We have seen several days of plunging share prices. We are now hearing several varieties of explanation. What began as fear stalking the Shanghai Exchange, as rumours swirled of a forthcoming clamp down on borrowing and speculation by the Chinese authorities, has transmuted into a more general panic about the US economy.

Mr Bernancke, the current President of the Fed, has said he still expects the US economy to grow this year. Mr Greenspan, his predecessor, warns that there could be a recession. The Martians could land as well, but the Fed probably doesn’t think that very likely either.

So why did Mr Greenspan say it, and why did some people apparently believe him? All the forecasts I see still show some growth in the US during 2007.

??The answer appears to lie in the mortgage market. Banks are reporting big losses in the riskier??mortgages in the US, with the real estate market in the doldrums. Suddenly banks that were game to extend more credit a couple??of weeks ago, are pulling in their horns. In today’s markets this causes a contraction of credit elsewhere, as hedge funds and others rush to reduce their exposure and repay any borrowings that were financing share positions.

This could go on for longer. However, it is difficult to see the Fed wanting to make the problem much worse by hiking interest rates ever higher. The more the markets unwind these credit positions quickly, the less likely further interest rate rises become. If the credit crunch becomes too severe, we should assume the authorites will start to cut rates again.

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