The International Monetary Fund, as predicted, is now forecasting that British gross domestic product will contract 2.8pc this year, worse than the U.S., the eurozone and Japan.

Last year we reported here on the first use of the “T” word (trillion) for losses across the banking sector. Now we’re into the “2T” word, a graphic indication of how much conditions are deteriorating around the globe.

The IMF expects the US economy to contract 1.6 percent; Japan to shrink 2.6 percent and the eurozone to decline 2 percent. Overall, the IMF expects the global economy to expand 0.5 percent, its weakest showing since the Second World War.

Economists at the IMF also estimated that bank losses may reach $2.2 trillion, almost twice the $1.4 trillion the organization predicted in October.

It warned that, “unless stronger financial strains and uncertainties are forcefully addressed, the pernicious feedback loop between real activity and financial markets will intensify, leading to even more toxic effects on global growth.”

In Britain, the bank bail-out is already projected to take national debt to 8 percent of GDP, and today the Institute Fiscal Studies warned that national debt levels are unlikely to return to the pre-crisis levels for more than 20 years.

The difficult question of when the current financial/economic slump will end is fraught with complications. However, the answer is really quite a simple proposition.

Assets prices are falling so fast, no financier can back them until a loan against them is guaranteed against loss.

What that means is that asset prices have to find a floor. Only then will the real economy find willing partners in the financial economy and finance start to flow. When will that happen?

Guesstimates vary from the ridiculously optimistic — the British Treasury forecast — to the ridiculously pessimistic — “never”.

In between, the more realistic: “2012″.

From there we may see a slow growth back to financial and economic health, but it will need a sea-change in regulation and business administration. In particular we need to create bulkheads against the madness of globalized swings that can disrupt the strongest of economies. As David Brook wrote in the New York Times:

“We’re living in an age when a vast excess of capital sloshes around the world fueling cycles of bubble and bust. When the capital floods into a sector or economy, it washes away sober business practices, and habits of discipline and self-denial. Then the money managers panic and it sloshes out, punishing the just and unjust alike.”

As the BBC’s Business Editor, Robert Peston points out: “If you combine consumer, corporate and public sector debt [in the UK], the ratio of our borrowings to our annual economic output is a bit over 300 per cent, or more than £4,000 billion [six trillion dollars].”

Those numbers make even 2012 seem optimistic.

The only safe answer is, “Rebuilding starts when there are no more cliffs to fall off.”

A version of this piece appeared recently on The Money Log.

Can we really have witnessed the demise of three top investment banks in so short a time? Bears Stearns, Lehman Brothers and Merrill Lynch have all disappeared off the radar in quick succession.

What is happening to the world’s — and especially the American’s — financial system?

It started with the slicing, dicing and splicing of U.S. mortgages of sub-prime customers. The structured financial instruments that were sold off around the world became known as CDOs (Collateralized Debt Obligations).

They have poisoned the world’s financial system, like seeping toxic waste. Now a new danger is forming on the horizon.

CDSs (Credit Default Swaps — insurance policies for bonded commercial IOUs), which are out there in their trillions and trillions, are beginning to crumble in the face of massive defaults.

The world’s biggest insurer AIG is already in Lehman territory — its shares plummeted by 70 percent in early trading yesterday. The long-foretold CDS crisis is with us at last.

So what precisely are CDSs and how will their demise affect most of us in coming days, weeks, months and years?

George Soros estimates that the value of CDSs now equals half of U.S. household wealth, an almost unimaginable number — let’s call it $23 trillion.

CDSs are hedges made by investors in case a company defaults on its debts. In effect you bet on a company failing to protect your investment in the event it does just that. The problem arises when large numbers of companies go bust and the CDSs themselves become worthless since no-one can pay them out.

A CDS seller undertakes to compensate a buyer if a corporate bond defaults. Since there is no limit to the size of cover taken out, the value of CDSs often exceeds a company’s debts. Moreover, many CDSs are bought with borrowed money so the infection of the system drives deep into the financial heartland like veins in a blue cheese.

The danger now is debt deflation: a rapid reversal of debt issuance, or deleveraging as it is called.

Tim Congdon of the London School of Economics says, “Banking system capital is being wiped out. The risk is that this could lead to a contraction of credit and set off a self-reinforcing downward spiral, leading to the sort of debt-deflation we saw in the 1930s.

“It is already clear that money growth has ground to a halt over the past three months. We must prevent it from actually contracting. If the Fed and European Central Bank don’t cut interest rates soon, it is going to be a problem.”

The Bank of England’s rigid inflation target, set by Gordon Brown when inflation was low, is now a millstone round Mervyn King’s neck at a time when energy, food and commodity price rises are being imported from global markets.

The Eurozone is similarly caught in a time warp relating to Germany’s neurotic fear of hyperinflation. Add the growing divergence between euro economies and a far deeper than necessary downturn is guaranteed for Western European countries.

America is already suffering a double blow: the fading of the effect from the summer tax stimulus and a loss of export competitiveness as the dollar rises.

What began as bad government, worse regulation, grasping banks, financial structures that lacked resilience because they were built on sand, have left us with a perfect storm that is about to come ashore and swallow large parts of the economy.

The European Central Bank (ECB) today defied the threat of recession in many eurozone countries and raised interest rates to their highest level for almost seven years, despite frantic political pressure.

ECB President, Jean-Claude Trichet, issued a strong warning on Wednesday that inflation in the zone could explode if left unchecked.

The decision by the ECB’s Governing Council is set against calls to hold firm from European leaders led by President Sarkozy of France. It comes after a leap in eurozone inflation to 4pc in June which set alarm bells ringing over price pressures. This was further fuelled by a rise in factory-gate producer prices within the eurozone, which jumped 1.7pc in May, to stand 7.1pc up on a year earlier. The hike was largely driven by an 18.2pc year-on-year rise in energy costs.

More depressing numbers were released today confirming that the eurozone’s services sector, which is at the heart of its economy, shrank in June for the first time since mid-2003.

Economists pointed out new indications of “stagflation” in the eurozone economy, with output contracting as price pressures continue to build. They believe that today’s interest rate increase is a single-shot for the rest of the year.

Could that be more in hope than expectation though?