How has this sudden capitulation taken place in such strong and vibrant economies? Why Europe, even US is reeling under the pressure of mounting debt. On 30 June 2010, the Congressional Budget Office(CBO) in US predicted that US debt will reach 62% of GDP by year end, which happens to be the highest percentage since just after World War II. Further, China happens to be the biggest creditor to US and also has huge exposure to Euro in its reserve. So you see, with every crisis of US and Europe in terms of debt servicing, China will be wincing in pain. Many South Asian economies will do the same since their economies in turn are China-centric. In other words Asia will be in pain whenever Europe and US feel the heat of sovereign debt default. As for African nations, most of them are already so badly managed economies that they figure in the Forbes list of top ten worst economies of the world. Since they depend on US and its financial organizations giving aid in some form or the other, Africa also will be under the weather with US economy in spot. That leaves us with South American nations. Well most of those economies are fully dependent on trade with US and hence will be effected too, if US is forced to go through austerity drive to curtail its fiscal challenge. In short, the entire world is under threat of an impending economic crisis.
But our central question still remains unanswered. How has this catastrophic situation come about? What has triggered this avalanche of economic woes upon affluent nations? In quest of an answer let us proceed step by step in the following direction :-
- The US sub prime crisis had morphed into global credit crisis of epic proportions. As we had seen in my last post on 12th June 2010 titled "Wall Street Shenanigans - Is Iconic Brand US Under Threat?", billions of dollars had been lost by global financial institutions in the wake of sub prime crisis. Every financial institution worth its name was on the verge of being bankrupt.
- These financial institutions were the backbone of every nation and this backbone was under threat of being broken. That is when Governments had to step in to save these financial institutions. It was a rare display of synchronized actions taken by all nations as they pumped in billions of dollars to save their terminally ill financial institutions. Such heavy injection of steroids(bailout money) is being popularly referred to as "Stimulus Package".
- This unified stand taken by all nations speak of the severity of threat of annihilation, since politics of nations has never before allowed the world to be united on any single issue. But this time was an exception, a time to unite for survival. On 28Mar2009 in a post titled " Aftermath of Global Slowdown" I had emphasized that for the leaders of G20 nations, meeting on 02Apr2009, it was their last chance to steer the world away from global catastrophe. And this time leaders of 20 most powerful nations united to deliver what is now popularly known as "Stimulus Package".
- Apart from many actions which increased liquidity, Governments across the globe injected money to bail out their financial institutions who had lost billions to the machinations of Wall Street investment banks.
- This bailout money eroded the coffers of nations making them credit unworthy. Injection of bailout money to save financial institutions at that point was unavoidable, but then measures should have been taken to ensure that this money was used for activities that kickstart economic revival. Instead billions of dollars again ended up in the kitty of people who planned and executed sub prime crisis in the first place. Take the example of AIG taking US tax payers' money as bailout to the tune of $182 billion and immediately paying off counterparties like Goldman Sachs and other Wall Street banks at 100% on the dollar. No negotiations?? Joseph Cassano, former head of AIG's derivatives unit, appearing before Financial Crisis Inquiry Commission, said he could have saved tax payers billions of dollars by negotiating harder with banks. Are the American tax payers paying attention?
- So instead of reviving the economy with activities which create jobs, these billions of dollars of stimulus money were siphoned off to people who have again used it for more speculative purposes like dollar carry trade. To read more on dollar carry trade do look up my post on 27Nov2009 titled "Dollar Carry Trade - Easy Money in Difficult Times".
- With no revenue generation activities and empty coffers of nations, time had to come when debt servicing and debt repayment by nations was to become difficult. And that time has now come upon the world in the form of impending Sovereign Debt Default. To get a grasp on the implications of Sovereign debt default it is recommended that you visit my post of 18Dec2009 titled "Sovereign Debt Default Scare - Is Dubai Too Big To Fail?".
Stimulus Induced Growth that we have seen for the last one and half year is at its end. Having taken not enough measures to induce structural economic growth, US is on the path of double dip recession. And history tells us that the Great Depression of 1929 got prolonged for similar reasons. You can get more details on stimulus packages in my post of 17Jan2010 titled "Stimulus Induced Growth - Is It Global Recovery On Steroids". At this stage it is judicious to remember that earlier World Wars were basically fought not for ideological or emotional reasons but for economic reasons, sparked by trade wars. I hope the world leaders are listening.