically advanced countries is to insist that, on the contrary, the living standards of the mass of the population is maintained and instead luxury and military consumption is cut - which will also require the state intervening more into the investment process to attempt to limit recession.
The main international shifts are evident. The US will be weakened, China and India will be strengthened. The leftward shift in Latin America will be placed in an economic situation in which compromise is harder - shifts to the right and to the left may be expected. Significant financial destabilisation will occur in some economically exposed countries - merely within Europe to the financial crisis in Iceland has now been added significant problems in Hungary and Ukraine. Overshadowing all this will be the issue of shifts in alignment between the major economic centres in the US, Europe and Asia. And the depth of the recession itself.
The economic process unleashed by the financial crisis is only at its beginning - not at its end.