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Comment: Real economy plunge threatens new collapse

In the earlier phases of the crisis, financial weakness was the driving
force; real economies, which were initially resilient, succumbed only gradually.
But the post-Lehman plunge changed the situation radically. Financial easing has
failed to underpin the real economy. Instead, huge falls in activity threaten to
unleash new financial turmoil.

US job losses totalled 2.6 million in 2008, of which 1.9 million occurred in the
last four months of the year. The position will probably worsen early in 2009.

First official estimates for fourth quarter 2008 GDP, due in the next few
weeks, are expected to be awful. The US, the eurozone, and the UK will all
register quarterly declines of 1% to 2%. It is clear that this recession will be
worse than that of the early 1990s.

Only forceful measures may ensure that the downturn is not as bad as in the
early 1980s.

The US Fed has cut its key policy rate to a range of 0% to 0.25%, a record low.
With rates effectively at zero, quantitative measures are now the main focus of
US policy, particularly action to reduce mortgage rates. Other key economies
will continue to act more slowly than the US. In January, the European Central
Bank (ECB) cut its key rate from 2.5% to 2.0% and the UK has lowered rates from
2.0% to 1.5%. While further cuts are expected soon, towards 1%, both the ECB and
the UK will move slowly to quantitative easing, along the lines adopted by the

Recent financial improvements have not totally dissipated. Narrower spreads
between inter-bank and official rates signal easier liquidity and credit
conditions. But new fears over banking sector stability are emerging. Citigroup
reported its fifth consecutive quarterly loss, and is splitting its business.
Bank of America announced its first loss since 1991 and cut its dividend to one
cent per share, after receiving new emergency government funds in mid-January.

Ominous reports outside the US include a record quarterly loss at Deutsche
Bank, big job cuts at Barclays and a broker’s warning that HSBC might need to
raise up to $30bn and could halve its dividend. Bank shares are facing renewed
downward pressure.

Unless governments can stabilise the relentless decline in real economic
activity, we could face a new and more dangerous financial crisis.

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