Issue and Position
The crisis that we see in the world today is not actually a crisis of just debt face by the governments all over the world. It is result of the over leveraged balance sheets of banks internationally that has sparked off the global meltdown in the markets all over the world, not just capital markets but also the overall economic activity. The governments all over the world have resorted to borrowings to provide a stimulus to their economies. Some economies like China are also pursuing a policy of aggressive stimulus to escape at a velocity which would surpass any upcoming slow growth phase. However the governments do not realize one basic fundamental principle that when the problems are structural, it should be tackled to strengthen the fundamentals. For example, The BASEL Committee norms on ensuring banks’ capital adequacy to ensure cover against systematic risk is one such fundamental improvement. However the Budgets of the countries over the world are in bad shape. The reason the crisis have emerged again this year is because the resurgence in the world economy was spurred by artificial stimulus created by governments and since the government money is now drying up, the fundamentals are now floating up again, which unfortunately are in no better than in 2008. Thus it is not the right direction that governments have taken since the start of the crisis.
Detailed Background
The Historical origin of the crisis has taken place mainly from the failure of banking systems especially in the major western economies. Their failures lead to financial system’s failure and also of the insurance companies like AIG and others. The sub-prime papers of the markets were also the underlying for the (toxic asset) derivative products like MBSs and CDOs. Thus overleveraging of assets was the main reason for the banks’ failure. Also another important reason for the current GDP growth in US and Europe is the unemployment and the resultant lower disposable income in the hands of consumers. Thus the domestic economy has not much strength left. The lifestyle of the people in the west is the main reason behind the emergence of the crisis which has grasped the world.
Relation to International Community
The countries of the world are no longer in isolation. Thus a decrease in interest rates in US results in greater FII flows in India to catch opportunity to make extra money because of high interest rates in India. Thus it is a crisis which affects all the countries equally. They all need to bail out one another in order to take the world economy back to the growth trajectory. If one country defaults, it is followed by a series effect since trading partners are all connected to the economy of the defaulting country.
Previous Actions
There have been many previous actions taken by the various governments in this regard. The European governments (EURO Region) are bailing out smaller countries to keep Euro afloat. PIGS countries are the primarily affected. The US government bought the toxic assets and also rolled out massive stimulus in the form of very low fed interest rates of 0.25%. This means the cost of money is virtually free in the US. In China and India and other emerging markets too the Central banks reduced the central bank lending rates to stimulate the flow of money in the economy. Also the US government brought restrictions the jobs given to migrant workers and students working in US. Also stress was given to bring back jobs to US. Similar steps were taken by UK. The Emerging countries diversified their reserved to save themselves from the situation. Commodities became the hot spot and that is where China invested. This lead to a rally in commodity prices and Inflation shot up in world.
Success & Failures
The actions taken by the governments have been successful for some time. The capital markets were back on track and confidence was back in the banking industry which was most delicate in the crisis. There were few quarters of good GDP growth. But problems emerged again when the stimulus lead growth ran out of steam for countries and fundamental again started to emerge. The important development was investment by CHINA IN COMMODITIES. This lead to a global race between countries to conquer natural resources to buy them at cheaper costs today than to pay a high price later on. Thus Demand went up and inflation shot up significantly. This has lead to fear of stagflation in western countries. Also the unemployment numbers are consistently weak in US at around 10% since a year.
Problem not addressed
The main problem not addressed by the west, and which the emerging market is paying for, is the problem of bank leveraging. The banking system is too flexible and instruments floated are too complex to make sense of the sustainability of the economy as a whole, leave alone the banking system. Also the typical western habits of Outsourcing had led to the habit of deriving more profits consistently by hiring cheaper labor elsewhere. This has pushed up unemployment and greater responsibility on governments to stretch their budgets. The typical spending habits has led to the creation of their own problems.
Proposed Solutions:
1) Banking System: There is a need to very strictly regulate the banking system. Like in India there needs to be systematic watches and curbs on too much leveraging. Also banks need to have more CASA deposits in west to cover for their underlying securities. The US government and Federal Reserve need to hike interest rates. Also the spreads for banks should be allowed to be hiked. This may be uncompetitive but it is better for the economy in the long run. The demand for credit will come down and over leveraging will reduce. This will indulge bring down the habit of over leveraging by people and high deposit rates will indulge saving habit in people. This can significantly impact the financial system. The FII money can get diverted back to US with increasing rates of interest. Same thing can be applicable to European companies as well. The global imbalances in trade can be reduced through this and capital markets will be more stabilized.
2) Employment: One of the main reasons for the slower growth of domestic GDP of west is the lack of disposable income in hands of the people. The government should implement laws to bring back the outsourced jobs and employ the citizens of the country. This may be painful in short term since it impacts the profit margins hard especially in downturn, but in the long run, it will be good for the domestic growth of the economy. This policy can be implemented gradually on case to case basis.
3) Greater involvement of Emerging Market Group in World Economy: There should be a greater participation of Emerging markets in major organizations. For example India and China are actually powering the growth engines of the world economy today and helping it keep its head above water. Thus these countries should be given better say in international politics and decision making. This will make the world politics a multipolar affair. Hence there can be no single country or superpower whose economy once affected will affect the entire world. Example of US is perfect in today’s scenario. The participation or greater number of countries especially emerging nations will bring together resources, knowledge and wisdom to solve the current Dect Crisis which is standing on a Stranger position today. It is like investing in a portfolio of assets which is diversified to as to absorb the risk of loss of one to another and enjoying the co-relation between them to make the portfolio grow along with shock absorbing capacity.
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