Shot in the arm for an addict patient
What happened this week on the world's markets almost makes it difficult to believe that there is intelligent life on Earth, or at least among the financial and political tribes that claim to be in charge of the global financial architecture.
One by one, from Sydney to Tokyo, on to Hong Kong and Shanghai, then to Mumbai, Frankfurt and London - and back to Sydney, Tokyo and Hong Kong, stock markets nosedived as if competing like lemmings to see which could fall furthest and fastest off the edge of rationality.
In these days of round-the-clock trading Wall Street was out of action, closed for a public holiday on Monday, but the US Federal Reserve came riding to the rescue with emergency interest rate cuts of 75 basis points. The markets immediately clamoured for more, and leading commentators demanded a further 50-point cut at the Fed's next meeting, on Tuesday.
Finally, Washington's politicians and economists are waking up to see a recession - which they have tried to keep at bay by denying it - staring back at them. US President George W. Bush made a knee-jerk proposal of tax cuts, a US$145 billion 'shot in the arm', to try to avert a crisis. Even the chorus of commentators could see this was, at best, too little, too late, and an irrelevance to the real problems of America - and thus the world.
More thoughtful economists questioned whether Americans really need a US$145 billion incentive to buy more goods that they don't need with money they don't have. The best advice to heavily indebted Americans was to use the rebate to pay off some of their debts, which would do nothing to kick-start the economy.
There are many deep and disturbing aspects to this week's events. The US Fed was suckered in to act as a cheerleader for 'Mr Market'. Markets, it should be remembered, are just that: meeting places for buyers and sellers. By trying to prop up Wall Street, the Fed also risked the credibility, not just the value, of the US dollar. Henry Paulson, the treasury secretary, risked his own credibility by praising the Fed for being 'nimble'.
Mr Paulson has forgotten the wise advice of John Maynard Keynes, that trying to control an economy by monetary policy is like pushing on a string. Symptomatic of the unreality is the belief that central bankers are either miracle workers or magicians. Even if, by waving the magic wand of interest rate cuts, the Fed has averted panic on the world stock markets, we should worry why the world's richest economy needs a magician to calm its nerves.
To go from magic to miracles is a bigger step. What will save an economy from recession is consumer spending, but US consumers have been spending too much and saving too little for years. Interest rate cuts may, in due course, stimulate economic activity by lowering the costs of borrowing. But in the global economy today, the normal economic levers are not working normally.
One snag is that members of the global financial tribe have ingeniously created new and dangerous financial structures. The much-heralded crisis in subprime housing is one indicator.
So far banks have written off about US$100 billion because of the soured subprime market, but a lack of knowledge about total exposure has led to the freezing of credit markets, and it is not clear that the Fed's cuts will be sufficient to bring a thaw.
Claims that the subprime crisis is largely limited to North America - because that was where the stupid loans were made - were belied when the Swiss bank UBS admitted to being snared. Then, this week, the South China Morning Post revealed that the Bank of China is also about to take a big hit due to subprime exposure.
Subprime losses may soar to US$500 billion. No one really knows. But this is not a mere house of cards, more a giant metropolis. The financial engineering skills of the multimillionaire bankers have gone way beyond housing to create what Bill Gross, head of Pimco - the world's biggest bond fund - calls a 'shadow banking system', with chain letter, pyramid schemes of leverage that in many cases has no reserve cushion.
The Bank for International Settlements said credit default swaps totalling US$43 trillion, half the entire asset base of the global banking system, were outstanding at the end of 2007. Mr Gross estimates total derivatives at more than US$500 trillion.
All this is occurring when the US economy is in a deep structural mess, with 1 million households in danger of losing their homes because of mortgage problems. Record debts, savings rates at record lows and mounting current account deficits have placed US global economic leadership in question.
With the record growth of China, joined recently by India, can the big Asian economies take over as the engine of world growth? The jury is out, but the twitchy markets don't believe so.
Is anyone in charge? Surely there should be better global economic advice and surveillance. British Prime Minister Gordon Brown argued this week that the International Monetary Fund should set up an early warning system to avert crises like the current global credit crunch. But the IMF needs top-down reform before it can play such an ambitious role.
The new economic powers, China and India do not have a place at the global top tables. The US, the big but ailing power, has been able to avoid the nasty economic medicine lesser countries were forced to take, because the US dollar serves as the principal global currency. Economists like Nobel laureate Robert Mundell also say that the US Treasury has undue power over the IMF.
Where was the IMF this week? Its spokesman said it did not foresee recession in the US. Dominique Strauss-Kahn, its managing director, was in his native France meeting President Nicolas Sarkozy and saying, in French, that the global economic situation was 'serious'.
If the IMF is to get serious and play a leading role, the US and the Europeans have to stop being so arrogant. China and India must take their new responsibilities more seriously. Nothing this week suggests that this is about to happen.
Kevin Rafferty was a managing editor at the World Bank