News APP

NewsApp (Free)

Read news as it happens
Download NewsApp

Available on  gplay

Rediff.com  » Business » This crisis ain't going to disappear soon

This crisis ain't going to disappear soon

By T N Ninan
February 07, 2009 14:55 IST
Get Rediff News in your Inbox:

What governments are doing to tackle the economic crisis raises uncomfortable questions. Take the problem of excessive US debt, which has grown from being equal to US GDP in the early 1980s, to being three-and-a-half times the country's GDP today.

That is the result of the US government living beyond its means and running up massive fiscal deficits, of US households going overboard with mortgage obligations and credit card debt, and of the country running an annual trade deficit of about 5 per cent of GDP.

The common sense solution to excessive debt is a cutback in consumption, and using the money thus saved to repay debt; it is what the International Monetary Fund would ask every non-American country to do. The problem is that a recession normally prompts more spending, not less.

And so the budget deficit this year is officially forecast to be 8.5 per cent of GDP, and predicted after the Obama plan to climb to 14 per cent - by far the highest since World War II. To be sure, these are crisis times and you have to set aside your usual rules. But good housekeeping at the end of the day has to follow the same rules, and if the government keeps borrowing and printing currency notes on this scale, the chickens will come home to roost.

What of the trade deficit? As American financial firms pull out of international markets in order to deal with the crisis at home, they have taken dollars into the US - and this giant sucking in has meant that the US currency has gained against virtually every other currency in the world.

The pound used to be equal to nearly two dollars; now it is $1.45. The euro used to be $1.66; it is now less than $1.30. A stronger currency means cheaper imports, and more difficulties for American firms trying to export. In other words, the trade deficit too is likely to get worse, not better - and the US' international debt is about to grow further.

These developments are building more imbalances in an already unbalanced world, not reducing them. The Obama administration has responded by putting pressure on China to revalue the yuan, using the old argument that China shares the blame for the imbalance. It is a view that the Chinese prime minister dismissed with uncharacteristic bluntness earlier this week, as 'ridiculous'. So there isn't much joy to be expected from that quarter.

Perhaps the best news in this scenario is that the recession itself, and the GDP shrinking by 2.2 per cent this year. To be sure, no one likes the thought of 9 per cent unemployment, which is what has been forecast, especially since it is a level hit only once since the Great Depression of the 1930s.

But all the evidence of Americans postponing consumption and staying clear of shopping malls and car showrooms suggests that individuals are taking the sensible course of cutting spending, in order to cope with their debt overhang. This process will have to go on for some time, perhaps many years; after all, you cannot wash off overnight the sins accumulated over a quarter century.

But what is the government to do? A developing country would devalue its currency in order to address the trade imbalance, and allow some inflation - which automatically increases nominal GDP and thereby reduces the proportionate scale of the accumulated debt, thus making it more manageable.

But inflation during a recession is contradictory. And the sole economic superpower does not want to go down that route, or dethrone the dollar, or for that matter practise Third World economics. All of which is reason to fear that this crisis ain't going to disappear any time soon.

Get Rediff News in your Inbox:
T N Ninan
Source: source
 

Moneywiz Live!