There's a tumultuous week ahead for the world economy. Is there enough political leadership to create a "global bargain" to stabilize markets?
Only an urgent global deal will stave off a depression
Friday's downgrading of US debt, by the ratings agency Standard & Poor's, capped the world economy's worst week since the dark days of the 2008-09 financial crisis.
Amid fears of a new slump, massive sell-offs wiped more than $2.5 trillion (Dh9.2 trillion) from the value of equities around the globe. On Saturday, Saudi Arabian markets alone lost $7.5 billion, and the outlook is pessimistic as markets around the world open today. As investors seek refuge in safe assets, the market volatility we have seen in commodities and shares is set to continue.
On Thursday, Wall Street and a host of European stock markets saw their biggest one-day drops since the bankruptcy of Lehman Brothers in September 2008 turned the transatlantic "credit crunch" into a global recession.
Then, the world's 20 leading economies acted swiftly, recapitalising banks and providing temporary stimulus that compensated in part for the collapse in private demand. A great depression was averted.
Now, political leadership is lacking, both nationally and internationally. Some decision-makers, such as Angela Merkel, Germany's chancellor, are conspicuous by their absence. Others, including Silvio Berlusconi, Italy's premier, remain in a state of denial.
With every month of inaction or delayed response, the bailout bill has increased. As the euro zone's sovereign debt crisis moves from the periphery to the core, a cacophony of dissent highlights Europe's political vacuum. No wonder that spreads on Spanish and Italian bonds have widened, compared with safe German bonds.
In the US, last week's debt deal portends worse than merely partisan stalemate until the 2012 presidential vote. Indeed, reckless brinkmanship risks inducing permanent political paralysis at a time when the economy has hit stall speed.
Better-than-expected job figures provided some relief on Friday, but second-quarter US economic growth of merely 1.3 per cent per year spooked investors.
Western leaders are behind the curve and playing catch up, at a time when decisive action in the West plus a global grand bargain are needed to avoid a "double-dip" recession or Japan-like stagnation.
A repeat of the post-Lehman period is not on the cards. Most banking groups now have greater capital cushions and fewer toxic assets. Interbank lending continues. Money markets are not about to freeze.
But some similarities with the financial crash of 2008 are real - and dangerous. These include commodity bubbles, large-scale capital flight and sheer market panic. Unless the fear that has beset investors subsides, gyrations in commodity and share prices will carry on this week and beyond.
The greater fear is a combination of slowing growth, rising interest rates on sovereign debt and a marked decline in consumer and investor confidence. That is compounded by growing indications that expansion in China and other emerging markets is slowing, which would hurt exporting economies like those of the US and Germany, which are respectively the world economy's locomotive and the euro zone's powerhouse.
Austerity plans in Europe and now the US are hurting private consumption and investment, just as households and businesses are paying off debt and being squeezed by higher commodity prices, notably for oil. This dangerous dynamic depresses the economy.
Similarly, banks and governments are caught in a vicious circle of mutual dependence. Banks hold national bonds that serve as collateral in interbank lending but are falling in value. That exacerbates funding shortages, which over time may require bank bailouts just when governments face sovereign debt crises. If global investors keep swapping national bonds for safer assets, this vicious circle will mutate into a downwards spiral.
With political leadership lacking, market attention has shifted to central banks, especially the US Federal Reserve (Fed) and the European Central Bank (ECB). Nervous investors will look for any signs of another round of asset purchases (or quantitative easing) when the Fed meets on Tuesday. Likewise, European stock markets will probably continue to plunge unless the ECB starts buying both Spanish and Italian bonds. But central bank interventions can provide a temporary reprieve at best.
Western governments must now confront three challenges: in the short term they need to restore investor and consumer confidence by getting real about faltering growth and growing debt. Cutting sales taxes or suspending payroll taxes, for example, could boost consumption, investment and employment.
In the medium term, governments have to come up with credible programmes for growth and job creation. Local investment trusts and regional banks are needed to fund high-tech manufacturing. States could also underwrite needed infrastructure projects and support vocational training.
In the long term, a global "grand bargain" is needed to ensure that the burden of fixing the global imbalance between debtors and creditors does not fall on debtors alone.
Leaving that burden all with debtors would be a mistake. Across the West, austerity is already expected to have an effect twice as bad as in the last synchronised squeeze in the 1980s, which bequeathed high unemployment and deindustrialisation. Meanwhile, China's property boom is close to bust and its manufacturing output is slowing.
A conference call of G7 finance ministers before Asian markets open today won't do; only a grand bargain will.
Unless the collective interest is defended, currency or trade wars could trigger a collapse in global economic activity - not unlike the 1870s or the 1930s when a recession turned into a depression.
Last week, that prospect became frighteningly real.
Adrian Pabst is lecturer in politics at the University of Kent, UK, and visiting professor at the Institut d'Etudes Politiques de Lille, France