Part III - The Solution

What's the use of discussing the problem if one doesn't provide the solution. So this it then, let us read my version of the solution to this issue.

As the boom began from 2003 and lasted till 2007, the fall will also last till 2013 or 2014. Most of the solutions require a long term approach to resolving our current conundrum. I feel we should stop the austerity measures as they aren't producing the desired results. On the contrary austerity has led to reduced consumption, lower tax collections, high unemployment and a feeling of helplessness among the masses. We need to complement the Monetary Stimulus i.e. the Quantitative Easing by USA and England and Long Term Refinance Operations (LTRO) i.e. lending by the European Commercial Bank at 0% for 3 years with Fiscal Stimulus as the money supply has not met with money demand which has led to inflation as the system if flush with liquidity and there are no other options but to speculate.

EU nations should revert to pay-cuts, pension and labour reforms to make their more productive and reduce taxes to fuel consumption. People will need to accept the fact that the days of superb social security web are over. In the USA banks should be made to realise that the funds that have been provided to them are for lending to the people and not for prop trading. The US government should come up with large scale infrastructure spending measures and alternate fiscal stimulus measures to create employment. We need to emancipate people from their current state of mind. 

EU will need to work together for a solution for the debt-ridden countries, they should be provided with more liquidity and a long term aid package should be finalised without penal austerity and fiscal goals. This will help to remove the insecurity and provide a definite road map for the revival of their Economy and re-entry into the Debt Markets. The current indecisiveness and disparate solutions by different countries needs to go, the stronger countries like Germany, Finland, the Netherlands and Norway need to sacrifice for the long term survival of the Euro. 

For India these measures will lead to higher prices and even higher inflation. If we exclude fuel price inflation from the indices we will see that the other components like agricultural and manufacturing prices can be tackled my taking prudential steps like de-bottlenecking the infrastructure and providing impetus to agricultural reforms. I feel the major beneficiaries of subsidies have been the rich farmers and the middle class, we need to provide them on a need basis and to the deserving. And we need to start making tough decisions pretty soon or the situation will be such that decisions will be made for us. I feel that the latter situation will prevail. It's human tendency to procrastinate and we are seeing this all over the globe.

Let us see what the future beholds.    

The Current State of the Global Economy - Part II

The bail-out funds came with many covenants, fiscal consolidation being the major one. Fiscal consolidation aims to reduce the fiscal deficit i.e. reduce government spending on social security measures like pensions, healthcare education and unemployment benefits. Hence these countries had to cut down on jobs in government departments, increase the retirement age from 55 years to somewhere near 60 years, wage cuts and tax increases to augment government finances. The caveat for receiving further funds was on reducing the fiscal deficit. Subsequently these measures led to large scale protests and resentment among the general public. 

e) USA - Post 2008 USA bailed out its ailing financial sector which included housing finance companies, banks, insurance companies and investment banks. Under Federal Reserve's (Fed) ( USA's Reserve Bank) blessings also several financial institutions were merged with their stronger counterparts. To spur up the economy the Fed came up with a monetary stimulus package called Quantitative Easing (QE) of about $600 billion and reduced the borrowing rate to Zero, this money was used to buy US Government Bonds which was used to bail out the financial companies and help the US Government to meet social security benefits , in layman terms the Fed printed $'s and gave them to the Government to splurge. This infusion of money didn't have the desired effect of increasing the growth rate or creating job opportunities. So in 2010-11 the Fed announced QE II of another $600 billion, this additional funds were used by banks to hoard or increase their cash reserves and speculate in commodity and forex markets, which led to increase in commodity prices without any tangible increase neither the growth rate nor the employment figures. This wasn't the last step which the Fed took, another measure called operation Twist i.e. replacing short term bonds with long term bonds in the Fed's Balance Sheet, this measure was introduced to reduce long term borrowing rates and propel infrastructure spending. But in 2012 the unemployment rate continues to remain above 8% and the number of people receiving unemployment benefits have remained the same. 

f) China - China's biggest trading partner is the US, hence it was thought that post the QE measures the consumer spending in the US would increase on the contrary it has remained at 2007-08 levels and is slowing moving lower and with very little employment growth the signs look bad. So to prop-up domestic consumption to sustain its manufacturing base, China also undertook a monetary stimulus which led to a property bubble and the inflation rate inched above 5%. Mid 2011 China's Reserve Bank increased the borrowing rate and put curbs on real estate lending, this tightening coupled with the slowdown in exports has also slowed down the Chinese growth rate to mid 8% level.

g) India - Recent economic surveys and reports haven't been kind to India. We all know the story by now, policy paralysis, high inflation, huge subsidies, fiscal deficit, current account deficit, crippling infrastructure etc. Last year inflation was the major issue in India which was caused to rise in agricultural commodities, dairy and poultry products and supply chain constraints in manufacturing products. Few of our problems can be because of international issues but the majority have been our doing.

My last part of this series will be about how we can tackle this mess.

The Current State of the Global Economy

June 13, 2012

This is my 1st post realting to Economic scenarios and hopefully many will follow. Currently we are encountering varied issues all over the globe, let me list them down...

1) Japan - Aging population and deflation

2) USA - High unemployment, low growth, low rates of interest

3) China - Propety bubble, falling exports, slowing growth

4) European Union (EU) - High unemployment, high debt to GDP ratios, low growth

5) Australia - High unemployment, low growth

6) India - Low growth, weakening currency, high inflation

The common feature among all is Low Growth and High Unemployment. Precursor to our current state was the Financial Meltdown of 2007-08 and we are still in its aftermath. Let's begin with the EU, which is the main reason for the current crisis. EU countries are currently facing high debt to GDP ratios ( in the range of 70% to 150%), i.e. their debt levels are not sustainable with their current GDP and neither will their economies grow at such a rate that they can repay the interest or the principal. Let us see what led to such a situation for a few of the countries...

a) Greece - Greece's entry into the EU was done in haste and without adequate due diligence by the initial member countries, to shore up member nations that have adopted the Euro, so it could convert into Euro at a highly favourable exchange rate. Greek citizens suddenly became rich as they possessed a stronger currency. The Greek government started borrowing at very low rates due to their EU association. These reasons coupled with an unproductive economy, high social security benefits and low retirement age made them profligate. To sustain such high levels of social security benefits, the government got into a debt spiral in which they had to borrow more money to pay the interest on the initial debt. This situation was sustainable till the world markets were flush with liquidity, but the 2007-08 crisis which led to a trust-deficit made borrowings by such profligate economies expensive as liquidity dried up and lenders became sceptical. Now the government could not mend its ways hence they started borrowing at higher interest rates compared to other EU nations. Earlier they were borrowing at 2% - 3% now the rates rose to 7% for a ten year note, a country which doesn't have the means to even pay the interest on such loans and has a GDP growth rate of 1%-2% can't sustain such a high cost of debt. If Greece had the power to print the Euro it could have easily repaid these loans, but the EU doesn't have a monetary union which allows its member countries to print notes and get out of jail. The EU treaty has a mandated the European Central Bank (ECB) to expand money supply i.e print notes at a certain fixed level. Eventually it had to approach the member countries for a bail-out.

b) Ireland - It also had similar story as Greece and it also had to approach the EU countries for bail-out.

c) Iceland - A non-EU state had a huge boom in real estate prices, being a country having a small population such price rise was unsustainable and had attained bubble proportions. The exposure of 2of the largest banks of Iceland in real estate loans was higher than the GDP of Iceland, when the 2007-08 financial crisis struck it was the first nation to seek help, the real estate bubble burst which lead to huge non-performing loans following which the banks faced huge losses. These banks were bailed-out with government i.e. tax-payer and IMF borrowed funds. Iceland was in a favourable position because it could print its own currency which was severely devalued during the real-estate crash and due to which it could restrain foreign capital from leaving its shores.

d) Spain - Spain also saw a real-estate bubble which was propped up by Cajas (Loca Savings Bank are known as cajas), the typical case of sub-prime lending. Even its real estate bubble burst post the financial meltdown and the Cajas are sitting on potential NPAs of billions of dollars. Just a few days back the EU sanctioned a $100 billion bail-out package to re-capitalise these banks.

Similar story resonates around other EU nations like Portugal and Italy. Till now Iceland, Greece, Ireland and Portugal have received bail-out funds from EU and they have stopped issuing fresh notes as there is no  market for their debt instruments. Greece's 10 year note has a yield of 27%. All the nations (except Iceland) approached the EU for assistance after the yield on their 10 year notes crossed 7%. As of today the yield on Spanish and Italian 10 year notes is 6.5% and 6% respectively and rising.

This the background of the current imbroglio and in the following post I shall provide further details with regards to the measures adopted by the EU, current state of the economy in the USA and China, and finally the impact of all this on India as well as our own follies.