Economy In Crisis: How Global Financial Crisis Affects India & The World? US Economy is in worst recession since the Great Depression and the Federal Government of the United States has already announced the enormous amount of bailout package to help the ailing Financial System. After Obama's inauguration, the question arises - will the Obama Administration fulfill their promises they have made during the election campaign? In our "Economy in Crisis" series, we had earlier discussed about the economic future of India especially in the year 2009, which tells that the global economy would continue to contract till H1CY2009 - afterwards we might see growth in the global economy or at least the downfall should be stagnated. Since, the US President Barack Obama has won the Presidential Elections in Nov, 2008 there are lot of anticipation about how the global economy would shape under his leadership. As he understands the current economic mess, he also believes that the damage to the economy has already been done. Now, the economy is in dire situation - needs an urgent action to impede the Depression type of risk to the global economy. But, how the US deal with this dreadful circumstances which affecting the global economic growth? Americans has borrowed and spent beyond their ordinary means and put the economy in deep trouble. Banks lent astounding amount of money to homeowners without having concern of credit, certain that real estate prices could go up. US President Barack Obama has said in his inaugural address, that the "challenges are real and they're many". The Economic crisis is his top priority and effective policies are needed. Unemployment rate soared to over 7%, though some economists believe the real jobless rate, including discouraged workers and part time workers, is closer to 14%. On the other side, Housing prices ceaselessly falling and have lost over $3 trillion in its value since the mid 2007, banks becomes paralyzed after huge amount of losses and afraid to fresh lending, US deficit inflated to record $1.19 trillion for the year 2008. In the year 2008 alone, the Federal Government of the United States has announced bailout of over $1.369 Trillion and the Federal Reserve has announced $2 Trillion emergency Fed Loans by expanding its balance sheet from $900 billion to over $2 trillion. But the big question is where does all this money come from? Projected US Deficit and Surplus Projected US Deficits Deficits in Billions of US Dolllars 1,400 1,200 1,000 800 600 400 200 0 2008 2009 2010 2011 2012 2013 2014 2015 US Def icit 455 1,186 703 498 264 257 250 234 (Billions of US Dollars) Actual 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 On-Budget Deficit -638-1,340-843 -641-412 -413-411 -398-434 -393-342 -381 Off-Budget Surplus 183 155 140 143 149 156 162 164 162 159 154 146 Total Deficit -455-1,186-703 -498-264 -257-250 -234-272 -234-188 -235 Source: US Congressional Budget Office (CBO)
US is the largest debtor nation with over $10 trillion of national debt and to fund its trillion dollars bailout package, US will print more money or sell more treasuries. Initially, US have already started issuing fresh debt to finance its initial $700 billion Wall Street bailout package. Now the obvious question has arisen - who will finance this massive bailout amount. Of course, the Asian Tigers, which hold $4.35 trillion in foreign reserves. US need coordinated action from the East. The global leaders has already argued that the G8 (Group of 8 Developed Nations) won't work on this massive financial turmoil, however the Nov-08 meeting in Washington D.C. when the former US President George W. Bush has called the G20 nations to joint hands cooperatively to undertake the global economic crisis. G20 nations which includes the fastest growing economy such as India, China, Brazil, Mexico and Russia has enormous amount of foreign reserves. In which China has accumulated large chunk of foreign reserves. China s Trade with the United States and its Foreign Reserves China's Trade With The United States China's Foreign Exchange Reserves Value in Billion of US Dollars 350 300 250 200 150 100 50 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 In Billions of US Dollars 1900 1700 1500 1300 1100 900 700 500 300 04 04 05 05 06 06 07 07 08 08 US Exports US Imports China's Foreign Exchange Reserves Sources: China s Commerce Dept, People s Bank of China, US Commerce Dept. US is the largest export market for China, thereby China certainly has an interest in ensuring the viability of the US economy. As of now, China holds nearly $1.9 trillion of foreign reserve assets in which between 60% and 70% has already been invested in dollar denominated assets such as US Treasury and other corporate bonds like Fannie Mae and Freddie Mac. According to the latest data available with the VMW, China holds $540 billion of US Treasury Securities. China s savings were key reason of lower long term interest rates in the US. China needs to support the dwindling US economy by investing more in the US Treasury; however there are certain limits to the investments in to the US by China, because Chinese economy also suffers the huge crackdown in its economy despite getting Number 3 slot. GDP per capita of China is $5,325 which is still very low in compared to Germany s $34,000. Unemployment rate also soared to 4.5% from 4% since the global economic downturn and large number of manufacturing units has halted their operations as no demand exist for their products in the international markets. Chinese economy is entirely relying upon exports and the recent export data showed the major downturn. China might consider focusing on its own economic problems. But the another interesting point here is Japan, which has reduced the investments in US Treasury from peak of $600 billion last year due to its own economic problem and needed large amount of cash to meet its own requirement, China still expanding its investment portfolio by buying more in US securities. A European analyst has commented that China needs to spend its trillions; the world could avert the recession, thereby, some economists called it as Chimerica the relationship between China and America. China needs to finance the US debt in order to make the economy progressive. 2
What should be the negative consequences of this Economic Catastrophe? According to the US Treasury data, the value of outstanding American Treasury bills top $10 trillion, double since the year 2000 and this number sure to increase as the bailout package announced to support the distressed Auto industry, preventing collapse of government backed mortgage giants Fannie Mae and Freddie Mac. This could be real problem for the United States as the foreign investors could doubt the American money to pay back such an extraordinary sum inducing them to stop or slow their deposits in to the US. That could send to Dollar plummeting and making imports dearer to the American consumers and businesses. Then the US Treasury needs to pay higher interest rates to attract investments. The ongoing crisis has a potential to inflict serious damage to the international status and power of the United States. But, does it really going to happen? I guess no! During the time of Great Depression in 1930s, US has intervened in the economy by way of taking over the toxic assets of the banks and created the new company known as Fannie Mae, which convert the bank's assets in to marketable securities. It said to be a new wave of government intervention because the 2008 Presidential Election was equivalent to the 1932 election, when President Franklin D Roosevelt adopted the "New Deal" policy in which mortgage backed security issuer Fannie Mae founded. Thereby, the US will find it much easier to run into large deficits as the foreign investors continue to hold dollars and will continue to invest in the US Treasury and the new US Administration could bring some changes in its policies and they will bailout the whole economy without worrying about their finances.
Useful Resources by VMW G20 Nations and its Foreign Reserves Country Amount in Millions of USD Argentina 46,637 Australia 30,692 Brazil 207,539 Canada 41,402 China 1,950,000 France 102,836 Germany 133,139 India 255,240 Indonesia 50,580 Italy 100,246 Japan 1,030,600 Mexico 85,187 Russia 484,700 Saudi Arabia 34,171 South Africa 34,099 South Korea 201,200 Turkey 74,234 United Kingdom 68,980 United States 73,378 4
Bibliography VMW may have used the following sources for the research. Bank of England Bank for International Settlements (BIS) Bank of Korea China s Commerce Dept Congressional Budget Office (CBO) International Monetary Fund People s Bank of China (PBC or PBOC) Reserve Bank of India Saudi Arabian Monetary Agency (SAMA) US Bureau of Economic Analysis US Federal Reserve US Dept of Treasury US Dept of Commerce VMW Research World Bank 5