It can be worse than the Great Depression

In the 1930s, states did not go bankrupt, fearful of the consequences of those who had done so in the wake of the first world war.

Now, major states, such as Italy, have more than 100 percent of GDP in public debt even before the crisis, rendering major state bankruptcies a real danger. Fiscal and monetary stimulation are needed and deflation must be avoided, but currently fiscal considerations are disregarded altogether, which is a recipe for disaster. State default can easily lead to hyperinflation, which is far worse than deflation.

The global financial system is so much deeper and more sophisticated than in the 1920s, but that is a problem. The 1920s had its version of subprime loans, but it did not have non-transparent collateralized debt obligations. The many derivatives have created the mother of all bubbles. The deeper the financial system, the harder we may fall.

Although the Great Depression had worldwide reach, it largely emanated from two countries, the US and Germany. Never before has the world seen such a monstrous and truly global bubble. The real estate bubble is probably worst in the Persian Gulf and Moscow, while also extreme in Britain, Spain and Ireland.

Never have big financial institutions been as overleveraged as Fannie Mae and Freddie Mac or the former US investment banks, not to mention the hedge funds. The excessive leverage is now being unwound by financial panic, apart from what is countered with re-capitalization.

The 1930s protectionism must not be repeated, but frozen finances have already left countries such as Iceland and Ukraine temporarily outside of the world financial system. Such exclusion must not be allowed to become permanent.