Is US Debt Destroying the World Economy?

Ever since the Wall Street started tumbling and the American economic crisis came out in the open in September 2008, there have been effects around the world. This disaster and meltdown was not restricted to this country alone; the repercussions are being felt across the globe.

It is aptly termed as a global recession.

The American Economy and the World Economy

Volatility and uncertainty are widespread at this time in the financial markets.

The growth rate of the world’s economy has slowed down.

China has been posting double-digit growth rates for the last four years. However, the growth rate has fallen to 9.0 percent in this quarter, according to the National Bureau of Statistics. This fall is primarily attributed to the unstable international economic climate.

Similar reports are coming from Japan, the second-biggest economy in the world. The Bank of Japan is Japan’s central bank. It’s Governor, Masaaki Shirakawa, has predicted stagnancy in economic growth of the country as the result of fallout of the economic recession in countries across the world.

With the American economy, development across different states of America, its lending to other developing countries and the overall state of affairs in the United States has a direct effect on the economic situation of other major countries of the world.

From current U.S.A. data, new home sales in the United States fell to their lowest level since the recession in 1991.

The Start of the 2008 Crisis

The present financial crisis in the U.S.A. had its beginnings in the highly acclaimed and popular sub-prime US home loans. These high-risk loans were packaged as derivatives or complex investment instruments and sold to banks and investors across the world.

The crunch began when people defaulted on these loans. Repayment delays and defaults in paying back loans started a grim chain of events in motion.

The worst-hit businesses were the lending banks. They became cash-strapped. Inter-banks loans alone could no longer ensure the smooth functioning of the world financial economy. It became clear that not all banks could survive this situation which could have led to bank failures across the world.

This caused world governments to pump in as much as three trillion dollars, in addition to huge cash infusions, into these affected banks.

ING, one of the largest banks in the world, reported a loss of around 675 million dollars in the current quarter. The Netherlands then announced a 13.4-billion-dollar bailout for ING.

Similar scenes occurred when South Korea offered of over hundred billion dollars in guarantees to meet offshore debts of their domestic banks. Britain’s Finance Minister, Alistair Darling, put up plans for boosting public spending to overcome the negative growth rate of the British economy over the last two quarters.

However, the overall sentiment was not all depressing.

The announcement by US President George W. Bush and the European leaders to hold various summits to address this worst world crisis since the Great Depression has brought some cheer into investors and markets alike.

The first summit is to be held soon after US presidential elections on November 4. The summit will primarily address reforms to set the international financial system right.

The most urgent need of the hour is an extensive overhaul of the system while preserving the traditional foundations of democratic capitalism such as free enterprise, free markets, free enterprise and free trade.

Critical Appraisal

The ongoing global financial crisis has many similarities to the Great Depression of the twenties. Major changes like bank failures, the worsening credit crunch, rushed mergers of banks and financial institutions, sinking stock markets and some financial giants tumbling cause similar sentiments to those which were common during that Depression.

However, the major difference is that there is no great change in day-to-day life of the common person. The Great Depression pushed millions of families into extreme poverty.

Today, while a significant number suffer severe hardship, most people are still able to purchase goods, ATMs are working, and the scale of job losses is not as massive at this point.

Some experts say that this indicates the current crisis to be more of a financial correction and subsequent panic, rather than a full economic meltdown.

This has still caused extensive damage to Wall Street institutions. But, so far, the repercussions have not been felt as deeply as during the Great Depression.

History has been a great teacher. Politicians, bankers and others at Federal Reserve, Treasury and elsewhere are well aware of how all this could translate and bring changes in the economic scene. They are trying their best to soften as much of the depressive effects and reduce the number and effects of business closures and stresses.

Although the world economy is witnessing immense uncertainty, there are certain safeguards within the economy as an aftermath of the Great Depression which are helping.

Unemployment rates were as high as 24.9% in 1933. The current rate is 6.1%. It may go up to 7% or 8% which has severe effects on those directly affected but is much less than during the Great Depression.

Most banks presently have Federal deposit insurance. Most investors do not have a risk of losing all their money. Foreclosure problems are restricted to subprime mortgages alone.

Presently about one-third of all homeowners have a clear and free title. The present Federal Reserve is not on the gold standard.

Interest rates can be decreased to increase liquidity.

The current tax structures are not entirely progressive. There are automatic stabilizers within the system.

The impact of a dollar decline in Gross Domestic Product may be offset by tax decreases and automatic government spending increases.

There are some safety nets put into place after the lessons that were learned from the Great Depression.

These include the Securities and Exchange Commission to regulate stock markets and protect investors, unemployment insurance, deposit insurance and various social security measures.

All these help to ensure greater flexibility in financial markets.

This may help the world economy to recover faster and reduce the speed and extent of negative events in the markets across the world.

The appraisal shows that there is definitely a recession but not all are convinced that we have, or may experience, a depression.

Many feel that the world economy will bounce back after two or three quarters and things will slowly start looking up.

Sources:

The Federal Response to Home Mortgage Distress: Lessons from the Great Depression by David C. Wheelock

America's Greatest Depression 1929-1941, by Lester V. Chandler National Association for Business Economics

For more detailed information on the current situation and how you can protect you and your family order your copy of Surviving the Debt Crisis today.