NEW YORK – The rich world’s financial system is headed towards meltdown. Stock markets have been falling most days, money markets and credit markets have shut down as their interest-rate spreads skyrocket, and it is still too early to tell whether the raft of measures adopted by the United States and Europe will stem the bleeding on a sustained basis.
A generalized run on the banking system has been a source of fear for the first time in seven decades, while the shadow banking system – broker-dealers, non-bank mortgage lenders, structured investment vehicles and conduits, hedge funds, money market funds, and private equity firms – are at risk of a run on their short-term liabilities.
On the real economic side, all the advanced economies – representing 55% of global GDP – entered a recession even before the massive financial shocks that started in late summer. So we now have recession, a severe financial crisis, and a severe banking crisis in the advanced economies.
Emerging markets were initially tied to this distress only when foreign investors began pulling out their money. Then panic spread to credit markets, money markets, and currency markets, highlighting the vulnerabilities of many developing countries’ financial systems and corporate sectors, which had experienced credit booms and had borrowed short and in foreign currencies. Countries with large current-account deficits and/or large fiscal deficits and with large short-term foreign currency liabilities have been the most fragile. But even the better-performing ones – like Brazil, Russia, India, and China – are now at risk of a hard landing. Many emerging markets are now at risk of a severe financial crisis.