The 5 big hurdles on the road to lasting economic recovery

A home for sale in Haight Ashbury, San Francisco. The US housing crisis is a destabilising influence on the global economy. Photograph: Robert Galbraith/Reuters

The first indications of the damage caused by the financial turbulence of the past few weeks will be seen on Wednesday, with the manufacturing figures from around the globe. These purchasing managers' indices are closely watched as indicators of industrial orders, and output and any readings markedly below 50 will sound recessionary warning bells.

At the Bank of England, as at the US Federal Reserve and the European Central Bank, there is a weary acceptance that the recovery from the recession of 2008-09 has received yet another setback. Even so, the view is that after a tough few months, the pace of growth will pick up gradually in 2012.

There are alternative views. Nouriel Roubini, the Dr Doom of economics forecasting, told the Wall Street Journal earlier this month that Marx was right when he said capitalism could destroy itself by continually shifting income and wealth from labour to capital.

The greens say it proves that EF Schumacher had it right when he wrote Small Is Beautiful almost four decades ago, and that the world is now being pushed beyond its carrying capacity by an orgy of excess.

The Austrian school of economics says that the sluggish global economyis the result of central bank governors and finance ministers ignoring the teachings of economists Friedrich Hayek and Joseph Schumpeter. Rather than prop up failed banks, policy makers should have let them go bust. The consequence of not doing so is that the west now has a motley collection of zombie banks that are not fit for purpose.

Finally, there are the followers of John Maynard Keynes, who say the problem is that there was a dangerous reversion to economic orthodoxy once the global economy started to recover in the spring of 2009. The Keynesians see the solution as more quantitative easing, less fiscal austerity and public infrastructure projects to kickstart demand.

History would suggest that Sir Mervyn King, Ben Bernanke and Jean-Claude Trichet are right to be cautiously optimistic. Over the past 250 years, industrial capitalism has displayed a remarkable ability to regenerate itself. The mainstream view is that it will do so again, even though the severity of the shock to the financial system means the process will be slower than usual.

But confidence has been dented in recent months as it has become clear that the road to lasting recovery is obstructed by five big hurdles.

1. Europe's debt crisis

Easily the biggest short-term challenge currently is the need to sort out Europe's sovereign debt crisis. King has identified Europe as the biggest threat to Britain's economic prospects and the Bank can already detect evidence that the bickering over Greece's bailout, the perceived vulnerability of Italy and Spain, and fears that already weakened banks could be wiped out by losses on eurozone bonds is having an impact on the willingness of banks to lend. There are already echoes of 2007-08, when interbank lending dried up and the cost of insuring banks against default rose sharply.

The duration and depth of the crisis in Europe mean financial markets are no longer going to be mollified by stop-gap solutions. They want to see the size of Europe's bailout fund massively increased; they want the Germans to agree to common European bonds in order to provide collective security for the weaker members of monetary union; and they want Europe to move quickly towards full economic union. It is not just dealers on Wall Street and the City who see closer integration as the alternative to collapse: George Osborne believes that too.

2. The US housing market

The second obstacle is the American housing market, which has seen a deeper slump over the past five years than was suffered during the Great Depression. Prices are still falling and with a quarter of households in negative equity and mortgage arrears on the rise, consumers feel progressively less well off and that makes them reluctant to spend. The Federal Reserve's quantitative easing programme is designed to help homeowners by driving up the cost of US Treasury bonds, which reduces the interest rates paid on the money Washington borrows. Lower bond yields feed through into cheaper fixed-rate mortgages.

But the desire of consumers to pay down their debts means QE has so far proved ineffective as a cure for the woes of the real estate market. Other more radical solutions are now being canvassed such as federal loans for those homeowners whose mortgages are under water to cover the negative equity. While politically attractive to the Obama regime, this would have trouble getting through Congress even if the programme involved Washington getting a slice of the proceeds when house prices start to rise once more.

3 and 4. Global imbalances

Giants three and four are the two aspects of globalisation that were at the root of the crisis in the first place – the imbalances between creditor and debtor nations, and the financial system.

Little progress has been found through official channels – the International Monetary Fund and the G20 – to deal with the former, running the risk that the global economy will find a new equilibrium through debtor countries deflating rather than through creditor countries reflating. Economists at Lombard Street believe the key imbalance – between China and the US – may eventually be resolved by rising prices in China, which is pushing up the real (inflation-adjusted) exchange rate. Other analysts believe China's continued trade surplus with the US will fan protectionist pressures.

The good news on the global financial system is that banks have spent the past three years building up their capital. Prudential oversight has also been strengthened in countries like Britain through the Bank of England's financial policy committee. The bad news is that flows of credit to the new businesses that will generate the next economic upswing are still lacking. And the regulatory reforms necessary to prevent a future speculative frenzy are incomplete.

5. Oil prices

Finally, there are oil prices. Despite the slowdown of recent months, a barrel of Brent crude is still changing hands for more than $110, five times its price a decade ago. The expectation is that the cost of energy will come down over the coming months, boosting the spending power of consumers. But a return to the 1990s – when oil at $10 a barrel was one reason for strong global growth – appears to be over for good.

Faced with these five challenges – sovereign debt in Europe, a bombed-out US real estate market, an under-valued Chinese currency, a dysfunctional banking system and high oil prices – it is little wonder policy makers are mulling over what more they can do to keep the recovery going. The global economy has slowed to a stall; it would not take much for it to crash land.

Vince Cable: disingenuous bankers are trying to derail reforms

Vince Cable: 'Banks are in a way trying to create a panic around something which they know has got to happen.' Photograph: Steve Parsons/PA

Vince Cable has accused bankers of using the economic turmoil in Europe to try to derail reform of the financial sector.

The business secretary said that "louder and louder voices" were being raised among some of the big British banks giving warning that regulatory change in Britain would put the recovery at risk.

The Independent Commission on Banking is expected to recommend separating banks' retail operations from their investment arms when it reports on 12 September.

There have been attacks on the proposals from the director general of the CBI, John Cridland, and British Bankers' Association's chief executive, Angela Knight.

Cridland has said taking action to reform the banks now would be "barking mad", while Knight warned imposing the measures on lenders risked denting confidence and cutting the supply of credit.

However, Cable said in an interview with the Times that the fact that there were still fears about the collapse of big financial institutions was "all the more reason for grappling with this issue".

"It is disingenuous in the extreme to use the current context to argue against reform. Banks are in a way trying to create a panic around something which they know has got to happen," he said.

Cable has long favoured the separation of retail and investment banking. He added: "The governor of the Bank of England and many other people have been arguing that we have to deal with the 'too big to fail' problem. We can't have big global banks with balance sheets bigger than British GDP underwritten by the taxpayer; this can't go on and it has got to be dealt with."

The business secretary also said that he did not expect another 2008-style meltdown in the banking sector, but acknowledged that difficulties could still lie ahead for the British economy.

"To my mind, the greater worry is not a massive financial crisis again but it is a general slowing down of western economies, with all the problems that presents for employment and long-term dynamism," said Cable.

In comments reported in the Financial Times, Cridland had said: "Taking action at this moment – this moment of growth peril, which weakens the ability of banks in Britain to provide the finance that businesses need to grow – is just to me barking mad."

He added that a perceived political need for action after banks were bailed out in 2008 was driving the scale and pace of reform, and warned that "there's an own goal here about to be scored if we get this wrong".

European bank stocks plunge as investors shun risk

The Swiss bank's analysis of reserves and likley profits concludes investing in Greek banks could be costly. Photograph EPA

Credit Suisse, the Swiss bank, has warned investors against buying shares in Greek banks. It was a conclusion reached after lengthy analysis of bank reserves, likely profits and relationship to the ailing Greek economy. But it hardly seemed necessary – there can be few investors queueing up to add Greek bank stock to their portfolio.

That is the case for most European banks. Share prices have dived since last year and despite a few mini rallies, remain depressed. In March Credit Agricole shares topped €12; last week they were just above €6. BNP Paribas shares have slumped from €58 to €32.

The comments of Christine Lagarde, head of the International Monetary Fund, will have done little to calm jittery nerves. She said Europe's banks needed to call on their shareholders for more money to boost their capital buffers and prevent another credit crunch tipping them into bankruptcy.

UK banks are in the same boat. Lloyds Banking Group, which includes Halifax, went above 78p a share last September. Last week it was trading down 56% at 28p. Barclays reached a post-crash peak of 377p in August 2009 and remained above 300p until April this year when it began a slide that leaves the bank stock now struggling at 145p.

But it is the German institutions that have taken the greatest pounding. Commerzbank, Germany's second largest bank, has lost two thirds of its value since March when its share price stood above €6. Its larger rival,Deutsche Bank, has dropped almost 50% from a high of €50 to less than €27 a share.

Analysts argue the German banks face a three-way squeeze. Holdings of financial instruments have been left almost worthless by the Greek crisis. In the never-ending chain that is modern capitalism, German banks have lent funds to institutions that in turn hold Greek sovereign and corporate bonds and other financial instruments such as credit default swaps that insure transactions by Greek companies.

Secondly, there is the struggle to improve profits when European economies are slowing. And thirdly, there are the difficulties faced by the government now most investors believe Berlin will find itself insuring the debts of most peripheral eurozone countries within the next couple of years, whether the German electorate likes it or not.

The generally held view that Greece, Portugal, Spain and Italy will need vast amounts of financial aid from Berlin via the European Central Bank's lending facility has sent the cost of insuring German sovereign bonds soaring and had knock-on effects for banks.

Investors are expected to remain wary of supporting European banks while politicians wrangle among themselves over the extent of the Brussels' bailout fund, the European Financial Stability Facility.

The US has similar difficulties. Bank of America, the largest bank in the US, has seen its share price halve this year to less than $8. Before the crash its value was based on a share price north of $50. Citigroup has dived from $50 to $30 a share and Wells Fargo, considered one of the better capitalised banks, has dropped from $34 to $24 a share.

As in many western countries, many of the worst-hit financial institutions remain in government hands. The biggest mortgage lenders in the US, Fanny Mae and Freddie Mac, are still government owned and in effect bust without federal support.

Germany's Hypo Real Estate bank is in government hands after a €50bn bailout and the UK's Royal Bank of Scotland and Lloyds are still partly nationalised. French banks have escaped, though analysts remain nervous that lending to Latin countries leaves them vulnerable to default.

Warren Buffett, the maverick US investor, has stepped in with a $5bn investment to boost Bank of America's reserves. He expects to make a sizeable return on his capital much as he did following a $10bn injection into Goldman Sachs at the height of the crisis in 2008. But most investors are expected to wait for an economic upturn and political resolution before following his example.

Christine Lagarde calls for European banks to find more capital

Christine Lagarde, head of the IMF, warned of the risks of another global downturn and said banks need ‘urgent recapitalisation’. Photograph Michael Reynolds/EPA

The British Bankers' Association (BBA) has thrown its weight behind a call from Christine Lagarde, head of the International Monetary Fund, forEuropean banks to be forced to recapitalise to help prevent anotherfinancial crisis.

Fears of a sequel to the 2008 credit crunch are growing because of banks' exposure to weak economies in the eurozone, where countries such as Italy, Spain and Greece are struggling to maintain international investor confidence.

Angela Knight, chief executive of the BBA, said that she agreed with Lagarde, who suggested at the weekend that European banks should be forced to accept capital injections.

Knight said: "I think she is right: some European banks should hold more capital as action is urgently required to stabilise the situation inside the eurozone." But she thought that British banks would not have to recapitalise "because they already did so in 2009-10" and that further strains on the banking system were "more apparent on the continent than here".

But Knight admitted that if Europe lurched into a significant slowdown and the US also faltered, "even British banks will be minded to hoard cash" rather than lend it to companies and individuals. "One could envisage a situation where there would be less readily available credit from the UK banks."

Knight added that British banks could also withdraw capital if the upcoming Independent Commission on Banking orders a split of banks' deposit-taking arms from their investment banking operations.

Lagarde's comments about European banks were made at a central bankers' meeting at Jackson Hole in the US, against a backdrop of concern that some eurozone institutions are being shut out of international money markets.

There is no evidence, however, that UK banks are finding it hard to borrow and Knight said American lenders tended to trust UK banks, "but were far more wary of European institutions".

In one of her strongest warnings yet about the risk of a new global slowdown, Lagarde also said US policymakers should do more to ensure that house prices were not hit by another downward spiral.

The IMF managing director said European banks must be strong enough "to withstand the risks of sovereigns and weak growth. This is the key to cutting the chains of contagion. If it's not addressed, we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis."

Lagarde spoke after a grisly August in the financial markets when nearly $6tn (£3.7tn) was wiped off the value of global equities amid concern that growth is slowing and governments will be unable to tackle their debt burden.

UBS and Citigroup recently lowered their forecast for global growth, with sharp reductions to its eurozone view and more modest cuts for China, but ruled out the likelihood of a recession for now.

The cuts are the latest in a series of downgrades to global growth forecasts by major securities firms. Morgan Stanley has also cut its global growth view, but was even more bearish: it said the US and the eurozone were "dangerously close to recession".

Household finances squeezed by food and travel costs as inflation continues to rise

Consumers are restricting their spending, helping to depress the retail industry and UK economy. Photograph: Graham Turner for the Guardian

The soaring cost of food and transport left households £11 a week worse off last month than they were a year ago, according to a survey that reveals the erosion of family spending power.

The average UK household had £166 a week of discretionary income to spend in July, according to the Asda Income Tracker – 6.4% lower than at the same time last year.

Family budgets were squeezed after the cost of travelling increased by 16.5% year on year, according to figures from the AA motoring organisation, while food prices remained high despite food price inflationeasing marginally.

The Asda survey is likely to put pressure on the chancellor, who hascome under fire from business groups and some of his own MPs to boost growth.

Ed Balls, the shadow chancellor, said that George Osborne needed to act to stimulate the economy, which has failed to grow for almost a year.

A forthcoming slew of business surveys will indicate the health of the construction and manufacturing industries. Separate figures from the British Bankers' Association are expected to show that small businesses are struggling to persuade banks to release much-needed cash for investment.

The rate of inflation as measured by the consumer prices index increased to 4.4% in July, from 4.2% in June, with conditions in the labour market also worsening.

Osborne is known to believe that while a combination of wage freezes and inflation has eaten into family incomes, low interest rates have protected 12 million homeowners, who are paying mortgage rates far lower than before the 2008 banking crash. The Bank of England has signalled that rates will remain low for the rest of the year. Many analysts believe they will remain at 0.5% for much of 2012.

The British Chambers of Commerce said over the weekend that the Bank of England should add to its support of the economy with a further round of quantitative easing (QE).

The purchase of government bonds under the QE programme is designed to boost bank balance sheets and promote lending. Up to now, high-street banks have faced criticism for hoarding the proceeds of QE.

Andy Clarke, Asda's chief executive, said that families were under pressure to restrict spending to essentials. "The maths is simple – the rising cost of feeding the family, getting around and increasing unemployment add up to the biggest squeeze on families since the last recession," he said.

The retailer found customers were trying to economise by half-filling petrol tanks and cutting their own hair instead of visiting hairdressers.

July's inflation figures from the Office for National Statistics showed that the cost of clothing and footwear went up by 3.1% year on year – the highest annual surge since records began in 1997.

The cost of water, electricity and gas increased by 4.6% on an annual basis, the highest increase in two years. British Gas, E.ON, npower, ScottishPower and Scottish and Southern Energy have all unveiled price increases in the past few weeks.

Charles Davis, managing economist at the Centre for Economics and Business Research, a thinktank, said: "Pressure on household finances continued to mount up in July as the cost of essential spending grows rapidly while wage increases remain slow."

The pressure on commuters' budgets will further increase when rail fares rise by an average of 8% from January.

Goldman Sachs targeted as 'Jaws' joins battle over banking crash

Lawyer Jacob 'Jaws' Zamansky has filed a lawsuit against Goldman Sachs. Photograph: John Rizzo/Bloomberg News

He is known as "Jaws", the perfect nickname for a lawyer entangled in a lawsuit filed against a massive investment bank that has been dubbed a "vampire squid" by its critics. But Jacob Zamansky, a renowned Wall Street defender of the little guy, with a record of extracting large settlements from giant firms, does not fear the tough reputation ofGoldman Sachs.

Indeed, he is happy to be helping on a class-action lawsuit against the bank taken out on behalf of a group of shareholders seeking millions of dollars in damages for alleged illegal behaviour. "Goldman misled these investors. So they came to me," Zamansky said.

However, Zamansky's lawsuit is just one of a swarm of legal problems that surround Goldman, whose name once typified blue-blooded banker wealth but now attracts a legion of critics who see it as a byword for out-of-control greed.

Then news broke that Goldman's chief executive, Lloyd Blankfein, had appointed his own lawyer, in the shape of top criminal defence attorney Reid Weingarten. The firm insisted that such a step was merely routine, but some of the bank's detractors saw it as a sign that criminal charges might be edging closer to Goldman and its senior staff. What is beyond doubt is that the bank is facing choppy legal waters due to its actions around the mortgage industry before and during the financial crisis and the bursting of the house price bubble.

The firm agreed last year to a $550m (£336m) settlement in a suit alleging that it misled investors in one sub-prime mortgage investment vehicle. But that could be just the beginning. Goldman has also revealed recently that it could eventually pay out as much as $3.4bn because of other expected legal cases.

This is where suits such as Zamansky's come in. The class action is grouping together a number of shareholders who say the firm's activities around one now notorious security, known as Abacus, have caused them massive losses. But Zamansky says the issue has a wider symbolism for a nation with a moribund economy that many people blame on the actions of big banks. "This gets to the core of the crisis … their business model was against the law," said Zamansky.

Goldman is fiercely contesting the claims and has repeatedly said it did nothing wrong. But what might really worry its top executives is not the rising tide of private lawsuits but the possibility that the US department of justice may be laying criminal charges. The firm was hit with a subpoena in June, asking for documents related to the mortgage security industry and other topics. That follows on from Goldman's starring role – along with other major banks – in a Senate report that detailed numerous examples of bad behaviour as it sought to investigate the origins of the financial crisis. The report found many banks guilty of privately trash-talking the mortgage debt they were happily selling. There have also been allegations, robustly denied by Goldman, that Blankfein may have perjured himself during testimony to the Senate.

The market's sensitivity to the issue was shown by the dramatic fall in Goldman's share price when news broke that Blankfein had hired Weingarten. Indeed, in the space of a few hours more than $2.5bn was wiped off the firm's market value as traders digested the news, although the price later recovered. The instant reaction is perhaps partly explained by looking at some of Weingarten's previous clients, who include executives involved in scandals like Tyco and Enron.

However, Goldman insisted that Weingarten's appointment was routine – and some observers agree. "It was not big news," said Columbia University law professor John Coffee.

Others were less sure. They pointed to the fact that Weingarten is best known for his work as a defence lawyer in white-collar criminal cases and in some ways was an unusual choice for Blankfein if he was not expecting trouble. They also point to Weingarten's close ties to the department of justice, where he has previously worked in its public integrity section.

Whatever happens legally, Goldman's supporters will take heart from the fact that other top banking figures who played key roles during the financial crisis – such as Lehman head Dick Fuld and John Thain of Merrill Lynch – also hired their own lawyers, but have yet to face any criminal charges.

What is more clear is the intense damage done to Goldman's reputation in the years since the crisis. Even as the bank's bottom line has recovered and it has resumed paying out handsome bonuses worth billions of dollars to its staff, it still has a huge image problem. "Their image has been greatly tarnished. They were the best and the brightest, but all that has been called into question," said Zamansky.

Goldman-bashing is now practically a national sport among pundits, who question why banks have remained so wealthy and profitable, even as the country grapples with a devastated housing market and high unemployment.

Even the religious have got in on the action. A group of nuns called the Sisters of St Francis of Philadelphia led a high-profile campaign earlier this year over the huge amounts that Goldman executives were paying themselves. Now they are planning further meetings. "They have a business model, but we have a justice model," said Sister Nora Nash.

Yet many observers say the bank is as powerful and influential as ever. "It is still large. They have close allies throughout the administration and in Congress, and they are going to make a lot of campaign contributions in the coming election," said Baker. Indeed, Goldman's wealth is the subject of a popular mocking Twitter account. Called @gselevator, it purports to tweet the overheard comments of Goldman employees as they ride the company lifts. One recent update read: "Suit#1: Was that really an earthquake? Suit#2: No, I just dropped my wallet."

Perception is important in the world of finance and, with lawyers and the justice department circling, not many people at Goldman are laughing at the moment. "They have become the whipping boy," said Coffee.

Three years after Lehman, a new debt crisis looms

Financial crisis: traders on the floor of the New York Stock Exchange shortly after the collapse of Lehman Brothers in September 2008. Photograph: Mario Tama/Getty Images

The F word is back. Back in the financial markets, back in the conclaves of central bank governors, back among the manufacturers and the high-street retailers. The four-letter word is fear.

Back in the spring, few imagined that we would be approaching the third anniversary of the collapse of Lehman Brothers on 15 September with such a sense of unease. The belief in early 2011 was that economic recovery was now well enough embedded for central banks to start raising interest rates and for finance ministries to crack on with the job of reducing budget deficits.

Although pockets of optimism remain, the mood today is different. Ben Bernanke, the chairman of the Federal Reserve, has said the US central bank will discuss possible ways to stimulate growth when it meets next month. The Bank of England appears to be heading in a similar direction. There is anxiety at the International Monetary Fund that blanket austerity will tip fragile western economies back into recession. Concerns are once again being expressed about the health of the banks, about America's national debt and, above all, about whether the eurozone can survive its current crisis intact.

Standard Chartered and HSBC were the two UK-based banks to emerge relatively unscathed from the first financial crisis, partly because their global reach allowed them to benefit from the rapid recovery in Asia. This, though, is how the chief economists at the two banks see things.

"America is drowning in debt, Europe is imploding as problems in the euro area intensify, while, in contrast, Asia's economy is cooling, as growth rates moderate from a strong to a solid pace," says Gerard Lyons at Standard Chartered. Putting the possibility of a recession in the US as high as one in three and of an eventual euro crisis as high as one in two, Lyons adds: "It should be little surprise that there is increased uncertainty and heightened risk aversion across financial markets."

Stephen King at HSBC describes the world as a "frozen economic tundra", with the power of central bankers to influence events on the wane. "After the Great Recession, there has sadly been no 'Great Recovery'," King says. He too is unsurprised that investors are rushing for the exit, given the bickering between Democrats and Republicans on how to tackle America's budget problems, and the inability of Europe's politicians to sort out the single currency.

"The west is increasingly looking like a bad version of Japan. And, like Japan, our political leaders are offering few answers."

Collapse

This is not how it was supposed to be. It took time for policymakers to comprehend the enormity of the shock administered to the global economy by the collapse of the US housing market, but once the penny dropped in the autumn of 2008, they were at pains to show that lessons had been learned from the 1930s. Banks were recapitalised to prevent them from going bust, interest rates were slashed, money was created, public spending was increased.

To widespread relief, there was no second Great Depression. Unemployment in the US rose to almost 10% but not the 25% seen in the 1930s. Industrial production and international trade started to pick up in the spring of 2009. By and large, countries resisted the temptations of protectionism.

Over time, however, it has become clear that the recovery has been both slow and costly. If it is aborted, the risk is that the global economy will return to where this all started in 2007, with another crisis in the banking system. The recovery has been slow because the crisis was caused by over-indebtedness among private individuals and banks. Both, in the jargon of the markets, were over-leveraged: they had borrowed an awful lot of money, in other words, in anticipation of asset prices going up and up. When the bubbles burst, households and banks realised how exposed they were. As a result, they started to pay off their debts and even when the cost of borrowing came down to virtually zero, the demand for credit remained weak.

As HSBC's King notes: "The ambient noise of deleveraging is now deafening." But western economies have become so dependent on debt-driven growth in the good years that they are finding the sobering-up process painful. As things stand, it will take the UK longer to return to pre-recession levels of output than it did in the 1930s.

What's more, this lacklustre recovery has not come cheap. As private demand fell, governments stepped up their spending. They cranked up the electronic printing presses, they bought shares in banks and they allowed budget deficits to balloon, gambling that any damage to the public finances would be temporary. Again, things have hardly gone according to plan. Quantitative easing has proved a double-edged sword: it has flooded financial markets with cash and may well have underpinned activity. But it has also pushed up commodity prices, leading to higher inflation and a squeeze on real incomes that has held back recovery.

By effectively nationalising a good chunk of the debts accumulated by the private sector, western governments have now raised concerns about their own solvency. The US has seen its credit rating downgraded; Europe's problems are even more acute after bailouts for Greece (twice), Ireland and Portugal, followed in the past month by emergency action by the European Central Bank to drive down the interest rate on Italian and Spanish bonds.

Just as in the summer of 2008, the assumption is that the global economy will experience a slowdown but not a full-blown contraction. Central banks are still providing massive amounts of monetary stimulus through record-low interest rates, even though finance ministries are tightening fiscal policy by raising taxes and trimming spending. Large corporations outside of the banking sector have money in the bank that could be used for new investment. And consumers should feel better off next year as inflation falls.

Soft landing

Financial markets want to believe the "soft landing" scenario but somehow can't quite bring themselves to do so. The fear comes from the knowledge that commercial banks in Europe are up to their eyeballs in sovereign debt from the weaker peripheral countries, so a default would trigger a feedback loop back into the financial system. Banks have more capital than they had three years ago and are less heavily leveraged. Yet there are doubts about whether they could survive a double-dip recession. And until consumers are spending more freely, there will be a temptation for companies to hoard their cash rather than invest it.

Economic downturns usually go through five distinct phases: bubble, denial, acceptance, panic and recovery. This fifth phase officially started two and a half years ago, but the drip-drip of disappointing news from the around the world in recent weeks has made financial markets highly averse to taking risks. Higher unemployment, slower growth, currency tensions have all led to a rush for safe havens.

The markets are now wondering whether this is one of the rare crises that has a sixth phase – relapse. At root, the suspicion is that the problems that caused the crisis in the first place have not been solved, that politicians are offering weak leadership, and that the next few months could see the start of phase two of the Great Contraction.