Stock markets around the world have been rallying. They are up 15% since they hit a low for the year in mid-March and they are now hardly down in value since credit crunch began last August. Investor optimism is rising that the great global credit crunch is nearly over.

The mood is changing from one of deep pessimism to hope that the credit squeeze that has seen banks and other investment institutions post up to $400bn of losses and ‘writedowns’ on their loans and assets has been curbed and that any resulting slowdown in the world economy will be small and shortlived.

The reason for the optimism is two-fold. First, no great financial institution has collapsed, bringing down many others like a pack of cards. That was a real worry up to January this year as the losses in the big banks and investment brokers mounted. The French bank Societe Generale had to announce a loss of $5bn in one week after they discovered that one of their traders had got into seriously large loss-making positions similar to that achieved by ‘rogue trader’ Nick Leeson in the famous Barings bank disaster back in 1995. 

The rumours abounded that one of the top five Wall Street investment houses, Bear Stearns, was in trouble. And so it seemed. However, over a weekend, the US central bank, the Federal Reserve, organised a bailout of Bear Stearns, by arranging for JP Morgan, another big five house, to take it over for $1 a share with the help of $30bn of taxpayers’ money.

Once that happened and JP Morgan mopped up Bear Stearns assets and commitments and began sacking its staff, investor confidence rocketed. Then they knew that whatever the cost, the Federal Reserve would come to the rescue.

The other factor that has renewed confidence in capitalism at least for a while is the huge amount of credit that the central banks of the world are pumping into the financial sector. Since the crunch started, the Federal Reserve has put in over $200bn in new money. Other government institutions like the Federal Home Loans Banks and state mortgage agencies have put in another $300bn surreptitiously. At the same time, the European Central bank and the Bank of England have added another $250bn through various credit ‘facilities’. Altogether, the world’s banks and investment houses have been ‘given’ around $1trn to help them get through their ‘difficulties’.

No wonder investors feel better! The taxpayer (that’s us) stands by to help the banks avoid the consequences of their disastrous policies. It is socialism for the few in order to preserve capitalism for the many.

But this optimism by investors is just a great piece of wishful thinking. All this rushing about to help the banks will not avoid the economic slump that is heading capitalism’s way. Every economic indicator is glowing red.  GDP growth has slowed to nearly zero in the US. It is beginning to slow in Europe and Japan too. And the forecasts for the next few quarters are dire.

Take the United Nations among many others. It has just reported that the world economy is "teetering on the brink" of a severe downturn and will grow only 1.8% percent in 2008. That's down from a global growth rate of 3.8% in 2007, and the downturn is expected to continue with only a slightly higher growth of 2.1%

And the UN is not referring to just the US or Europe.  It is talking about the world, including fast-growing China and India.  The UN said developing countries will suffer as badly as the mature capitalist economies: They should grow by 5% this year compared to a robust 7.3% in 2007. The UN even argued that global growth this year could fall to 0.8%.  At the same time, global inflation is expected to accelerate this year to 3.7%, while world trade growth slid back from 7.2% in 2007 to 4.7%, largely due to weak U.S. demand for imported goods.

Any way you look at it, this is a dire forecast. This pessimism among economists about the future stands in contrast to the optimism of the speculators in stock markets. Even the notoriously optimistic Association of Business Economists in the US has now come out as a majority in expecting the US economy to go into recession by the end of the year. The Bank of England in its quarterly inflation report was just as black.  It now expected the UK economy to grow by less than 1% this year while inflation rose to 4%!

The truth is that the credit crunch has still some way to play out in the damage it will cause to world capitalism. The overall losses from the credit crunch are likely to reach $1.5trn or about 3% of global GDP before it is over, while it could take 5% points of growth in the US and 3% points off Europe. 

Why is that? It’s because the great liquidity boom on the 2000s since the stock market bust of Year 2000 had created such a huge mound of excess liquidity that it has finally toppled over.  By 2007, the global credit mountain made up of money, bonds and exotic forms of liquidity called derivatives had reached $600trn in value compared to just $50trn of annual world GDP. That’s 12 times the real values created each year in the world capitalist economy.  That had helped fuel a stock market boom from 2002 and above all a property bubble that infected the US, Europe, parts of Asia – indeed everywhere. 

This expansion of what Marx called fictitious capital was not matched by real production of things or even services.  Eventually, the price of houses reached such a level that nobody but the very rich could afford to get onto the property ladder in the US or the UK. Suddenly, purchasers stopped buying and soon prices were falling. Once prices fell, the mortgages that the banks had loaned and then passed on in the form of ‘safe, securitised debt’ to investors all round the globe began to look dodgy.  The credit crunch began.

Now the whole ball of wool is unravelling and with it the so-called prosperity of the last few years. Capitalist profits in the last few years had risen mainly on the back of this financial boom. It was the financial sector that made the huge profits and paid the big money to its owners. The companies in the ‘real economy’ did less well.  Indeed, their profitability was falling and has been since 1997.