Governments and Global Crisis PDF Print E-mail
Political Science
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“While the stock market is dominating the headlines, the more important story is the grim news about the real economy,” stated the NewYork Times some time ago. “Rescuing banks is just the beginning; the non-financial economy too is in a desperate need of help”. A series of indicators point to the fact that there is no doubt that the US recession is already under way.

In September 2008, US industrial production suffered its sharpest drop in 34 years
(-4% month to month), partly due to a “dramatic fall in new orders” (the drop was exaggerated by Hurricane Ike and a strike at Boeing).

Sales of construction equipment have slowed by 24% in 2008 and are expected to drop further by 20% in 2009.

The junk bond market is signalling a deep recession, current risk premium is about 15% which indicates a spike in the default rate to a level last witnessed in the 1930s.
The real estate market continues to be under pressure. Roughly 12 million US households or 16% of the total population, hold negative equity in their home, up from 4% in 2006. Experts expect further slide of prices by 10 to 15%.
There has been a decline of almost 1.5 million in payroll employment in the year 2008 (half of which occured in the last quarter). The unemployment rate has doubled in one year.

Weak labour market figures, combined with high level of debt (around 130% of yearly income) and deflating value of assets (stocks and real estate) has drastically reduced the US consumer confidence from 80% to 50 % in one year. Retail sales have decreased for four consecutive months (in spite of Christmas, New Year and school beginning period). This indicates that this time American consumers will not help to bail out the US economy.

Credit card companies have announced heavily increased provisions on the back of deteriorating credit quality. Their write-offs have increased by 50% in one year, to nearly 70%.

Europe also offers equally dismal picture. Eurozone and United Kingdom entered a recession in the last quarter of 2008. With two consecutive quarters of real GDP decline, the Governments in Eurozone formally accepted the beginning of recession.
The composite Purchasing Managers Index (PMI) of the Eurozone, an important business sentiment indicator, decelerated  month after month driven mainly by a fall in new orders.

Monthly retail sales have decreased steadily. Spain, Ireland and the United Kingdom have their own real estate bubbles to cope with – all of which have burst.

Meanwhile, Germany – which, by virtue of its status as the world’s largest exporter has long been deemed to be a stabilising element in the Eurozone – has experienced a steep reduction in orders in its export industries. The IMF announced assistance to Ukraine and Belarus, and Hungary has increased interest rates to protect its currency. These actions indicate that the repercussions are not restricted to the developed economies.
The Asian economies are in much better shape than they were ten years ago. They mostly have solid public and private finances and a cash surplus built on successful exports. In spite of that, signs of slowdown are visible.
The Baltic Dry Index, the benchmark for global freight costs, has fallen by 50% in the last four months. This indicates shrinking global demand for commodities.
Major mining companies see lower demand from China and other Asian countries, with these exporters affected by a slowdown in Europe and the Americas.
The prices of key raw materials such as steel, copper, nickel, sulphur, oil etc. have dropped sharply in the last four months. CRB, the global commodities index, has halved in the last six months.
Lower raw material prices will lead to lower income further slowing the economies of the West.

Meanwhile, the currencies of several Asian countries have depreciated rapidly against the US dollar due to outflows of funds from their countries. The Reserve Bank of India has supported by cutting the repo rate from 9% to 6%.

South Korea recently followed Europe and USA in supporting banks, guaranteeing 100 billion dollars of its banks’ foreign currency borrowing, as well as providing 30 billion dollars in liquidity. The growth rate in Asian countries has come down but they are still far away from recession.

In 2006 and 2007, the global GDP has grown by 5%. IMF now forecasts that this growth rate will come down to 3% in 2009. There are many lessons to be learnt. The claims by some politicians to have solved the inevitability of economic cycles ( the promise of no more boom and bust) have proved to be empty. The leading central banks focussed on controlling consumer inflation but allowed asset inflation to get out of hand. While they thought that this would help them beat the economic cycle, it actually meant that they were storing up even worse problems.

IMF has warned that recessions accompanied by financial crisis tend to be “two to three times as deep and two to four times as long” and lead to “negative growth of 4.5% of GDP”. Several factors increase the risk of a prolonged and severe downturn.
Record high levels of debt. The underlying cause of the current difficulties are the record-high levels of debt of households and the private sector in major economies such as the United States, the United Kingdom and Spain. As households struggle to restore their balance sheets amid deflating asset values, zero saving rates, and the increasing risk of unemployment, demand will continue to be weak.

Unclear effects of recent government interventions

The effectiveness of the recent measures to stabilise the financial sector remains to be seen. Open risks in the market for credit default swap (CDS to tallying about 58 trillion dollars) are still unclear. The refinancing needs of corporations and cities. About 800 billion dollars of outstanding debt will need to be refinanced by the end of 2009. About 30% of this amount is speculative grade, and it will be challenging for such companies to get capital. For investment-grade companies, refinancing should be available, although at significantly higher costs than in the past. Beyond the corporate sector, some municipalities face serious debt problems similar to those experienced by New York City in the 1970s.

The increased risk of protectionism

The US Government has subsidised Detroit with 25 billion dollars to support development of new technologies for auto industry and France supporting its auto industry directly, by supporting R&D and indirectly, by structuring tax laws in favour of smaller cars. Such signals are being amplified in the corporate sector, with companies favouring domestic manufacture and cutting it abroad. United Kingdom is likely to impose stricter rules on immigration to protect local labour. President Sarkozy of France has proposed to take direct stakes in industries to protect them from foreign ownership. Germany has already declared opposition to foreign ownership of strategic industries. Indeed, there is a risk of increased tensions between countries; and the recession has only just started.

Similar actions from Governments were seen in the past. Federal Reserve lowered interest rates quickly after the crash in 1929 and supported banks as well. After the bursting of real estate bubble of the late 1980s, Japan faced a malaise in the 1990s, but could build on a very high savings rate and low government debt. Sweden has seen a crisis in 1992. They nationalised the banks which helped in stabilising the market with simultaneous devaluation of Kroner.

The economists are asking governments to take more steps and fast, however, the governments with limited resources are still mostly in wait-and-see mode. In some countries, the burden of debt is drowning households. Troubled countries are being helped to restructure their debt, and corporations can file for protection from their creditors. In the same way, it may be necessary to launch a programme to help distressed households.

The governments own the responsibility of making policy decisions to direct and govern the economic activities in the respective nations. In so-called free market economy, people have taken the freedom (and government has given it) to earn and spend as per their desire. Obviously, in the individual’s desire, the individual’s gain prevails over the society’s gain. When individuals were able to corner the wealth, they did not want government to interfere and now when the individuals have failed (rather they have messed up), they are looking forward to the help from government saying that government is supposed to take care of the public.

When governments are trying to rescue the troubled companies and banks, they are doing it at the cost of other tax payers. Senior executives of banks and companies have walked away pocketing billions of dollars as their salaries and bonuses leaving the companies’ budgets in deficit and now they expect government’s help to protect the interest of small investors and depositors who are members of general public. Governments have no choice but to rescue these institutions because they do not have alternative model for managing society’s wealth.

Therefore PROUT says that no individual should have the power to play with the society’s wealth. The utilisation of funds deposited by general public in banks and financial institutions must happen with the permission of those depositors, and people who manage those funds must have high moral character and control over their selfish propensities. Such high moral character and control over selfish propensities can be achieved only by adopting spiritual path of life.