Fenil's Library

“We’re certainly in the midst of a once-in-a-lifetime set of economic conditions. The perspective I would bring is not one of recession. Rather, the economy is resetting to a lower level of business and consumer spending based largely on the reduced leverage in the economy.” —Steve Balmer

She had just been fired from her job, but her face gave away no hint of sadness.

“I always wanted to teach math to fifth standard kids, you know, but never really had the guts to go about doing it,” she said, as we drove to the airport. 

It was late in the night, and FM was playing Bob Dylan. “Goodbye’s too good a word, babe. So I’ll just say fare thee well,” the lines went. How ironic! 

“So what have you been reading lately? Or have you bid adieu to books, too?” I asked. 

“I couldn’t give up reading for anything now, you know. I hate to acknowledge this, but it’s the only good thing I learnt from you.”

I fell quite at that rare show of emotion from her.

She didn’t say anything either.

I kept driving.

“You know, people who saved money in the Western economies and did not borrow must be the ones feeling the most short-changed at this point of time,” she said after a while.

“Why do you say that?” 

“Well, when they saved money, they were not going out in the market, spending the money and enjoying it. They wanted to save it up for a later day. So they must have deposited all that money in the bank or invested in the stock market. Meanwhile, most people went around borrowing much beyond their means and spent that money. Now, with most western economies in a mess, they cannot repay. To revive these economies, interest rates are being cut, so that people will start borrowing and spending again,” she explained.

“So?” 

“When you cut interest rates, you end up hurting people who had saved money in banks. They get lesser interest on their savings. On the other hand, stock markets across the world have fallen steeply, so savers who had invested in the stock market have faced huge losses.” 

“Hmmm... But governments around the world are taking steps to turn around their respective economies. They have been cutting interest rates to ensure people borrow and spend more. All this spending in turn will help companies sell more and earn more, and thus end up saving thousands of jobs. Governments are also trying to help banks by investing in them and guaranteeing their assets. Citigroup, for one, has received an investment of $45 billion from the original $700 billion bailout plan created by George Bush and his treasury secretary Henry Paulson. The US government has also guaranteed $301 billion of Citigroup’s assets. So, in case of any losses on those assets, Citigroup will receive further help from the government. All this is being done so that banks start lending again,” I said. 

“See, all these things are done whenever there is a banking crisis that leads to an economic crisis. But this time it is different. In the past, banking crises happened because corporates borrowed much beyond their repayment capacity, putting banks in the respective economies in trouble. Take the case of Japan, which saw a banking crisis in the early nineties. Corporates had borrowed big time against rising shares and the property they owned. And once the prices collapsed, banks ended up with all kinds of dud loans. In the US and much of the western world, it is not the corporates who have over-borrowed this time around; it is the citizens of these countries who have over-borrowed. The total household debt in the United States is around $14 trillion, almost equal to the gross domestic product of the US.” 

“So?” I interrupted. 

“Well, with so much debt on their heads; people are unlikely to borrow more. They have realised that the good times are over and its time to pay off all that debt. In fact, from almost $350 billion a quarter sometime back, household borrowings came down to only $14 billion in the three months from October to December. In fact, some experts are of the view that stock markets in the US have not factored in this contraction in household debt, and thus need to fall more.” 

“It sure doesn’t make sense for households to keep borrowing after all that they have borrowed. Does that mean the idea of propping up demand by getting people to borrow and spend, and thus revive the economy won’t work?

“It won’t, I tell you. Also, in the past, banking crises have been limited to a few banks. Take the case of the banking crisis in Sweden, which happened in 1992. The Swedes followed what is known as the “good bank-bad bank” strategy, which essentially involved handing over the bad assets of a bank to a separate bank, which managed them. This allowed the good banks, which had the remaining assets, to concentrate on proper banking functions, instead of worrying about the bad assets on their books. But then, the crisis in Sweden was largely limited to two banks. The current banking crisis is much more widespread, making it more difficult for the governments to react. The latest issue of The Economist estimates that the troubled assets of US banks amount to $5.7 trillion. And now there is news coming in that troubled assets of banks in the European Union may be around $25 trillion. If that is true, Europe may be in for bigger trouble than the US currently is,” she explained. 

“You are making it sound worse with every passing day,” I said. 

“Yeah, and recovery is even more unlikely since recession has spread to all parts of the world. In the past, countries exported their way out of trouble. Take the case of South East Asia countries, which faced a major banking crisis around 12 years back. What saved the day for them was demand for their goods in the US and other parts of the world. Even Japan recovered partly through exports. But right now, demand has been falling. In fact, between October and December last year, most major economies, such as the US, UK and Japan, contracted. So there is no way a country can export its way out of trouble this time.”

We reached the airport. She got down, took out her stuff, smiled and started walking towards the departure terminal. I looked on.

(The example is hypothetical) 

k_vivek@dnaindia.net 

References: The Looming Collapse ofEuropean Banking, Gary North, www.LewRockwell.com,February 19, 2009; America’s bankingcrisis worse than Japan?, The Economist,February 14 -20, 2009; We’ve Only Just Begun?Brian Pretti, www.ContraryInvestor.com, Feb 2009.