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Bubble bursting?

• Evan Davis | Notes on Real Life |
• 22 Jan 08, 03:30 PM

We escaped the last big bursting of a bubble - the - with a relatively light US recession. On that occasion, the world economy found its way back on track fairly quickly.

And that time, it was activist monetary policies - ie the slashing of interest rates that appeared to save the day. No wonder the has chosen to repeat the formula today.

But this episode seems more serious than the dotcom one however, and it probably won't be resolved quite as easily.

Why? Because in 2000, we only managed to soften the landing from the crashing of the stock market bubble by creating a housing bubble. That supported American consumer spending, (enabling Asia to carry on exporting).

Alas this time there are no more obvious bubbles to create.

So today's cut in interest rates will struggle to support consumer spending at the levels necessary to act as a motor to the global economy.

Indeed, fiscal policy will struggle to do that either.

If you want to know the challenge facing the world, it is summarised by the American savings ratio - the proportion of disposable income saved by American households.

Back in 2000 and 2001, it was about 2%. It has now drifted down to zero (if not actually negative this year). That figure at some stage will probably have to drift up to something more normal, around 5%. As American consumers save more, the US imports and spends less.

The rest of the world feels the effect.

Now the fact that the American consumer motor is unable to power the world economy anymore, does not mean the world economy has to endure a long breakdown. We just have to replace the engine.

That means the world really needs spending in Asia to rise, to offset the slowdown in the US.

At the moment though, it's looking hard to see how Asia can pick up the baton as quickly as the world needs.

Which brings us to today.

The potential for a serious slowdown in global spending is spooking the markets.

But the markets themselves now threaten to exacerbate the very downturn of which they are so scared.

The Fed is spooked by the markets, so no wonder the Fed felt it needed to take drastic action. Even if it isn't going to work as well as it did in 2000, it might at least prevent markets and the economy driving themselves ever deeper in to a quagmire.

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