The problem with the comment about evening out in the longrun is that a severe and prolonged recession would in fact be the world economy evening itself out from the long period of excess.
That the federal reserve has chose to reduce rate in an out of regular meeting devision by 3/4% and is expected to quite possibly reduce by a further 1/2% at its next regular meeting next week with potentially two more such 1/2% reductions anticipated by most analysts over the coming several months is testimony that the fed is so worried that they have decided to print even more money, the very process that contributed to encouraging so many of the practices that have led to the subprime mortgage situation, with various knock on effects to CDO's and various other less obvious problems within the bond markets, rating of re-insurers, those who back the various bond issuances and so forth.
The worst of the news is still to come, and the dollar is likely to come under continued pressure as it becomes a much less attractive place to hold funds. There is even the possiblility that the Dollar could become a funding curriency for the carry trade. Interest rate differentials are likely to worsen considerably for the dollar.
A recession in the US would have a knock on effect to the rest of the world, but the slow downs in other regions might be more muted given that the US is not their only customer.
So much money resided in assets in the US and other high yielding currency areas as a consequence of being able to borrow cheaply in Japan or Switzerland, and then invet in much higher yields in other countries like US, UK, Iceland, Australia, New Zealand and so forth. But that is a very high risk approach, and considering the levels of gearing these funds have employed, when things start going astray, they are going to run for the hills and start unwinding these carry trades, and preferably without losing too much in the process. Commodity producing nations have fared well due to their incomes being bolstered by increased prices of those commodities. The oil situation has not been so severe in other many areas due to the falling dollar muting the effect of high Dollar prices for oil. This has meant that second round inflationary effects have been muted in places like the EU for example.
Deficits don't matter? the mantra served up many time in the last 12 months? So why did the fed need to drip feed so many 1/4 point increases into the system rather than credibly tackling the inflation issues (the numbers for those are distorted by the way and true inflation is higher than stated even now!). The answer is that they needed to attract in enough inward investment to cover the twin deficits i.e. budget and current account. As long as the money keeps flowing in, then all is hunky dory, but more recently it hasn't been...
Combine the housing ATM closed down so consumer spending is under pressure, Combine the foreclosure situation leaving excess supply in the housing market, Combine the knock on effect in the Bond markets, various derivative, CDO's and a whole alphabet soup of related product, A banking secotr that has seized up. (Note Northern Rock of the UK as a high profile caualty of the interbank lending system in temprorary spasm)
THis is not something that is going to be worked through easily or quickly. I read today one report that suggested that the main reason everyone is so scared of a full blown recession is that with all the woes that now exist in the system, it would spill over into a depression and that is the reason they will attempt to avert a recession at all costs.
So what does borrowing another $150bn dollars do? (note Bush's fiscal stimulus package) it means the deficitis just got bigger. Deficits don't matter huh? You try living on Outgoings bigger than incomes for a long period and it will come to roost. But I suspect that is what many in Britain and the US have done for many years...
I'm of the opinion there will be some serious casualties along the way before all this is over, and there will be many times when it all looks like it hase been contained and we're back to 'business as normal'. False dawns if you like are a feature of this stage of the cycle.
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