return of the crisis

7/31/2019 Return of the Crisis

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Return of the Crisis

Are we on the brink of another Recession?


2/15

Tethering on the Brink: Why?

European Debt Crisis Uncertainties and negative outlook in major

economies of the world

Non-viability of current economic structure and

trajectory of the European Union How and whether Greece might exit is the biggest

and fattest uncertainty of all (Article in TheEconomist)
http://charurastogi.wordpress.com/2012/04/25/european-debt-crisis/http://www.economist.com/node/21556583http://www.economist.com/node/21556583http://charurastogi.wordpress.com/2012/04/25/european-debt-crisis/


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Is austerity the right way to go?

No, the drive for fiscal austerity is completelymisplaced

Fiscal tightening, in this context, is self-defeating

It reduces gross domestic product (GDP) growth and

fiscal revenues It makes fiscal consolidation targets even harder to

reach


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Struggling Economies

Greece's national income is nearly 30% lower than whatit was four years ago

The current strategy that is making the output fall further,reducing the hope to recover (and therefore be in aposition to repay debts)

The austerity strategy is being imposed on all theperipheral countries in the euro-zone that have debtproblems.

Ireland and Portugal which had rigorously fulfilled all thedraconian austerity measures, are still struggling to grow.

Spain's huge economy is being pushed into a downwardspiral as the asset deflation of the collapse of theconstruction boom combines with reductions in publicspending to throw more people out of employment andcause incomes to fall further.

Italy is set to join that group, with massive implications for

all of Europe.


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Whats next?

Break-up of the currency union in the dearth ofsignificant structural and policy changes

Given the situation, it is only a matter of time before oneor more of these countries defaults on at least a part of itsdebt and then leaves the currency union.


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What if the currency union breaks? Weaker economies will immediately face the pressure on their domestic

banking systems, as investors begin to doubt whether their deposits willreally continue to be denominated in euros in future.

Bank runs will start. Indeed, bank runs in Europe have already started.

So far they have been slow, but such processes can very quickly accelerateand precipitate a crisis. (All financial crises are usually associated with bankruns.)

Deposits in Greek banks have fallen by more than one-third since thebeginning of the crisis, and1.2 billion was withdrawn in just two days afterthe inconclusive election.

Even banking systems in other countries that do not have such politicalinstability are experiencing similar slow runs. Deposits held in Spanish andItalian banks have also fallen by more than300 billion since the start of2012.

The flight to safety of Europeans has led to increases in German bankdeposits of approximately an equivalent amount.

But since the banks of north European countries are also deeply implicatedin lending to the peripheral countries, they are not really safe either.(Incidentally, United States banks will also be affected.)


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What if the currency union breaks? (contd.)

The doomsday scenario has been summarised byMartin Wolf of Financial Times (May 17, 2012):

The mechanisms at work would be powerful: runs;

the imposition of (illegal) exchange controls; legal

uncertainties; asset price collapses; unpredictableshifts in balance sheets; freezing of the financial

system; disruption of central banking; collapse in

spending and trade; and enormous shifts in the

exchange rates of new currencies.


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What if Greece Leaves the Euro?


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Can this be averted? The only way to prevent havoc is to create a common deposit

insurance and bank resolution regime that covers the entireeuro-zone, issue of jointly held euro-zone bonds and and fiscaltransfers to assist regions in distress.

These are now seen as more acceptable: France underFrancois Hollande has already declared its support.

But Germany and some other north European countries opposesuch reforms. German Chancellor Angela Merkel keeps insisting on Budget Discipline.

There is lack of recognition in surplus countries that they have been hugebeneficiaries of the monetary union.

They have been able to preserve employment through export surpluses andthen use these to finance investments (mostly in private non-tradable

activities like real estate and some public spending like arms purchases inGreece) that provided their banks high returns for a while and also furtherbenefited their own industries.

In such a context, non-symmetric adjustment, by making only the debtorssuffer and pay, is grossly unfair.


10/15

German business newspaper Handelsblatttakes a

swipe at the latest cover of The Economist


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Implications for Rest of the World

In the last recession (2008-09), emerging economies(China, India, Brazil, Argentina, etc.) experienced

less severe downswings and recovered faster andmore strongly to exhibit GDP growth rates similar to

those of the previous decade. However, this time internal trends within regions and

closer integration between regions may interfere inthe de-coupling with a global recession.


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USA

At G-8 summit 2012, U.S. President Barack Obamaoutlined that there was emerging consensus that moremust be done to promote economic growth and jobcreation, right now.

However, Obama had the U.S. economy in mind, not theGreek people, when he promoted growth in Europe.

The U.S. was worried that a second collapse of theEuropean banking system would adversely threaten U.S.banking institutions. U.S. banks have already reducedtheir exposure to the Greek financial system by 40%.

A Greek exit from the euro-zone might infect the rest of

southern Europe (Italy and Spain), in whose financialmarkets the U.S. banks are more heavily leveraged bothdirectly and indirectly.

A Europe-wide collapse would devastate the U.S.financial firms.


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China In China, the authorities had sought to slow growth because of

fears of overheating as evidenced by high inflation rates. However, slowdown has been sharper than expected, already

leading to calls for renewed state stimulation of the economy.

There are problems in trying to recreate the real estate andconstruction boom that has already spiralled out of control.

Falls in real estate prices continue to have unpleasantimplications for bad loans of the banking sector and foremployment in construction, which had been an important partof the increased employment since 2008.

There are growing fears that further slowdown in exports cancreate a hard landing for China's economy.

The political instability generated by the power struggle withinthe elite after the fall of Bo Xilai is also likely to have economicimplications, though these can still only be guessed at.


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India India is dealing with its own unique problems of political

lethargy in introducing economic reforms in addition to rupeedepreciation, capital flight, high fiscal deficit, low foreignexchange reserves and falling GDP growth rate.

International ratings agency Standard and Poors (S&P) haswarned that India could be the first BRIC nation to lose itsinvestment-grade rating, scaring away foreign investors evenfurther.

There are talks of the need for austerity and harsh decisionsamidst a slowdown in growth. Austerity would only convert falling growth into a recession. Harsh decisions involve measures such as cutting subsidies to

reduce expenditure and raising oil prices. Combined with the increase in the prices of imports as a result of

the rupee's depreciation, these administered price hikes will onlyfuel inflation and further aggravate the tendency towardsstagflation (prices keep rising but output stays stagnant).
http://charurastogi.wordpress.com/2012/05/23/a-primer-on-rupee-depreciation-2012-fall-of-the-rupee/http://charurastogi.wordpress.com/2012/05/23/a-primer-on-rupee-depreciation-2012-fall-of-the-rupee/http://charurastogi.wordpress.com/2012/05/23/a-primer-on-rupee-depreciation-2012-fall-of-the-rupee/http://charurastogi.wordpress.com/2012/05/23/a-primer-on-rupee-depreciation-2012-fall-of-the-rupee/


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Conclusion

There is no doubt that the world must brace itself foranother recession, possibly greater than the recent

one.

The performance of individual countries in this will

depend on the extent to which they are able toinsulate themselves by boosting domestic demand insustainable ways.

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