Correction, recession or depression

Following two days of major turmoil in worldwide stock markets the only question now seems to be if the US economy is going through a major correction or if it will slip into a full blown recession or, whisper it quietly, a depression.

The current crisis has been triggered by problems in the sub prime market in the US and the subsequent write off's by major US banks of significant sums of money. In turn this has caused a credit crunch around the world due to the fact that US banks had been repackaging their debts and selling them of to other banks worldwide. Now it seems that banks worldwide are uncertain just who is carrying what debt risk and as a result no one is prepared to lend much to anyone else.

The problem however is much more fundamental than that because debt levels in the US have for a long time been at historically high and unsustainable levels. The US and US citizens have in effect been living on credit to pay for expanding living standards. This is confirmed by other figures which show that savings levels in the US are also at extremely low and unsustainable levels.

And therein lies the rub. The Fed today cut interest rates in the hope that this will provide stimulus to the US economy and prevent recession. However falling interest rates seem hardly likely to encourage US consumers to increase their savings levels and in the long term the US economy seems likely to correct itself only when it stops expanding through current credit levels. The problem is that it seems that the only way that recession will be avoided is by continuing to shore up the US consumer through low interest rates - but this will compound the very problems that caused the present crisis. And, unless the US gets itself out of this crisis other economies throughout the world are likely to suffer - not least the UK.

So the hope has to be that the current crisis simply heralds a long overdue market correction the fear is that it marks the early signs of a recession. Worst of all - the anxiety that the problem is so severe that there is risk of full blown depression. Cool heads will be needed in financial markets around the world in the coming weeks.