Is credit crisis due to a consumption gap?

Is credit crisis due to a consumption gap?

Markets tried to calm down last week, but they couldn’t manage. It may be that the underlying problems are too great. As recently as Wednesday, the early August market panic looked to be winding down. Equities were again flirting with record highs. More than two-thirds of the risk aversion had been reversed, according to a Société Générale (SocGen) index. The commercial paper market was still almost frozen, but a rescue was on the way, in the form of a US government-supported $75 billion (Rs2.99 trillion) super-SIV (structured investment vehicle), a liquidity conduit set up by three lenders to ease credit market crisis.

But then the news turned bad. The super-SIV looked increasingly like a super-sieve: full of holes. Oil reached $90 a barrel—too high for comfort. Caterpillar Inc. and Wachovia Corp. both predicted that bad US business conditions would continue. The G7 finance ministers offered nothing stronger than hand-wringing on currencies and markets.

So by Monday, both world stock markets and the dollar were dropping. The recently banished talk of a US recession had returned. There were a few signs of risk-taking—most notably plans for an expensive, equity-financed bid for UK brewer Scottish & Newcastle Plc.—but overall, fear was again in the ascendant.

How long will it take for the markets to?regain?their?poise? That depends on whether the challenges are primarily financial or economic.

If finance is the issue, a resolution should come soon. After all, the asset-backed commercial paper market, the source of the sudden market illiquidity, is only a $100 billion problem —a little local difficulty in the $50 trillion global economy. Once the banks set some lower prices and take their losses, the world’s steady growth should once again keep markets reasonably strong.

But maybe the subprime crisis is a sign of something more serious. After all, the US housing boom was part of a great global imbalance—US overconsumption matched with the willingness of US trade creditors to buy low-yielding dollar-denominated debt. The crack in the credit markets could have been caused by a tectonic shift in that relationship. If so, more financial earthquakes are almost inevitable.