OIL

The crisis: The price of oil has rocketed from $25 a barrel in 2003 to more than $130 a barrel last week. It is as big a hike as the oil shocks of the 1970s that sparked recession, although not as sudden.

Best case: The slowdown in the US economy, which consumes 24% of all the world’s oil, begins to reduce demand. China, which currently subsidises its low petrol prices, allows them to rise despite popular protests, thus limiting its accelerating thirst for oil.

The Middle East and other producers keep supplies flowing at high levels. Financial speculators conclude that fears of demand outstripping supply have been overdone and begin to sell off their oil holdings. The price of oil falls back to $80 a barrel. At that level western economies have a bumpy ride rather than a crash and the world economy continues to grow.

Worst case: In a preemptive strike, Israel attacks Iranian military facilities to prevent it building a nuclear bomb. Iran retaliates, threatening wider conflict in the Middle East. The ensuing panic about disrupted oil supplies drives the price way above $200 a barrel.

Industry and business, hammered by higher costs, retrench and lay off thousands of workers. Consumers in many countries face the double whammy of higher prices and economic slowdown. As consumers cut their spending, asset prices collapse further. Millions suffer negative equity. Living standards fall. A global recession unfolds.

HOUSING

The problem: Fuelled by low interest rates and easy credit, house prices in many countries have soared, in most cases taking them well above normal levels in relation to household incomes. The unwinding of that boom has caused deep problems in America and is also hitting Ireland, Spain and Britain.

Best case: The vast sums injected into financial markets by central banks begin to ease the credit crunch. Governments and central bankers keep interest rates low, despite fears of inflation. Banks begin to lend more freely to consumers, although with tighter conditions than previously. Having seen house prices decline, buyers return in search of bargains. After a short sharp dip, prices begin to stabilise and even rise.

Worst case: Falling property values in the United States and Europe cause more huge losses at financial institutions that speculated in complex “derivatives” linked to sub-prime mortgages. Another big bank has to be rescued, propelling the credit crunch into a new phase.

Spooked by fears of even greater losses, lenders retreat further. Only house buyers with substantial deposits and unblemished credit records are considered for loans. A vicious spiral develops, with the lack of buyers and fear of further falls driving property prices down even further.

FOOD

The problem: The price of wheat has risen more than threefold in little over a year. Although it has since slipped back, wheat remains far more expensive than it was. Other staples, such as rice, soya beans and dairy products, have also seen sharp rises.

Best case: Wheat prices, which have fallen from a peak in February, drop a little further as unexpectedly good harvests boost global supplies. The resulting lower feed costs for animals ease pressure on the prices of meat, dairy and other products.

British farmers, still enjoying some of their best returns for years, boost production. Combined with a fall in oil costs, food producers and retailers are able to hold prices steady and even cut them on the most competitive items.

Worst case: More than 40% of Britain’s food is imported, leaving prices at the mercy of international markets. Drought, storms and flooding caused by global warming reduce world harvests of staples such as rice below expectations. Prices soar even higher.

As more land is turned over to producing biofuels, wheat prices leap again. Higher oil costs flow through to transport costs in farming and transporting food.

In Britain, consumers find they are spending far more of their disposable income on basic foodstuffs. In less developed parts of the world, millions face real hunger as staples are priced beyond their reach.

FINANCIAL SYSTEM

The crisis: After more than a decade of boom, the international financial system fell off a cliff last autumn as huge losses emerged in the American housing market. Only drastic action by central banks prevented institutions going bust.

Best case: Financial institutions rebuild their economic strength with the help of investors such as the “sovereign funds” of countries growing rich from oil revenues.

Governments and central banks manage to keep interest rates low, thus limiting the pain inflicted on borrowers, especially house buyers.

The losses from the sub-prime housing debacle work through the system and banks emerge restructured. They start to lend more freely once again to each other, to business and to consumers. The economy revives and growth recovers.

Worst case: Sub-prime mortgage losses prove to have been only the trigger for unwinding far greater excesses. As the economy slows and stock markets fall, banks discover that billions of dollars of derivatives – complex contracts that have mushroomed during recent years – are worth much less than previously thought.

Losses are spread throughout the system because derivatives have been so widely traded. Confidence evaporates and institutions have to be rescued by government intervention. Cash becomes king – if you can find somewhere safe to keep it.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

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