One year after the credit crunch first began to bite, the real-world pain is far worse than anyone predicted. True, a few doomy souls did warn that the credit markets could seize up indefinitely, that United States home prices could slump, and that some financial institutions would be in danger of going belly-up.
And sure enough 12 months on, corporate credit spreads remain wide enough to drive a truck through despite a series of emergency interest rate cuts, US house prices have plunged 18 per cent and the world's banks have been forced to write off some US$300 billion worth of subprime debt.
But what no one foresaw was just how much the credit crunch would hurt, combined with the doubling of oil prices between last August and early last month (see the first chart), which has helped ignite the highest inflation in years and slammed the brakes on global growth.
Now an increasing number of critics are arguing that at least some of the pain could have been avoided. They contend that far from helping the global economy ride out the credit crunch, the US Federal Reserve's 3.25 percentage point reduction in interest rates between last August and April this year inflated a bubble in commodity markets that drove up costs for both consumers and businesses and helped push economies to the brink of recession.
The trouble was that the funding squeeze that began last summer, started not so much because of a shortage of liquidity but because of banks' reluctance to lend amid a crisis of confidence about credit quality.
As a result, cutting interest rates did little to alleviate the financial crisis but it did make it cheaper for speculative investors to pump a flood of liquidity into the commodities markets through futures and over-the-counter derivatives (see the second chart), pushing forward energy prices sharply higher than the spot market price.
