Originally Posted by Maximus Zeebra When the people realize the western world governments are all bankrupt, the severity of this and how they continue to run deficits and increase the government debt?

Originally Posted by Maximus Zeebra -When people realize a massive number of western corporations are actually bankrupt with a huge trade deficit, massive credit crunches and unbearable debts?

Originally Posted by Maximus Zeebra -When people realize that the populations of western countries are bankrupt and that everything they own is on loans and that the loans they own are really 30 years of their lives?

Originally Posted by Maximus Zeebra -What will happen when the people realize the stock markets are worthless and massively overvalued? Who would want to pay 250 billion $ for a company with 10 billion $ in revenues? Who would pay hundreds of billions $ for a company with a less than billion $ annual profits?

Originally Posted by Maximus Zeebra Is the subprime crisis just the first in a line of financial crisis to come? Whats your opinion?

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Maximus Zeebra,

A lot more would have to occur for the world to face something even close to a financial collapse. Moreover, corporate profits are not synonymous with the trade balance. Corporations can be profitable even when nations run large trade and fiscal imbalances.

As for the U.S. economy, if one pores through the more detailed data, one finds that the weaknesses are confined to a few sectors. Many remain healthy. In the most recent report of GDP (preliminary 4th Quarter data), real GDP grew by an annualized 0.6%. However, two areas largely contributed to the drop. Fixed investment in residential structures fell by an annualized 1.25% and inventories fell by an annualized 1.49%. The former is on account of the ongoing contraction of the housing bubble. The latter is on account of slowed business production, but it offers a proverbial silver lining. So long as demand does not begin to contract, inventories will need to be replenished. As a result, one could begin to see a pickup in production down the road.

The big danger is inflation coupled with a falling dollar (and there is they are interrelated). Inflation expectations could discourage businesses from making investment and production decisions. Yet, the Fed has not been giving adequate attention to inflation in almost an eerie replay of 1970s Fed decisionmaking, even as inflation is being experienced in many parts of the world (with Canada being an exception on account of prudent monetary policy). Should inflation expectations become unanchored--and there is some evidence of that starting to take place based on the Fed's internal minutes, along with some evidence of pass-through of cost pressures to consumers--the inflationary problem could grow worse. Ultimately, the price of such a policy mistake could be postponement of a mild recession but at the cost of a much more serious one afterward to kill the inflation.

With respect to large trade imbalances, over some period of time, large trade balances inevitably unwind. Per research by the IMF, they can do so in an orderly fashion with little economic harm. They can also do so quite rapidly in which a significant economic shock results.

Also most of the traded stocks are based on intrinsic value (net assets). Many of the companies can expected long-run earnings. So, it is difficult to argue that the stock markets are "worthless," even as some stocks are overvalued (excessive market capitalizations). It is possible--indeed, probable--that the ongoing equities correction could continue before stocks bottom out.