No Nonsense
US recession and global woes
AMERICANS are known to spend money before they receive it. For example, I bought the ticket for my Bangladesh trip within hours after President George Bush's January 18 announcement of a $150 billion stimulus package to revamp the slumping economy, which promises a possible $1600 one-time tax rebate per family making less than $200,000 annually.
Of course, I charged my credit card. Why shouldn't I? That's the American way -- one that made America the world's biggest debtor nation, piling up the largest trade deficits, budget deficits, and consumer credit card debts to nearly untenable levels, which experts take to be the precursors to the record decline in the value of the dollar against all major currencies, the demise of the US housing market and the stock market threatening to take the US economy along. The final blow apparently came from the sub-prime mortgage (SPM) meltdown, triggering the ongoing and progressive economic slowdown.
Sub-prime mortgage (SPM) is a type of real estate financing that is normally made out to borrowers with low credit ratings, who fail to qualify for a conventional mortgage. These borrowers have a larger-than-average risk of defaulting; interest rates on SPMs are often higher than conventional mortgages in order to compensate for the additional higher risk.
Paradoxically, these risky borrowers, burdened with higher mortgage payments, became even riskier at higher interest mortgages, culminating in defaults and foreclosures. The casualties are the numerous US banks stricken with multi-billion dollar SPM losses.
Citigroup alone had written off $18.1 billion in mortgage investment losses. HSBC Holdings, the nation's largest sub-prime lender, took a $10.6 billion hit primarily from its SPMs. Merrill Lynch wrote off a shocking $9.8 billion. That takes the total reported hemorrhaging of the mighty Wall Street finance houses from the mortgage-market disarray to the tune of $100 billion and ticking.
Another predicament that will further acerbate the banking sector is the insurance claims by investors against losses and bankruptcies in their share portfolios.
All this debt-related mess is now the topic of postmortems and analyses on financial TV channels and magazines. The issues that are debated include: Is the US economy sliding into a recession? What effects, if any, such a recession would entail globally? What recourses are available to avert a potential global recession?
Some observers see a US recession as inevitable, while others have started feeling it already. Some of the issues and trends being tracked on the economy's radar screen, and affecting the US economy, are also seen tiptoeing around the world.
Globally influential investment-banking and securities company Goldman Sachs (GS) recently predicted that the US economy would slide into recession in 2008, prompting the Federal Reserve (the US Central Bank) to slice its benchmark lending rates (federal funds rate -- the equivalent of call money rate of Bangladesh Bank) to 2.5% from its current 4.25% by the third quarter.
GS sees the contraction of US real GDP by 1% on an annualised basis in both the second and third quarters, with an overall growth of 0.8% for 2008. This slowing down of the economy is expected to push unemployment rate to 6.5% in 2009 from the current 5%.
The slowing down of US consumer spending threatens developing countries, like Bangladesh, which export consumer goods to the US. Experts predict that the fallout of the SPM meltdown in the US will continue to be felt worldwide for a long time.
In the UK, the daily Independent reports that debt experts "are predicting a record number of personal insolvencies (bankruptcies) this year. The supply of cheap and easy credit that has revved the economy for years is being turned off as a result of the SML crisis in the US. Fewer mortgages are being granted to people in Britain with poor credit records."
If a US recession were to infect the rest of Europe, it won't be felt right away. Most observers, instead of seeing a recession, predict a slow growth -- employment opportunities in Europe are not yet exhausted so consumption spending won't come down in a hard landing.
The risk is the strong Euro, which will shrink European exports to the US. Analysts argue that strong growth in China, India, and Brazil is expected to partially recompense for a slowdown in exports to the US.
Although, domestic consumption in these high growth economies doesn't seem to be slowing down any time soon, they're not recession immune; if the US economy sprawls and takes Japan along, they could lose their steam and take a hit -- a widespread premonition that worries the World Bank.
The WB report cautions that the weaker dollar, increasing financial market volatilities, and the prospect of a US recession aren't without risk of a soft-landing scenario for the global economy.
The WB Global Economic Prospects 2008, published on January 8, predicts that the global economy is expected to grow at a modest 3.3% rate this year, down from 3.6% in 2007 and 3.9% in 2006. The projected growth rate of 3.3% could worsen if the US slips into recession.
With the US economy slumping into a recession, the possibility of a global recession seems real, given that the $14 trillion US economy accounts for nearly 30 percent of global GDP with its estimated $57 trillion ($57,000,000,000,000) financial system.
The damage is done. So what are the prescriptions for averting a hard landing scenario on the domestic economic front? Obviously, waging a war with Iran must wait. President Bush's 10-day Middle visit to the Kingdoms and Sheikhdoms may have had a softening effect on crude oil prices, which came down to $90 a barrel. But the world needs cheaper crude oil.
US consumers, living beyond their means for many years now, must sacrifice. Many are defaulting on their credit card payments and are unable to pay their other bills. This will force a cut-down in personal expenditures, slowing the aggregate demand. President Bush's proposed $150 billion stimulus package is designed to reach these financially derailed consumers as soon as possible.
Today, January 22, the Fed has cut its benchmark rate by 0.75% (or 75 basis points) to 3.50%. Since inflation expectation isn't threatening the US economy, as Federal Reserve Chairman Chairman Ben Bernanke argues, the interest rate cuts and the proposed fiscal stimulus package are expected to make the recession less painful. Even after such a huge rate cut-first such big cut since 1984, the stock market volatility was unsettling and every one was seen tightening seat belts to face an inevitable recession.
Bangladesh economy seems to be experiencing a different phenomenon -- all signs are consistent with stagflation (declining growth accompanied by double digit inflation and an unemployment rate, some say, over 30% or so) -- certainly not a recession. That analysis will appear in my next week's piece.
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