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October 06, 2008

What went wrong? Just rewind a 100 years.

Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management, has come with an interesting article in the Economic Times on how the current US financial crisis is more like the one 100 years ago rather than the Great Depression. And, in the process, gives hope for a roaring 2009!
The US does not currently suffer from widespread excesses in the real economy that typically mark a deflationary spiral. Capital spending is broadly in check and inventories levels are low. What’s forgotten is that the capex bubble was pricked in the 2001 recession following the tech boom-bust cycle and there has been little new investment outside the real estate sector since. Corporate balance sheets are in very good health with high cash flows.

The 1907 recession too did not arise out of an over-production problem that has otherwise marked deflationary busts from the Great Depression to the Asian meltdown in 1997-98. The panic of 1907 is the most relevant template for the current crisis as it was largely the result of a credit bubble burst in the financial sector.

...If the 1907 analogy holds, then the US is likely to experience a recession of 3-4 quarters, beginning with the third quarter of 2008. The global nature of the credit crisis implies the entire world economy will remain in recession territory till the second half of next year. But as the 1907 experience shows, once some confidence is restored in the financial system - and the odds are that the might of the global policymakers will eventually prevail - stock markets can start to recover well before the world economy turns around. After all, 1908 was one the best years in history for the US stock market.

Arun Natarajan is the Founder & CEO of Venture Intelligence, the leading provider of information and networking services to the private equity and venture capital ecosystem in India. View free samples of Venture Intelligence newsletters and reports.