A dollar default is unthinkable in these affluent modern times. Or is it?

Last week a “flight to safety” of investors in America’s $3.5 trillion Treasury money market was only halted by Secretary Henry Paulson’s swift action in nationalising the banking sector’s bad debts.

Read The Great Harvard Sausage Scandal 2008 over at Syntagma.

Of course, most of the movers and shakers have already salted away their massive bonuses and are probably even now relaxing with a cocktail or two on their yachts in Monte Carlo harbour.

They have left us with a colossal mountain to climb. In the UK, house prices have a further 25-30 percent to fall, according to Roger Bootle, and already Britain’s largest mortgage lender, HBOS, has failed. How many other banks will go before we hit bottom?

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Mark Hake, an analyst at Merrill Lynch, says the British housing market could take 20 years to recover from its current downturn.

Merrill, one of the City of London’s leading investment banks, said, in a note to clients, ” … it looks significantly worse [than the 1990 downturn], with house prices falling faster and further and very little recovery in real terms expected over 20 years. … House prices are expected to be below their August 2007 peak in a further 10 years’ time.”

The bank forecasts house prices to fall by as much as 17 per cent this year, while inflation is set to continue its upward march in coming months as the economy absorbs the effects of higher oil and food prices.

To add to the woes, David Kern, economic advisor to the British Chambers of Commerce, thinks unemployment will rise to nearly two million by the end of 2009. He commented, “The results of this survey signal a menacing deterioration in UK prospects We are now facing serious risks of recession. London appears pretty weak and it’s across the board. Businesses are in a lose-lose situation. Falling demand and the squeeze on consumer disposable incomes will limit how far prices can be increased.”

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?

In what seems to be a concerted action by the UK Treasury and the Bank of England, Bank Governor Mervyn King warned that pay demands for inflation-busting increases will be self-defeating if they trigger a rise in interest rates.

The Governor told the Treasury Select Committee of MPs that there is no magic bullet to protect workers from having their incomes squeezed by rising prices and interest rate increases. They could help themselves by avoiding excessive pay claims to cover the rising cost of living.

Cash-strapped families will find no shelter this year from rocketing oil and food prices.

“We are all in this together,” he said. “The most important thing is there’s no magic bullet that will protect the UK from higher oil and food prices imposed by the rest of the world. It is better than we face up to that now and recognize that fact, rather than pretend to ourselves that we can avoid it.”

MPC member, Tim Besley, said: “We have to adjust our living standards. One of the mistakes we can make collectively is to believe that by bidding up our wages we can somehow insulate ourselves from a global phenomenon – rising energy and food prices. If we do that that is a self-defeating process which will lead to higher inflation and wages will not end up being higher.”

Mervyn King said, “The cost of reducing inflation once it stays above the target for a period will be a very prolonged and deep slowdown in activity.”

With the housing market in meltdown, the next three years are set to be painful for everyone, with the possible exception of short sellers on the markets and the oil companies.

Ordinary folk need to batten down the hatches now, cut expenses to the minimum and protect their income sources as best they might. It’s not in the interests of the High Street, of course, but, for a few years at least, it’s everyone for himself.

One thing’s for sure, conditions will take the focus off rather abstract globalization matters, back to the real, local world that everyone lives in.