Tuesday, March 11, 2008

Roubini: losses may reach $2.7 trillion.

Nouriel Roubini was the first among well-known and respected economists to ring the alarm about the approaching crisis. He predicted the housing bust well in advance, he was the first to make a recession call (which appears to be right, as well) and he was the first to try and estimate the potential losses for the financial system - at $1 trillion.

In his latest column he notes that by now mainstream economists have caught up to his estimates, again proving that he was right, and right before everyone else.

But as the situation has evolved, Roubini updated his forecast. He now says that $1 trillion is a lower bound on the losses, and losses can easily reach $2.7 trillion in more pessimistic scenarios. Note that $2.7 trillion is roughly 20% of the GDP of the United States.

I think the size of these numbers makes it clear that any attempt to bail out the banking system by the government can only result in hyper-inflation. Note that $1 trillion is roughly $8000 per each American household and taxpayers simply do not have this money to spare.

There are only two ways forward for the American economy now.
a) Several big banks and large fraction of all companies go bankrupt, US experiences an equivalent of the Great Depression, after which rebuilding of the economy can start.
b) Government tries to save the financial system at any cost, hyperinflation results, torpedoing the dollar and the US economy. Economy experiences a downturn that is more severe than the Great Depression, with economic damage on the scale of the damage Soviet countries experienced after the fall of communism. Note that this scenario implies severe political tension with the foreign creditors, therefore I consider it less likely.

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