The G-20 pledged 1 trillion dollars to multilateral agencies to support poorer countries in getting bettwr access to credit. Will this help in speeding up the world economy to come out of recession. Te leaders think so, so i thought of putting together an alternate opinion that it may do just the opposite.
To start with, let’s trace back to where it started. Financial institutions, through complex instruments, raised the value of housing. Fuelled with speculation, the stock markets started to look good. While the real income did not grow, the opportunity to make money on the stock markets (including overseas) makes the consumer borrow more. This spiral was fine till it reached unsustainable position. That was the start of the fall. It spiralled out of control; people could not pay leading to a spate of foreclosures. The value of the assets started falling; leading to the financial institutions losing their ability to raise money to sustain themselves, and suddenly demand starts to shrink all around. The various governments starts to band-aid the institutions, but, as the fundamentals remain weak these bail-outs are not helping. GM continues to face bankruptcy, Citibank continues to remain iffy – the story is the same all over.
In the midst of these, many companies started “paying” bonuses to executives and that creates a hue and cry. Some back-off, others turn cautious while still others start playing to the gallery.
The first noises of protectionism is heard, the world starts getting divided, and all starts raising the pitch of the spectre of 1939, when protectionism apparently delayed the recovery. The countries in favour of protectionism starts backing down, but have not abandoned it.
Now comes the trillion dollar plan and not to forget the tighter international banking regulations.
There lies the problem. Will the trillion dollar (and all other bail-outs) help raise the value of assets to those levels when the institutions can continue to conduct business before the fall. The answer is no. The bail-out is like an extra cylinder when the patient is in ICU. Till such time the value of the assets does not start moving up, you are postponing the problem. In addition, you are creating a new problem, protectionism in another form. While earlier the institutions could raise funds internationally, now that route will become restrictive, so there will be less funds available or less free flow of money. I think the bad guy is not us, so I will make it difficult for the guy to take money from me.
All the bailout money is like water poured on sand, disappearing faster than you can give. Now somebody will have to cough up the bailout money as it is presumed gone forever. See the problem. It will only add to the woes quite reverse from what it should be doing.
So what will happen
Worst case:
You cannot bring interest rates down any further (unless you adopt Islamic Fundamentals), deflation will take place as people do not have the money to buy. Economies will shrink, for the moment unemployment will rise, salaries will decrease, parities between wages (developed and developing countries) will narrow, employment will start to rise again locally, and slowly (in about 5 - 7 years) things will start looking up. Credit card usage will fall, and so will easy loans. In the end, the world will be poorer in monetary terms but emotionally happier and mature. Industries worst hit will be “lifestyle” related industries. Earliest recovery will be seen by the “essential items” industries and generally unaffected the “luxury” industries.
Best Case:
The bailout money is used by the financial institutions to sell off the assets at a loss and using the bailout money to fund these losses. In parallel they start cutting down the cost of operations, not by removing people (and keeping the same lifestyle for the others), but by reducing salaries, bonuses etc. so that people survive with less. Recovery will take time
There is no place for GM here, they are far too out of phase with the reality to make it.
What would I prefer? The worst case as the recovery will be faster and the learning will be deeper. Yes the pain will be deeper, but the pain will be borne by more or less the same people who created it – that is fair.
The root cause of the current crisis is countries and individuals have gotten into the bad habit of living on debt. This is an opportunity to understand how to cut your coat according to the cloth and not to die with a debt burden. Carrying debt is a multi-life burden; you are born again and again till you are completely (debt) free as says the Hindu thought. Not a bad approach.
