The Dow Jones last night fell another 5% to end up below 8,000 - its lowest level for 5 years. Banking stocks were again savaged as were auto producers - a large slab of the US auto industry faces the prospects of collapse. In addition the US is experiencing deflation - the US CPI dropped 1% in October. The December Share Price Index Futures was down 4.6% in Australia so a future dramatic rout on Australian equity markets will occur today driven in part by an overnight commodity price retreat. The All Ordinaries is at half its peak level of about one year ago. Indeed the betting agency Intrade are selling bets on the possibility of the US going into Depression in 2009 with GNP falling by 10% or more (HT Gregory Mankiw) . The current implied depression probability is around 0.15. It is not a negligible disaster probability.
The problem for Australian and the world is that people all want to save more because they see their residential and share market wealth decreasing. This has created a 'paradox of thrift' - in seeking improvement in individual financial positions by saving more they bring about a sharp contraction in demand and therefore economic activity that makes society as a whole worse-off. Indeed they end up saving less. The RBA is not convinced that lower interest rates will succeed in expanding the economy - the real need is for a traditional Keynesian fiscal expansion.
The share market collapse is a leading indicator that Australia is in for very tough economic times ahead. That is for sure.