The first part of the economic crisis which began in early 2008 was the meltdown of the US mortgage market. This led to a breakdown in the asset backed securities market, which could no longer rely on the collateral of US mortgages. This in turn saw the breakdown of the balance sheets of the major trading banks, the forced takeover of Bear Sterns, followed by the bankruptcy of Lehman Brothers and the collapse of AIG. This forced governments to initiate rescue programmes for those banks most exposed to the secondary debt markets.
The last year has seen governments taking on colossal amounts of debt to try to recapitalise the banking system and avoid a 1930s style depression.
Unfortunately, this has not solved the problem, it has only moved it about.
Although the global economy is now no longer at risk of a synchronized collapse in GDP, those economies that are not competitive are now facing a very testing time. If Greece was not in the Eurozone, it would probably have already faced a currency crisis. But under the fixed currency system, it now faces an even more serious problem: defaulting on its debts, unless the other members of the Eurozone provide new credit lines.
This week we will find out whether or not the Eurozone can hold together in its current form.
The fact is that the global markets are not prepared to fund countries that are continuing to expand their debts without significant structural reform. Unless Greece, or Spain or Portugal address their structural inefficiency, they have already reached the end of the road. Neither is the UK in any better shape. Unless the country unveils serious plans to address its ballooning debts, then the UK is in the same boat as the Eurozone: this is a debt crisis based on economic, structural fundamentals at least as much as it is a simple currency crisis.
Ironically, some might say, the crisis that began with the collapse in US property is now leading to a debt crisis in Europe the like of which we have not seen since the bankruptcy of the Austrian Credit-Anstalt in 1931. While the United States continues to recover, the European economies are now set to face a severe escalation in the scale of the crisis.
Without emergency action to reassure the markets about the cohesion of the Eurozone, there could be a total meltdown in the Club Med debt and equity markets over the next few days, confidence is now so fragile. Even with decisive action from Berlin, the markets are so spooked that there will be continued fears over the stability of the Euro for some time to come. Without action from Germany, we could see a sovereign debt default that would make anything we have seen so far look like pretty small beer. The squeeze from such a default would put back any sustained recovery in Europe, including the UK, towards the middle of the decade.
This next month is set to see major market volatility. The markets have got very scared indeed.
The final rout seems set to begin.