An attractive female who reads my etchings in far away Hong Kong recently chirped: "I am so glad you say it’s decoupled, so we won’t go down with the US, nothing like 1997 is going to hit us again. Thank you!" Clearly, I was not communicating well. My formula: ‘There is likely to be a depression like scenario in the US, but Asia though battered, can avoid the worst if the right policy measures are taken’, was being read complacently. When I prevaricated, the feisty wench told me to explain myself! That is my job today.

Paulson’s flop

Last week-end the US Congress finally ratified the $700 billion bailout package cobbled together by Treasury Secretary Hank Paulson (Paulson’s Package or PP) and stock markets across the world responded on Monday morning by diving another 3 to 11%! The Asian composite index is down 50% since the beginning of the year; the Nikkei, Australian and New Zealand indices are at their lowest since 1995; Hong Kong is off 45% from its peak; the Dow Jones is down 30% this year. Commodities, oil, metals and assets are falling this week on fears of a deepening recession despite PP. Quite suddenly talk has switched from inflation fears to deflation panic. Tough luck though for Lanka, 25% inflation, driven by internal factors as well, is unlikely to improve much.

The intention of PP is to "re-liquefy" banks – that is, use public money to help Wall Street’s moguls; perish the thought of revving-up the real (productive) economy or providing relief to households. The government buys "toxic" assets from banks and banks employ the funds to start lending and restore "normal" financial activity. Since the "toxics" are taken off bank balance-sheets, inter-bank risk is reduced – that is they need not fear lending to each other. This is the theory; results, at best, will be mixed.

Nor do I see any scope for a Keynesian approach which emphasises expanding aggregate demand. In fact the opposite is what is needed; the last thing any sane person wants to do is raise consumption and aggregate demand in the US. What we have today is a huge crisis of over-consumption, as witnessed by reckless expansion of consumer credit, sub-prime mortgages, and chronic balance of payments deficits.

Hence, I don’t see any possibility of a Paulsonian or Keynesian way out. Come what may, US aggregate demand has to be slashed, financial houses have to bleed, lifestyles have to be pruned and the American consumer’s global footprint shrunk. Short of a revolution, this is the only way out for American capitalism.

Worst case in America

No two depressions look identical. Call it deep-recession, a term euphemists prefer, or the first depression of the 21st Century, or the Great Crash of 2008, but the outlines of what a worst case scenario may look like can be discerned.

But first the outlines of the Great Depression. GNP, in nominal dollars, declined by 45% between 1929 and 1933, unemployment rose to 25% that is millions of jobs were lost, banks bankrupted, farms and industries closed in thousands, people queued at soup kitchens, and Chaplin made some of the greatest films of all time. This time round the worst case, if it comes, will look different because society, government, and the structure of finance capital are different. Nevertheless, if it happens, the visible indicators of a depression will be unmistakable; it will be commotion, not just a blip on the business cycle. (There is no formal definition of a depression; the common usage is an economic meltdown of apocalyptic social proportions).

If recession turns to depression in 2008-9, what will it look like? The hardest hit in the US will be housing; foreclosures will escalate, thousands will have to find some other place to live and speculators who dabbled in the housing market for quick gain will go to the wall. The fall will hurt American consumers in the solar plexus; the housewife will have to tighten her obese midriff. With the collapse of credit and recall of debt consumer spending will be forced into steep decline. Overall the change in lifestyle will be dramatic; depression or no depression there is no way America can climb out of the hole it has dug itself into without considerable prolonged pain.

There will be worse to come for pensions and property valuations, even families not facing a mortgage crisis. Houses bought at the peak will see values slashed by up to 50% before the bottom is reached. If one can ride through, asset values can be partially recapitalised, but those who need to sell sooner will see a large part of their balance-sheets wiped out. The case of pensions is really painful. There are schemes such as 401K into which Americans contribute each month intending to withdraw a pension later in life. Fund managers invest the monies to secure gains for clients and fees for themselves. As markets decline, or bond issuing banks collapse, pension funds are wiped-out. Many people now approaching retirement find that up to 60% of their pension funds have gone up in smoke. They will have to work for several years since retirement is now not an option; but if the employer goes bust – no job, no pension! Pension funds can never recover fully as underlying bonds and assets have vaporised. Therefore the bankruptcy of finance capital is synonymous with a debacle in pensions, consumption and home ownership. These are the likely features of the next American depression.

The real economy, that is industry, farming and services, has not unravelled – as yet – and it may be possible to avoid the worst this time. This could be the biggest difference from the Great Depression. Though unemployment is approaching 6.5%, it may be possible to avoid hyper-unemployment and queues at soup kitchens.

Unhappy Europe

The roll call of failed or restructured financial institutions in America is too long to remember (Bears Stern, Fanny and Freddie, Lehman Brothers, AIG, Merrill Lynch, Morgan Stanley, Goldman Sachs, Washington Mutual, Wachovia, to recite only the giant names), but the contagion is rapidly spreading in Europe. Northern Rock, HBSO and Bradford & Bingley have gone under in the UK, European cross-border giant Fortis has received Euro 11 billion life-support from three EU governments, German Chancellor Angela Merkel just announced a $68 billion bailout package for the country’s second largest mortgage lender, Hypo Real Estate. Global banking giants UBS and HSBC have slashed thousands of jobs. Ireland is officially in recession.

Economists say that the American and European governments simply cannot afford to bailout all the banks that are likely to fail in the coming months. The financial chaos in Europe is unlikely to be as deep as the US, and public pain is unlikely to be as widespread or traumatic, but Europe will not be spared the effects of a US depression.

Asian decoupling and its limits

Let me begin by correcting the complacency that my previous pieces emphasising decoupling seem to have given rise to. If the US sinks into depression and Europe sees a recession, then conditions in Asia will be worse, much worse than during the 1997 Asian financial crisis. Life-savings are already being wiped out; for example people who bought into Lehman’s bonds which were aggressively flogged by many Asian banks. Pictures of these small savers and widows weeping on the steps of the Bank of China’s towering Hong Kong Headquarters are appearing in the press. For months to come things are going to get worse for the small man. There will be job losses

So what is this decoupling about? The 1997 financial crisis in the Far East was only a common cold compared to pneumonia – an economic depression. My point is that a crisis of depression like magnitude can be avoided if the economy is wrenched into a different direction. China is a prime example because it has potentially a huge domestic market. This would require raising wages to spur domestic demand, revaluing the Yuan and most important, swinging economic policy away from emphasis on the export sector towards producing for the domestic consumer. This last will encounter opposition from manufacturers and employees in the prosperous southern and eastern coastal belt. It will be a case of ‘Shanghai versus CCP’. The Party has the authority to win but seems not to have made a policy decision to switch as yet. Hence, let me repeat, Asia can garner the benefits of relative decoupling if and only if policy redirections are implemented.

Speaking more broadly Asia and Latin America are no longer American fiefdoms; in both the political and economic senses they are partially decoupled. Regional trade and mutual support is expanding. Latin America is pushing regional trade and banking options much more aggressively than Asia because the continent has swung to the left as a whole.