2012 and beyond

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[siamak]

The diminishing wealth

Last year when the depth of financial crisis became apparent the US Feds started to aggressively cut interest rates, in the hope of reducing the severity of the crisis. Other countries specially the Europeans soon followed the Americans in cutting their interest rates. As the crisis spread to Asia and the Middle East, they also began to cut their interest rates. But soon it became apparent that this crisis was not like any they had seen since the great depression and simply cutting interest rates was not going to solve the problem.

To start with the housing market had collapsed completely leaving many banks holding worthless pieces of paper. In addition, these papers were (partly) insured by many insurance and financial institutions that weren’t banks, but because of financial deregulations, had acted as banks. They were also hit by the bad mortgage problems. In short, all the financial institutions, banks, insurance companies and others were suddenly in trouble.

This hit the stock markets, with the shares of these institutions taking a nose dive. These institutions are extremely important for the economy. They provide the logistics for financial transactions. Any problem here affects all parts of the economy. So it was not a surprise to see that all normal financial transactions suddenly came to a halt, hitting other sectors of the economy. Share prices of all the affected sectors began to go down and with it the fortune of the share holders. To see the extent of the damage done one just has to look at how much various stock markets have fallen.

The following stock markets data was published by The Economist (21 Feb. 2009) which shows the extent of the fall since Dec 31st 2007:

US (NAScomp) - 44.7%, US (DJIA) -43%, US (S&P 500), Japan (Nikkei 225) -41.3%, China (SSEA) -55.1%, Hong Kong (Hang Seng) -52.9%, Canada (S&P TSX) -53%, Australia (All Ord.) -61%, Britain (FTSE 100) -55.8%, Euro area (FTSE 100) – 59.5%, Euro area (DJ STQxx 50) – 58.7%, France (CAC 40) -56.1%, Germany (DAX) -55.3%, Greece (Athex comp) -73.7%, Italy (S&P/MIB) -63.1%, Netherlands (AEX) -60.4%, Norway (OSEAX) -64%, Denmark (OMXCB) -55.2%, Sweden (Aff.Gen) -57.7%, Russia (RTS, $ terms) -77.1%, Turkey (ISE) -70.3%, India (BSE) -64.9%, South Korea (KOSPI) -62.6%, Taiwan (TWI) -50.5%, Brazil (BVSP) -53%, Argentina (MERV) -56%, Mexico (IPC) -52.9%, Venezuela (IBC) – 55.6%, Saudi Arabia (Tadawul) -56.8%, South Africa (JSE AS) – 54.1%.... WORLD all (MSCI) -51.2%.

For people in general, shares act both as saving and investment. The average person buys share in hope of getting better return than the banks. It is also easy to get in and out of the market. The advancements in information and communication technologies, the costs of buying and selling have fallen steadily in the last decade. So now anyone with a computer can buy and sell shares. This ease of entry enticed an ever increasing number of ordinary people to enter the stock markets.

Now the people have been hit by three disasters. First they lost a lot of money in the housing market. This was both real and illusory. First they were hit with the housing crisis. Many have lost their homes or have seen the value of their homes depreciate heavily. Then they were hit with the collapse of the stock markets. Trillions of Dollars, Yens, Euros and Yuans have been wiped-out in a relatively a short time. Then many have lost their jobs and many are uncertain about the future job security. All these have had a tremendous impact on the consumers, forcing many to heavily reduce their consumption, which in turn have begun to affect businesses which in-turn are shedding workers to compensate for the loss of sales and revenues. This is a classical deflationary circle that feed on itself.

The governments’ response to this threat has been to stimulate the economy by pumping large sums of money into the economy. A decade ago, a hundred billion dollar was an astronomical sum. Today we don’t even bother to look at it twice. Today we talk of Trillions. A few hundred billions here and a few hundred billions there soon add up to a few nice trillions; especially the trillions that we don’t have.

Now we face a classical problem: the increasing budget deficits. Exactly when the economy is contracting and tax receipts are falling, the government expenditure is rising rapidly. In addition, the governments are buying bad debts (US, UK, etc) and trying to spend more on whatever they can in order to arrest the increasing unemployment and stimulate the economy. These large sums have to come from somewhere. They can be borrowed or money can simply be printed. The problem is that some governments are opting for both.

The most important economy is of course the US economy. The US government under Bush spent close to one trillion dollars, and now the Obama administration is promising to spend trillions in the years to come to stimulate the economy. With official US debt now close to 11 trillion dollars and climbing fast, the situation is becoming untenable. According to treasurydirect.gov, last year ( 2008 ) US government paid $451 billion dollars interest on its debt. Add to this the Medicare and social security obligations and suddenly things look a lot worse than they appear.

So how can the US continue its deficit spending? By issuing treasury bonds and other security certificates of course. Both public and foreign governments buy these securities which are guaranteed by the US government. According to Reuters (February 18th 2009), foreign central banks alone held $1.76 trillion dollars in US treasuries. According to the same report “The combined holdings of Treasuries and agency securities by foreign central banks at the Fed totalled $2.573 trillion, up $11.223 billion”.

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