The title of this post is taken from two sources. One was a headline in British tabloid, The Sun, in January 1979, when then-prime minister James Callaghan denied that strike-torn Britain was in chaos. The second was the title of a 1975 album by prog rock band Supertramp that famously showed someone sunbathing amidst the grey awfulness of the declining industrial landscape.

Are we now getting blasé about the latest crisis? Not so long ago, perfectly respectable economists and financial analysts were talking about a new Great Depression. The world was on the brink, it was said. Now, though, consensus appears to be that it is all over bar the shouting. The world is safe.

Wealth managers at Barclays have gone as far as telling their clients to get over it.

Move past the crisis .... The past year's events were deeply traumatic for most investors, but now is the time to move on, and take a more "business as usual" approach ...."

Such bullishness may not be comforting to the record numbers of jobless in parts of the world, but it is bordering on consensus. It is left to the likes of perma-bears such as  Nouriel Roubini to try to burst the bubble of optimism on which many are floating. The economist began one of his latest articles bluntly:

Think the worst is over? Wrong.

Roubini's main point is that unemployment is likely to get worse rather than better and that many U.S. jobs that have been lost will not come back.

Now, there can obviously be a disconnect between markets and economics, but the former tends to be based on assumptions about the latter. So which is right? Are we out of the woods? Or should Supertramp be firing up their keyboards again?

(James Saft is a Reuters columnist. The opinions expressed are his own)

New studies from the Federal Reserve and European Central Bank show that, whatever else, a recovery in the economy is not being supported by a resumption in bank lending, raising concerns about how exactly growth will become self-sustaining when official stimulus ebbs.

The ECB last week released its loan survey showing banks tightened credit yet again for businesses and consumers, though at a less severe rate than in the previous quarter. Much was made of the fact that banks said they expected to ease terms to businesses, but not individuals, slightly in the last three months of the year.

Days later the Fed was out with its own survey, and again the news is getting worse more slowly, which must mean it is time to pop open the tap water. Banks are tightening terms and conditions to large firms, though fewer are doing so than before. Of course we should be thankful for small mercies, but the fact remains that this is a relative rather than an absolute survey, which means that even if fewer are being tougher the vast majority are being just as tight with money as they were three months ago when things were very tight indeed.

But wait, I can almost hear you ask, banks are making money again. If not making loans, what are they doing with it? Funny you should ask, they are lending it to the government. According to Fed data October marked the first time in years that banks held the same amount in Treasuries and Fannie Mae and Freddie Mac bonds as they did in commercial and industrial loans. Business loans have plunged 18 percent in a year, while Treasury and agency bonds are up 8 percent.

Banks are choosing to lend to the government and to government-backstopped mortgage firms because they see it as the best way to survive: hunker down, take fewer risks and content yourself with the thin gruel and thin margins of taking deposits and lending to the entity insuring those deposits. It’s a good way to get solvent but it will take a terribly long time.

Falling demand for credit is a factor too. Firms are concentrating on expanding margins by cutting back on costs, rather than positioning themselves for an upswing in demand. That means they want fewer loans to support capital expenditure. It also sadly means that they are not yet hiring.

OF JOB GROWTH AND SMALL FIRMS

The question becomes will the loans be there when companies do decide that it is time to tool up and hire again. There can be no certainty. Banks are still in pretty poor shape, more will fail and few look likely to expand.

If you believed in markets you would believe that this is simply setting the stage for new entrants to come in and make loans that the banks won’t. I’d like to believe this, but here we run into one of the terrible side effects of too-big and too-connected to fail. Who on earth wants to set themselves up in competition with government-backed firms? Some will do extremely well in making loans opportunistically to commercial real estate and industry over the next two years, but fewer than would be the case if there was a truly level playing field.

Two groups are doing reasonably well, but only because they don’t have to rely on bank credit: large credit-worthy borrowers and house buyers. Fannie and Freddie are still cranking out mortgages, and loans backed by the Federal Housing Authority have boomed. Rates are low, and though fees are high and terms tighter it has to be said that the decision to officially support the housing market by tax breaks and subsidized lending is making a difference. It may not be good policy, but it is effective poor policy.

Small firms seem to be getting particularly tough treatment; the Fed survey shows that terms, conditions, pricing and availability were all deteriorating more rapidly for the small than the large and medium-sized companies. Annaly Capital points out that while middle market firms paid only a slight premium in the loans market in 2007 and 2008, the difference between benchmark loans and middle market is now almost 6 full percentage points, meaning they pay nearly double.

A prepackaged bankruptcy for CIT Group and a chastened GE Capital will not improve things.

Two possibilities suggest themselves for how things play out. Banks may get their balance sheets in order and begin to lend again in force next year, meeting a need for investment as economic growth takes root, if indeed it does.

If demand rises and banks can’t meet it, look for more official arm-twisting, more ritual abasement by bankers called before Congress and, ultimately, more official interference in the process, probably in the form of insurance or even mandates.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

Amid the turmoil of the 2008 financial crisis a myriad of events unfolded that the general public knew nothing about, writes New York Times reporter Andrew Ross Sorkin in a new book titled "Too Big to Fail."

Wall Street fell from the dizzying heights of good fortune to calamity in a matter of months. To a large degree it's still to early to tell whether financiers and politicians involved made the right choices.

"At its core 'Too Big to Fail' is a chronicle of failure -- a failure that brought the world to its knees and raised questions about the very nature of capitalism," writes Sorkin in his behind-the-scenes account.

He spoke with Reuters before giving a lecture at the London School of Economics on Thursday.

– John Kemp is a Reuters columnist. The views expressed are his own –

Resounding defeats for Democratic Party gubernatorial candidates in Virginia and New Jersey on November 3 have killed any lingering hope Congress will enact climate change legislation this year, and may doom the prospect of passing a cap-and-trade bill this side of the 2010 mid-term elections.

Prospects for eventually passing legislation may now depend on winning Republican support with nuclear loan guarantees and more offshore drilling.

While the president remains personally popular, with high approval ratings, and does not need to face the voters again for another three years, 16 Democratic senators and 256 Democratic members of the House of Representatives will be on the ballot in November 2010.

The Virginia and New Jersey off-cycle elections are often idiosyncratic. But crushing defeats for Democrats at the top of the ticket in both states are already sparking a bout of soul-searching over the lessons that need to be learned if the party is to retain firm control of both houses of Congress next year.

What worries many Democrats is that turnout among the young voters who helped propel them to victory last year fell away sharply, self-identified independents broke heavily for the Republican candidates; and voters overwhelmingly cited the economy and jobs rather than healthcare or climate change as their major concern in exit polls.

Democrats face the classic dilemma for any party after a defeat — press ahead trying to enact a difficult agenda or pull back, re-focus on simpler and less controversial measures.

The White House insists both defeats were due to local factors (a poor candidate in Virginia, a souring economy in New Jersey) and will not change the president’s determination to press ahead with an ambitious domestic agenda centered on healthcare reform and climate change.

But the party’s congressional wing is divided. Liberals (mostly from safe seats at little risk next year) argue the administration and party should press ahead; voters will rally behind a record of accomplishment next year. Moderates and conservatives (mostly from swing seats or those carried by John McCain in 2008 or George W Bush in 2004) as well as those from heavy industrial states are pressing to scale-back and refocus on cutting unemployment.

In this context, it seems unlikely the administration can find the 60 predominantly Democratic votes it needs to pass a climate bill on the floor of the Senate; hammer out a compromise between the differing House and Senate versions in conference; then secure simple majorities in both houses to pass the agreed bill into law.

Even before this week’s election results, the prospects for passing climate change legislation this year were dimming rapidly. But the arithmetic, already challenging, has now become very tricky as the administration loses momentum.

60-VOTE DOUBT IN SENATE

In the Senate, only two Democrats are up for re-election in Republican-leaning states carried by John McCain (North Dakota’s Byron Dorgan and Arkansas’s Blanche Lincoln).

Both have already taken a cautious approach to climate legislation. Both broke ranks with the majority of their colleagues earlier this year to vote for a Republican amendment preventing the budget reconciliation process being used to push through cap-and-trade on a 51-vote straight majority rather than the 60-vote super-majority normally needed to end a filibuster.

But the party remains ambivalent over cap-and-trade, split between liberals from coastal states who want a commitment to tough emissions reduction objectives, and senators representing industrial areas or conservative states anxious about supporting anything that could be portrayed as a costly, job-killing energy tax by their opponents at election time.

In theory, the Democratic Party (together with its independent allies) has the 60 votes needed to push a climate bill through despite almost uniform Republican opposition. In practice, the party broke 26-31 in favor of the Republican amendment to the budget resolution earlier this year, in what many saw as a straw poll on cap-and-trade.

Some Democrats have fallen into line since then, and the administration may be able to pick up one or two Republican votes such as South Carolina’s Lindsey Graham with the promise of loan guarantees and other government help for the nuclear power industry.

With several Democrats harbouring concerns, though, there are not yet 60 votes for an ambitious climate bill.

The bill will not be openly defeated on the Senate floor. If it dies or gets delayed it will be in the cloakroom. Majority Leader Harry Reid will not bring it up for a vote unless and until 60 firm votes are in his pocket. So Democrats with doubts will be able to delay the bill indefinitely by holding out and asking for more concessions, without having to come out explicitly against it.

RISK OF REVERSAL IN HOUSE

The arithmetic looks as daunting in the House of Representatives. While the lower chamber has already approved its own climate bill (HR 2454) legislators will have to vote again to pass the consolidated version if and when it is agreed in conference.

There is nothing to stop congressmen changing their minds. As the election draws closer and the already bitter partisanship in the chamber intensifies, some of the bill’s earlier supporters may withdraw.

The original bill passed only by the narrowest of margins (219-212), with 44 Democrats voting “No.”

A total of 84 Democrats represent Republican-leaning districts carried by John McCain or George W Bush in 2004. It will take only a handful of further defections to sink the measure if it returns from conference.

If the consolidated bill has been toughened in line with the Senate version (S 1733), congressmen will have a ready-made excuse to claim it has gone too far.

Parties controlling the White House usually lose seats at the mid-term elections, so pressure on Democrats in Republican-leaning areas will be immense.

The party’s heavy losses in Virginia and New Jersey this week will make them very cautious.

CROWDED AGENDA, LOSING MOMENTUM

Arguably, the president has tried to push through too many ambitious reform proposals and stretched his political capital too thinly.

At the best of times, it would be difficult to get either healthcare reform or climate change through Congress when the president’s majority is an uneasy coalition of liberals and centrists. But when the president is having to deal with a recession, financial regulation, and whether to increase the military commitment to Afghanistan, it has proved impossible to rally support for them both at the same time.

Hopes that healthcare and climate change legislation could be rammed through early in the year, long before the mid-term elections, while the Republican Party was still consumed by infighting after losing heavily in 2008, have evaporated.

Climate change has become a second-order priority. The political capital needed to assemble winning coalitions for a bill in both chambers is being deployed elsewhere.

The best option for the administration may be seeking to broaden its coalition, buying more Republican support through a combination of nuclear financing guarantees and greater access to offshore drilling.

But if an agreed climate bill does not go through before the year end, its prospects next year, when legislators will be fixated on the looming elections, are no better.

– Wei Gu is a Reuters columnist. The opinions expressed are her own –

Everyone agrees that China’s economy must be rebalanced, but few have bothered to delve into the costs. Japan’s experience has shown that even well-meant changes could sow the seeds for a bubble.

China cannot stay with its current economic model forever. But as the economy has become extremely unbalanced, to some extent even more so than Japan’s in the 1980s, rocking the boat too much risks tipping it over. Instead of rushing into changes, it would be better to make reforms gradually.

Most observers believe an extremely loose monetary policy was the root cause of Japan’s bubble. But Tomo Kinoshita, an economist at Nomura, reckons that efforts to liberalise the economy, such as sharply revaluing the yen, developing a deeper bond market and deregulating interest rates were among the fundamental reasons behind the bubble.

The challenges facing China’s economy are similar to those seen in Japan in the 1980s. Foreigners are calling for a currency revaluation because the undervalued yuan gives China’s exports an extra boost. Capital markets need to play a bigger role because investment has been directed mostly by state-owned banks.

True, property price increases appear to be milder than in the Japan of the 1980s. Household loans only account for 30 percent of disposable incomes in China, versus about 90 percent in Japan in 1989, according to Nomura. But there are warning signs. New mortgages recently hit a record. And ratings agency Fitch has cited China’s property market as a cause for concern.

The Chinese stock market also looks less overvalued than Japan’s did. The ratio of Chinese stock prices to earnings is only a third of the peak levels reached in Japan. Stock market capitalization as a percentage of GDP is 62 percent, much lower than Japan’s 150 percent at end of 1989. But China is catching up fast, and the ChiNext market, China’s long-awaited Nasdaq-style market, debuted last week with a speculative surge.

Moreover, China has been more aggressive in terms of monetary easing as it tries to prop up the economy while waiting for exports to return. The broad money supply in China has been rising at almost 30 percent this year, twice as much as in Japan back in the 1980s. So if there is a bubble, it could grow bigger than the one in Japan.

Even much-needed efforts to liberalise and rebalance the economy may lead to asset price inflation. Similar to China, Japan’s banks were too big and small companies had trouble getting financing. So developing a corporate bond market and encouraging banks to lend more to small firms was seen as a healthy change.

But policymakers underestimated the negative impact on banks. After Japan developed a liquid corporate bond market, large corporations issued cheap equity-linked bonds to repay bank loans. Because Japanese financial institutions lacked other revenue sources, they targeted smaller corporations and consumers. Total bank loans made to small- and medium-sized companies and individuals rose to 71 percent of total loans in the late 1990s from 47 percent in the late 1980s.

Due to a lack of information on their new clients, the banks’ bad loans started to rise. Their lending standards deteriorated as they scrambled to make up for lost business. This could very well happen in China as the country encourages consumers to take on more debt to stimulate domestic demand.

Moreover, Kinoshita argues that in Japan interest rate deregulation “put a cat amongst the banking pigeons” because banks were forced to lend out more when their margins became compressed due to more competition. Pressure from the United States played a role, and the Japanese authorities were eager to internationalize the yen anyway. Letting banks set deposit and lending rates was one of the requirements for the yen’s internationalization.

The policy lesson for China is that when Beijing takes business away from banks, it needs to balance things out by allowing them to take on new business, such as securities underwriting and broking.

But that leads to the question of how to compensate securities firms for their lost business and prevent them from engaging in reckless behavior. This just underscores the complexity of China’s problems.

Most of the world believes that China risks moving too slowly, not too fast. President Barack Obama might give Chinese leaders another ear bashing during his upcoming trip to China. But without the right systems in place, big bang reforms could be disastrous. It is important that China, as well as the rest of the world, learns from Japan’s mistakes.

Recent U.S.  gross domestic product data show the world's biggest economy emerged from recession in the third quarter, while in the UK data show that in the same period Britain's economy contracted.

British economist and author John Kay theorizes that Britain is mired in its worst recession on record in part because government support has not been evenly distributed across sectors.

"We've poured money into the financial sector -- by and large the financial sector in Britain is doing OK," he said.  "But very little of that is getting through to small and medium-size businesses out there in the rest of the economy."

Even if a deal is reached among political delegates at the upcoming United Nations Climate Conference in Copenhagen, it is unlikely to set out specific emission targets, says Mike Hulme, author of "Why We Disagree About Climate Change" and a professor at the University of East Anglia in Norwich.

"What we've done with climate change is to attach so many pressing environmental concerns to the climate change agenda that trying to secure a negotiated multilateral agreement between 190 nations is actually beyond the reach of what we can achieve," he argues.

Hulme, who will take part in a debate hosted by the Institute of Economic Affairs in November about carbon emission policies and economic activity before he heads to the Copenhagen conference, discussed his views with Reuters.

- James Saft is a Reuters columnist. The views expressed are his own –

Even putting aside the spectacular but hard-to-measure risks of a financing crisis or the loss of its special status, the dollar faces really serious headwinds from boring old fundamentals.

The dollar has been weak for months and markets have been fretting over a host of big picture worries.

Perhaps the world’s oil exporters will stop using the dollar as the medium for petroleum trade. Or maybe the so-far patient and docile buyers of Treasuries will finally turn jittery. Either could be a disaster for the dollar, but you don’t need conspiracies or crises to be bearish on a currency from a country which on some measures has run the largest-ever deficit between what it imports and what it sells abroad.

One of the most interesting side effects of the first part of the financial crisis was that the dollar actually rose despite being the locus of the credit bubble and despite the U.S. consistently importing far more than it exports. That strength, which has now been reversed in part, was largely because the freezing up of markets set off a scramble for dollars.

The acute phase of the crisis is over and a return to something approaching normalcy is not treating the dollar kindly; from its peak this year the dollar has fallen more than 13 percent against a trade-weighted basket of currencies. The current account deficit — the balance of exports to imports — has also been reduced greatly, from a peak north of 6 percent of GDP to below 3 percent at the end of June, with further narrowing in the months since. That is because a weaker dollar makes U.S. products more competitive, but also because the price of oil, of which the U.S. is a net importer, has dropped, and consumption at home is flagging.

It is far too early, however, to say that the dollar adjustment has done its work and the deficit will now close.

“The U.S. current account shortfall was primarily driven by a consumption surge rather than an acceleration of investment on the back of productivity growth and high profitability,” Citigroup currency strategist Michael Hart wrote in a note to clients.
THINGS THAT CAN’T GO ON FOREVER DON’T

That is bad news for the dollar and bad news for the outlook for U.S. growth. A 2005 paper by Caroline Freund of the World Bank and Frank Warnock at the University of Virginia <http://papers.ssrn.com/sol3/papers.cfm?abstract_id=875699> found worse outcomes for the countries that ran current account deficits to finance consumption as opposed to those which ran deficits in aid of investment.

Industrialized countries which, like the U.S., run current account deficits for consumption, find that the currency depreciation that follows tends to be deeper. What’s more, the adjustment in the deficit lasts longer and is often twinned with lower growth. It is not, I suppose, a big surprise that importing more than you export and then consuming it leads to depressed growth. The real wonder is the way in which the U.S.’s special status and the generous financing terms offered by its trade partners made this possible without more immediate damage to the dollar.

There is also the possibility that globalization has permanently raised the “natural” level of the U.S. current account deficit. Huge swaths of the U.S. manufacturing base and a growing wedge of the country’s service sector have been offshored or simply moved out of the U.S. Many of these goods and services are still consumed by the U.S., but now much of the money generated by those sales will be the result of dollars being sold to buy pesos, ringgits or yuan.

This may place more structural pressure on the dollar to fall over time.

Australia’s decision to raise interest rates last week hurt the dollar and for good reason. It demonstrated that as a recovery happens the action will not be in the U.S., but in resource-based economies and in places, mostly in Asia, where the best prospects for productive investment lie. The U.S., where the Federal Reserve will likely need to keep rates low for a very long time, will have a hard time capturing the imagination of investors.

For policymakers, and not just U.S. ones, the puzzle is how to allow the dollar to fall gently without precipitating trade friction or a disastrous loss of confidence. Because it’s more or less in everyone’s interest, it will probably more or less be avoided. A weaker dollar, though, is simply consistent with the outlook for the U.S.

A long shamble downwards rather than a fall off a cliff looks to be in the dollar’s future.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. )

-David Kuo, Director at the financial website The Motley Fool. The opinions expressed are his own.-

Go on. Admit it. You didn’t see it coming, did you? You never thought a member of the G20 nations would dare to break ranks and raise interest rates this soon.

But Australia has done just that. The Central Bank of Australia has increased the cost of borrowing by 0.25 percent to 3.25 percent. It is doing what it thinks is right for the country regardless of what the rest may think. Now, Asian countries, keen to avert another bubble, may follow Australia’s lead and ratchet up interest rates before long.

Of course, Australia’s economy is vastly different to the UK’s. It has huge deposits of iron, aluminium and nickel that are in demand by mineral-hungry China. That said, Australia did briefly flirt with a downturn, which it successfully corrected with 21 billion pounds of fiscal stimulus.

But the UK is not Australia. We do not have huge deposits of mineral, and we are not near fasting-growing Asian countries either. What we do have are consumers saddled with over a trillion pounds of debt following a decade of binge borrowing, and a national debt burden of similar magnitude.
Therefore, it is unlikely that we will experience demand-led inflation. In fact, consumers are saving more of their household income than they have done for eight years.

The most recent Office for National Statistics report shows that between March and June British households saved 5.60 pounds out of every 100 pounds of household income. That is very different from the first three months of 2008 when we not only failed to save any money, but we even borrowed 50 pence for every 100 pounds of household income.

That said, we are still some way off getting our overstretched household finances back on an even keel. So, the savings ratio could go higher. In fact, it is still some way short of the long-run savings-ratio average of 8 percent of household income.

And herein lies the problem for the Bank of England.

According to the paradox of thrift, high levels of savings in a recession can prolong the economic downturn. That is because two-thirds of economic growth comes from consumer spending. So the less we spend, the longer it will take the UK economy to recover from the slump.
So what is the Monetary Policy Committee to do?

It has already slashed interest rates to historic lows. But that has failed to stimulate consumer spending. It has pumped 158 billion pounds of fresh money into the coffers of lenders through quantitative easing. But the money has, as yet, failed to invigorate the ailing economy.

However, both those measures will, in time, achieve their goals. The risk is not whether they will work, but instead, whether they will work too well and stoke inflation. Just as no one expected Australia to hike rates this soon, our days of enjoying low interest rates may end just as abruptly, and without warning. So save and invest what you can now.

Problems sparked by the financial crisis have not gone away, but have been transferred to the public sector, economist Roger Bootle posits in his new book.

In "The Trouble With Markets: Saving Capitalism from Itself" Bootle argues that in large measure, the underlying cause of the financial crisis was the result of an idea that markets work, and that governments do not.

"Despite the trillions of dollars lost, and despite the worries of millions of people, more than this -- much, much more -- is at stake," Bootle writes. "For this crisis has delivered the killer blow to an idea that has underpinned the structure of society, framed the political debate, and moulded international relations for decades."

Bootle, director of Capital Economics and an economic advisor to business accountancy firm Deloitte, reflects on the pitfalls of the corporate system and puts forth his ideas on the future of capitalism.

He discussed his book and his economic predictions with Reuters at his London office.