Most people will know from the news by now that the net effect of the 'credit crunch' is that a reduced pool of capital is being hoarded. That is driving up the cost for any type of borrowing, with many of the more speculative projects or borrowers simply being unable to attract money at all. Credit crunches almost invariably trigger recessions (assuming recessions are not in effect already) because they greatly degrade the ability of firms, individuals and governments alike to engage in economic activity.

In time, this will work through the system, as in the many recessions of the past. For some time, credit will be extended only to obviously profitable ventures and to deeply qualified borrowers, while questionable firms are crunched out of business. As efficiency improves, lenders will become more willing to extend credit to less-than-sure things. And a recovery will be under way.

Between now and then, governments will do what they can to lessen the impact of the credit crunch. Some will enact bailouts, or even nationalizations, of banks to ensure there is as little of a crunch as possible. Others, think the United States, are looking to simply take the questionable subprime assets out of the equation altogether so that the reasons for the credit crunch disappear. Ultimately, mitigating the effects of a credit crunch comes down to how much a government is able to tinker with finances; fighting off a credit crunch ultimately requires money, and not a small amount of it.

That means that there are three leading criteria to consider. First, there is the degree to which the government already dominates the economy. Governments tend to not be for-profit institutions, so issues of creditworthiness or low demand do not, as a rule, force them out of business. That means that any slowdown hits the private sector disproportionately, and the more resources the government absorbs, the fewer resources the private sector has to cope (in comparison, the government sector tends to just glide on). This factor is far more important in developed countries, where the state is strong and present throughout society, than in developing countries, where often broad swathes of territory, even economic sectors, are beyond the government’s reach.

Second, there is the level that the state’s budget is already in the red. A key means of kick-starting growth, and certainly a key means of extending credit, is to spend money. In theory, government spending can generate demand, create employment opportunities and help the private sector through a slowdown until such time that the private sector can take over. (And, of course, government spending can also be used to bail out banks.) But if the government’s budget is already in deficit, there is much less roo to maneuver. A credit crunch means that the cost of borrowing goes up for everyone, governments included.

Third, there is the issue of pre-existing national debts. This one is pretty straightforward. If a country has a history of running fast and loose with its budget, it will have accrued a hefty national debt. This both increases the costs of future financing and acts as a drag on existing expenditures because the government has to factor interest payments into its budget, reducing the amount of resources available for anything else, such as dealing with a credit crunch.

The map indicates which states have the capacity to deal with a broad credit crunch based on the three criteria above.

Of course, the ability of a state to fight off a credit crunch is only half of the equation. The remainder involves the severity with which the state is affected. Just as not all countries are created equal, not all countries will be affected by financial crises in the same way. For example, the United States can count on many investors piling into U.S. government debt even on the worst of days. So financial crises may feel painful, but in reality they require few large-scale adjustments (bear in mind that in the impossible scenario that every cent of the $700 billion bailout is somehow lost, that “only” amounts to 5 percent of the gross domestic product).

But for states dependent upon foreign investment that also lack the ability to define global economic trends, Greece comes to mind, the next few months look very bleak indeed. In contrast, some states that are rich in capital and not particularly dependent upon foreign capital, nearly all of the Arab oil exporters make this list, will not suffer from a crisis because they are net exporters of capital already, and in fact will see phenomenal opportunities unveiled as other states struggle.

Meanwhile in the USA, it will take the Treasury Department weeks to hire and train a sufficient cadre of bureaucrats to run the bailout. The Treasury will not be paying full value for these assets, so time must be allotted for identification, offers and negotiation over price. (The Treasury will eventually sell these assets, buying low and selling high, and so is likely to make a profit for the taxpayer in the long run. Part of the deals struck are likely to grant the Treasury shares in the banks. That will increase again the chances of the Treasury earning a profit, it will choose when and under what market circumstances it sells the shares, but adding this layer of complexity will also lengthen the negotiations.) And even a nation as powerful as the United States cannot raise $700 billion in funding overnight, that will require months, at the very least.

The danger now is that, between today and the point in the future when the Treasury removes the mortgage-backed assets from the credit equation, a broader credit crunch will worsen economic activity which in turn will eat into banks’ profits via more traditional means. Normally, in a recession, peoples’ incomes suffer and normal, even healthy, loans fall into default. There are two ends to every loan: for a borrower, a loan is a way to purchase something; for a lender, it is a means of making money. Failed loans therefore enervate banks’ health in precisely the same way that the subprime crisis has. If this recession-triggered degradation proceeds faster than the Treasury can clear away the mortgage-backed securities, then the credit crunch will persist, widespread bank failures may well become inevitable and a “normal” recession could become something more serious. The Treasury is now in a race against time.

But while the United States suffers under a time constraint, it has a national plan already in motion to attack the problem at its source. But while the process in progress could mark the beginning of the end of the crisis for the United States, the American credit crunch is only the beginning of the story for the world’s other two major economic pillars: Europe and Japan.

 

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