There's this bit in Harry Potter and the Chamber of Secrets when Harry
and his friend Ron Weasely go into the dark forest and come upon a
giant spider. When Ron, who is mortally scared of spiders, looks like
panicking, Harry shuts him up with a stern "Don't Panic." A short
while later, when the duo are attacked by a huge hoard of giant
spiders, Ron turns to Harry and asks matter of factly, "Can we panic
now?" That's the question that many people are asking about the US
economy, the continuing credit crisis in that country and the
hastening collapse of the dollar. Back in August, when the subprime
crisis first broke, there was a worldwide panic but the US Federal
Reserve stopped it by lowering interest rates and generally acting
like it was determined to not let things get worse. However, now the
time has come for everyone around the world who could be affected to
turn back to the Federal Reserve chairman Ben Bernanke and ask the
question that Ron Weasely did.
Last Thursday, in a testimony before the US congress, Bernanke seemed
to suggest that the worst is yet to come and it could be a lot worse.
Bernanke admitted that the US credit crisis resulting from soaring
defaults of sub-prime mortgages had become worse since it first broke
in August. He predicted that US growth would fall sharply at least
over the next two quarters. He also said the crisis would worsen in
the coming months and appeared to hint that the crisis on Wall Street
could spiral into a full-blown recession. Counting everything that US
banks and financial institutions have owned up to so far, about US$ 55
billion have been lost in the credit mess. By some counts, this is
just the tip of the iceberg. Last week, the chief credit strategist of
the Royal Bank of Scotland Group (Europe's second largest bank) said
that total losses may touch US$ 250 billion. We've all become immune
to large numbers but that's a shocking sum of money by any standards.
Could it be that the world's banks and financial institutions can lose
so much money and the ill-effects don't ripple across the globe?
There's no shortage of optimists but I have my doubts.
For us in India, the US crisis throws up a set of questions that are interrelated but not quite the same. The larger question is how a US recession will impact the global economy as a whole and in what ways-if at all-could it impact the domestic Indian growth story. The more immediate question would be the impact on the inflows into the stock markets. Curiously, there is a street-level opinion among some investors that a US crisis would be good for the Indian markets because it would increase FII inflows. This is probably based on a highly selective memory of what happened the last time around. When the subprime crisis broke, the markets crashed. It was only when the Federal Reserve dropped interest rates did the inflows started in earnest that the Indian markets started zooming again. All things said and done, there's no way of predicting what exactly will happen if the worst-case scenario comes to pass in the US and spills over to the rest of the world. There is no shortage of experts who sound very confident while predicting what will happen but experts are not in the business of making correct predictions, they are in the business of sounding confident.