Global financial crisis may hit hardest outside U.S.

In April, for example, the IMF was criticized as unduly negative for an economic forecast that said the global economy would grow about 3.7% next year. This month, the organization issued a revised forecast that was even gloomier. Now, the IMF says the world economy will expand just 3% next year, its slowest pace since 2002 and right on the edge of what the world body considers a global recession. Other forecasters, such as Morgan Stanley's economists, say that recession already has begun.

A true global recession would be certain to hit commodity producers in the developing world especially hard. In the 1980-82 downdraft, non-fuel commodity prices fell almost 57%, says Vincent Truglia, managing director for research at NewOak Capital in New York. That's bad news for countries from Kenya to Argentina.

Oil producers with large populations — such as Iran, Venezuela and Russia — also face difficulties. In Russia, authorities are burning through financial reserves in a desperate bid to prop up the ruble. S&P last week lowered its outlook on Russian government credit to "negative," reflecting the danger of a downgrade prompted by the rising cost of Moscow's financial bailout. Russia has committed 15% of gross domestic product to recapitalize its financial sector, S&P said. But the ratings agency said it expects corporate defaults to increase as economic growth slows to less than 3% next year. And it expressed concern that the state's increasing hold on the economy might not be temporary.

Some investors remain sanguine. John Connor, portfolio manager for the Third Millennium Russia fund, says Russian consumers are relatively unencumbered by debt, so robust retail spending should keep the economy afloat. "I don't see any long-term problem. … It's a panic."

Countries worldwide share the pain

After the Sept. 15 Lehman Bros. bankruptcy intensified the credit crunch, some foreign officials seemed to delight in the USA's plight. Awash in debt and laid low by a Wall Street culture of heedless risk-taking, the U.S. had gotten what it deserved: "The U.S. will lose its status as the superpower of the global financial system. …Wall Street will never be what it was," German Finance Minister Peer Steinbrueck crowed in September.

Amid today's deepening gloom, that sense of schadenfreude— taking pleasure in others' misfortune — is long gone. Now everyone realizes they are in this global mess together. Reflecting that shared fate, Asian and European leaders gathered Saturday in Beijing to brainstorm ahead of a Nov. 15 international financial summit in Washington, D.C.

Likewise, G-7 finance ministers met in Tokyo as currency markets issued the latest signals of something gone terribly awry in the globe's financial mechanism. As hedge funds and other institutions cash out profitable stakes in developing countries, they are shifting to the relative safety of the U.S. dollar. It closed Wednesday at $1.28 against the euro, up 18% since the end of July. Morgan Stanley now likens the troubled U.S. economy to "the best house in a bad neighborhood."

Still, the soaring yen is the immediate focus of international concern. The Japanese currency is appreciating as investors hasten to unwind so-called carry trades — borrowing one currency at low interest rates to lend in a second country at much higher rates. It's a profitable trade, so long as the first currency doesn't unexpectedly appreciate, which is what is happening to the yen.

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