From the Economist….

UNTIL recently Japanese banks had largely avoided the agonies of the credit crunch that had caused such difficulties in much of the rest of the world. Now the misery has well and truly come to Tokyo. The culprit is not toxic derivatives and swaps, but ordinary shares held by banks in Japanese companies. These cross-shareholdings, a peculiar feature of Japanese capitalism, are having pernicious effects. As share prices fall, banks are force to revalue their assets, which in turn reduces their capital ratios. The result is a need to raise capital quickly.

In the past four trading days, the Nikkei 225-share index has tumbled by 23%. On Monday October 27th the index plunged by 6.4% to 7,162.90, the lowest level in 26 years. Mitsubishi UFJ Financial Group (MUFG), Japan’s biggest bank, plans to raise as much as Â¥990 billion ($10.6 billion) by issuing new common shares of perhaps Â¥600 billion and preferred securities of Â¥390 billion. Mizuho Financial Group and Sumitomo Mitsui Financial Group are said to be planning their own capital increases.

The government is scrambling to help out. It is poised to announce a set of new measures, including spending perhaps Â¥10 trillion to buy shares in companies that the banks hold (in an off-market transaction, so their values do not fall further). This was a tactic used by the Banks’ Shareholdings Purchase Corporation to respond to a banking crisis in 2002. The government may also request that pension funds and life insurance firms buy equities to support the market, though whether they would respond remains to be seen.

From the Wall Street Journal…..

The U.S. Department of Energy is working to release $5 billion in loans to General Motors Corp., according to a person familiar with the matter, a move that could help ease the way for the auto maker’s discussed merger with Chrysler LLC.

This is a surprise only because I have not been paying attention. Apparently the auto makers bail out was always supposed to be coming through the Department of Energy. The next thing I know, I will be finding out that the State Department will be handing out cash to international companies.

And doesn’t the part about helping a stupid merger go through make you sick? I mean, what is the point of using government money to tie two sinking ships together?

Spengler’s Gambling, Economic Growth and Imagination is this week’s essay of the week.

From Paul Kedrosky….

The following more or less supports what some have been saying for a while -– that major banks in the U.S. and the U.K. will end up being entirely nationalized before this crisis is over –- but it’s still a striking way of looking at the data. The gist: Government recapitalization and other fund-raising has largely been in service of banks’ prior subprime losses, while corporate and consumer loans are just starting to hit bank balance sheets. It won’t take much to tip banks over into insolvency again.

What follows is a chart that you all should take a look at. Alphaville has more.

From This Is Money…

The depth of the recession was revealed today as truckmaker Volvo admitted demand across the Continent has crashed by 99.7% as it took orders for just 115 new lorries in the last three months.

From the Economist….

Britain’s economy contracted by 0.5% (an annualised rate of 2%) in the third quarter, according to a preliminary estimate. The drop, far worse than forecasters had expected, was the first quarterly decline in output since 1992 and the biggest since 1990. The pound immediately sank below $1.56, an alarming fall. A week earlier it was trading above $1.73 and could be exchanged for $2 as recently as July.

The economic news from the euro area was scarcely better. An index of manufacturing industry based on a survey of purchasing managers slumped from 45.0 to 41.3, its lowest level since it began in 1997 (a reading below 50 is consistent with falling activity). The corresponding index for services fell to 46.9.

It is absurd to blame the current economic crisis on America when most of the other rich and powerful countries in the world were running trade surpluses. A trade surplus is sign that a country thinks it would make more money investing in other countries then it would make investing in itself. So China, Japan, Germany, Russia, and others had more faith in American and few other countries than they had in their own economies. It was the fact that so many countries had no faith in their own economic future that led to the crisis.

Felix Salmon explains how that worked out for Germany…..

Maybe it’s just that Germany was running a massive current-account surplus, and needed to lend lots of money abroad, and that German banks as a consequence would lend to just about anyone. After all, the $21 billion in exposure to Iceland might be multiples of Iceland’s GDP, but it’s still a mere fraction of German banks’ $311 billion exposure to Spain, or their $241 billion exposure to Ireland.

Germany is likely to lose serious amounts of money on all of those investments. But why did they ever place themselves in a position of loaning more money to Iceland then its GDP was worth? Why were Germans so eager to loan money to Iceland instead of their fellow Germans?

We can restate that same question with America as the subject.

The problem with America is that it was growing its net indebtedness faster then it was growing GDP. In other words, it was destroying capital. This is not sustainable over the long haul. If US GDP growth had kept up with the trade deficit, then the trade deficit would have been a good thing.

But why were the world markets willing to throw vast amounts of money at a country that was clearly a net destroyer of capital? The short answer is obvious. Many large and powerful countries thought they could make more money investing in America then in their own countries. But why?

I don’t know that I can prove the answer to that question. But I can’t help noting that most of the big exporters of capital have one thing in common. They are all facing serious demographic problems that make America’s demographic problems seem like a cake walk in comparison. When you add up China, Japan, Germany, and Russia you have most of the world’s trade surplus by dollar value. You also have a list countries that are at the top of the list as far as having unbalanced demographic.

Of course, there are many countries that have serious demographic problems and yet they are not running trade surpluses. Almost all of Eastern Europe would fall into this category. So one could have a good argument over just how relevant the demographic problems are.

But regardless of the outcomes of such arguments, the fact remains that the root of the crisis stems from the fact that the world depended on America, Ireland, Spain, and a few other such countries to create a decent return on investment. Anyone seeking to solve the crisis must first understand why so many rich and powerful countries had so little faith in their own countries that they preferred to invest huge sums elsewhere.