GLOBAL FINANCIAL CRISIS AND THE ASPIRATIONS OF A CONSUMERIST SOCIETY

ARTICLES- ECONOMICS
GLOBAL FINANCIAL CRISIS AND THE ASPIRATIONS OF A CONSUMERIST SOCIETY

Allen Greenspan, the former chairman of the Federal Reserve opined:
“This is a crisis which occurs once in a century”.

The situation confronted by the world economies today is very grave and severe. The crisis which began in the financial market has now spread to almost all sectors in the economy affecting the life of the people adversely. The crisis which began in the western world, especially United States of America has now gained a global character worsening the life in both developing and under developed economies.

The following items have been discussed in this presentation:
• What is a Financial Crisis?
• Financial Crisis and Economic Crisis.
• Worst Economic Crisis in recent years
• History of the Financial Crisis 2007-08
• Reasons behind this Crisis
• Impact of the Crisis
• Indian Scenario
• Measures Taken
• Policies of IMF and World Bank
• Measures to be Taken

WHAT IS FINANCIAL CRISIS?

In simple terms a financial crisis may be referred to as a crisis in the financial market. The credit crunch or the credit crisis accompanied by the meltdown in the stock markets, derivatives market, hedge funds and pension funds leads to a financial crisis. Thus a financial crisis shakes the foundations of the financial sector, sometimes damaging it completely. The financial crisis which has happened today is more severe. It has not only created fluctuations in the financial market but has also resulted in the collapse of a large number of banks and financial institutions. This in turn has resulted in the loss of confidence of the people in the banking mechanism and financial system.

Moreover a crisis which began in the developed economies has now gained a global character. It has gone beyond the financial lines and is gradually becoming an economic crisis.

FINANCIAL CRISIS AND ECONOMIC CRISIS

Though the terms ‘Financial Crisis’ and ‘Economic Crisis’ are used synonymously, there is a marginal difference between the two. A Financial Crisis affects the financial sector and the financial machineries but in case of an ‘Economic Crisis’ it affects all the components of the economy, real as well as monetary sector. The economic crisis is the one which has a more damaging effect on the lives of the people.

An Economic crisis may include Food Crisis, Oil Crisis, Financial Crisis including Forex Crisis, Inflationary situations, etc.

WORST ECONOMIC CRISES IN THE RECENT YEARS

Oil crisis, the crash in stock markets and speculative markets has led to some of the worst economic crisis in the recent years. Tracing the economic history from 1971 to 2008, ten major crises can be seen:

 Nixon Shock (1971): The crisis began when the then US President Nixon cancelled the Bretton Woods fixed exchange rate system and suspended the convertibility of dollar to gold in response to escalating cost of Vietnam War.

 Oil Shock (1973): The Yom Kippur War in the between the Middle- East nations of Iran, Iraq, Palestine, Syria on one side and Israel on the other created an oil embargo. This resulted in a panic buying by the people.


 Iranian Revolution (1979): In Iran there was an end to the rule of Shah resulting in a change of regime. This led to an Islamic Revolution that led to the Second Oil Shock.

 Iran- Iraq War (1980): The war between Iran and Iraq led to shoot- up in the oil prices. The oil prices hit $39.50 a barrel equivalent to $103.76 in today’s prices.


 Black Monday (1987): There occurred a Global stock market crash on October 19, 1987. This wiped off 22.6% value of New York Stock Exchange.

 Gulf War (1990): The war between the Gulf countries led to a crisis in the economic conditions of these countries in particular and the world as a whole. There has been an increase in the price of oil and a general inflation.

 Asian Meltdown (1997): Japan was confronted with a deep financial gloom. Consequently there was a fall by more than 50% in the share values of Thailand, Indonesia, Philippines, Malaysia resulting in a crisis in these economies.

 Rouble Trouble (1998): The devaluation of Russian currency Rouble created troubles. There were defaults on 540 billion of debt.

 Dotcom Bubble (2000): This resulted from the plummeting shares in hi-tech and internet companies.

 Financial Crisis (2008):
> July 11- The Oil pries hit an all time record of $147.27 a barrel.
> November- Oil falls to $55 per barrel on the fears of a forthcoming world
recession.


HISTORY

Tracing the history of the financial crisis, the background of all this was set by three major factors:-
• Financialization
• Mortgage crisis
• Systemic risks

The signs of this crisis began to be seen during July 2007 when the liquidity crisis began. The liquidity crunch worsened within the next few months and finally resulted in the crash of Northern Bank in Britain. On 14 September 2007, the bank was financed by the Bank of England. But this went unnoticed and USA was still in a period of boom. The crisis in the US began in March 2008 Bear Stearns, a securitization institution, fell prey to the crisis with their stock rates crashing from $154 to $3. J P Morgan took over the Bear Stearns at a rate of $10 a stock as agreed by the US Government. Lehman Brothers, an investment bank started way back in 1850 was next in the line to follow. Later around 19 banks collapsed in US alone. The great financial institutions of Fannie Mae and Freddie Mac had to be taken over by the Federal Reserve. The US Government is now bailing out the banks excessively.

This crisis has rippled across the world economies creating a great credit crunch. This liquidity crisis has led to a loss of faith in the banking system and other financial mechanism. People prefer to hoard money than invest in banks or shares anticipating a crash and thereby a loss of money. Thus, the whole world of consumers is in a state of dilemma coupled with fear.

REASONS

There are few underlying reasons behind the Global Financial Crisis which is slowly pulling the world economies from worse to worst. Like all other economic issues the financial crisis can also be viewed from long term and short term aspects.

Long term

i) Globalization: In the long term the most significant reason behind the financial crisis is the off- shoot of globalization. There has been a complete de- coupling between the real GDP and the fictious, financial, paper transactions. With the ‘Foreign Business Tycoons’ investing hugely in the financial markets in the form of Foreign Institutional Investment (FII) and in the production market as Foreign Direct Investment (FDI). This has given a global character to the economic activities but the inherent drawbacks remains.

ii) Trade Cycle: The trade cycle represents booms and depressions in the economy. After a period of boom a recessionary period is inevitable and this is what has struck the US economy. This means that there is going to be a recovery from the crisis soon. But the fact remains that necessary actions have to be taken to save the global economy from sinking down.

Short term

i) Sub- prime lending: - Borrowers are of two types, prime borrowers with the ability to repay the loans and sub- prime borrowers whose capacity to pay back is often doubted. Today in US market there has been an increase in the number of sub- prime borrowers. These loans bear more risks and they are not likely to be demanded. This has resulted in a financial crisis.

ii) Securitization:- In recent times there has been a trend followed by the mortgage banks of securitizing loans with the investment banks. These securities are sliced and ranked. These securities are insured and are pooled in the derivatives market. Thus, there has been a shift from the traditional banking system where there used to be a direct relation between the borrowers and the lenders.

iii) Bursting of the housing bubbles:- There has been a high boom in the housing sector which has resulted in the increased floating of loans. In the beginning of the 21st century, the US government has been insisting the banks to provide housing loans to the people. With the anticipation of increasing prices in the housing sector, Non- Income Non- Asset (NINA) loans have been issued in large numbers creating a housing bubble which has now burst.

iv) Consumerism:- Increasing consumerism of the present generation, especially among the American and European population has led to excessive borrowing leading to the financial crisis. With this can be associated the greed of men with an increase in income and the psychology of human being to imitate his neighbors (Demonstration Effect). The credit card culture is also an indicator of this.

v) Failure of the traditional baking sector:- The traditional banking sector has not been successful which has led way to a parallel banking system. Investment banks, derivatives markets, speculative markets etc have gained popularity which is devoid of government intervention and depends hugely on credit rating agencies. But today these agencies have turned out to be mere cheats.

These phenomena have caused a Domino Effect in the economy taking it from a global financial crisis to a global economic crisis.


CONSUMERISM AND GLOBAL ECONOMIC CRISIS

There has been a huge increase in consumerism in the recent times. This can be seen from the low income (or even negative) saving ratio of the developed economies. For example the saving ratio of the US economy is as low as 2% when it is at around 35% in the case of India and 30% in case of China. Thus, we can see that these economies are becoming increasingly consumerist and are moving towards a ‘credit’ culture. People have begun to borrow beyond their capacity. The financial institutions anticipating the booms prevailing in the economy to sustain has been issuing NINA and mortgaging these loans as securities to investment banks like Lehman Brothers.

Ask our parents what had been their beginning salaries? Surely it will be in thousands. But ask a present generation guy of his starting salary the reply will definitely be around lakhs. Though we can see that the cost of living has increased the lucrative salaries provided to the young recruits are in no way proportional to their consumption needs. This in turn has led to a greedy society characterized by unlimited want for goods and services. Thus there has been a dumping of luxuries over luxuries.

Psychologists say human beings have tendency to imitate the behavior of his fellow beings, especially if they belong to the same income groups. This can be made clear if we observe the consumption behavior of the individuals in an economy. And this is the psychology behind the advertisements. In economics, we call it as Demonstration Effect wherein consumers belonging to the same income group show a similar consumption behavior.

Thus we can summarize that the Global Financial Crisis is closely knit to Consumerism in lieu of –
• The emerging credit culture
• The increasing greed
• The demonstration effect.

THE INDIAN SCENARIO

Though the financial crisis, particularly in the US sub-prime market, has gained the status of ‘Global’ Financial Crisis, it would not be incorrect to say that its effect on India has not been so severe. The American, European and the Asian economies like China and Japan have been adversely affected by the crisis. Not a single bank in India has collapsed till date (ignoring hue created with regard to the ICICI bank). What is the secret behind India?

This can be seen from the following points:
• India is a mixed economy with appropriate government intervention in every sector.
• The Reserve Bank of India acts as a regulator regulating the monetary policies of the banks.
• The public sector banks in India play a prominent role and are more reliable than the private sector ones.
• The speculative market including the shares and bonds and the insurance companies are government regulated.
• Prices of commodities are also regulated by the government by way of minimum support prices and public distribution system.

Thus the Indian economy is built on a very strong edifice. As the foundations of the economy are strong, there are minimal chances of this being collapsed.

In spite of these observations made above, it cannot be said that India is fully insulated from the financial crisis. There have been a few blows on the Indian economy.
 The Foreign Institutional Investment (FII) has registered a decline which has led to the crash of the Indian stock market.
 The Depreciation of the rupee value in terms of dollar has adversely affected imports.
 The companies which own shares of the foreign companies and which are dependent on foreign funds are in crisis.
 The global recession in real estate has rippled to the Indian scene also.
 Tourism has been negatively affected because of a tremendous fall in the arrival of foreign tourists.
 There has also been a fall in the Foreign Direct Investment (FDI) resulting from a general fall in aggregate demand.
 There has been a fall in employment rate and recruitment rate. Also the huge salaries have shown a declining trend.


RESULTS

The global financial crisis had a number of lessons to teach the world economies. These are to be considered seriously for a better functioning of the world economy in future.

 America has emerged as the number 1 economic power after the disintegration of the USSR. But it is believed that the American economy will cease to be the ‘leader’ economy of the world, i.e., it is expected to loose the position it has in the present situation. According to Joseph Stiglitz “American economy is a sinking economy”. There is a scope for the emergence of regional economic powers like India, China Brazil and Russia.

 Capitalism without any regulation will leave the economy in a crippled condition as of now. Thus, capitalism must essentially be regulated by the government. Market cannot correct itself; the forces of demand and supply are not strong enough to correct the instabilities arising in the market.


 There must also be a regulation or rather control over the speculative markets. The share prices must not be left to fluctuate based on the market condition. This is especially because there has been a rise in the popularity of the speculative market with the people forecasting immediate capital gains.

 Traditional banking system should not be ignored as they are the foundations on which the entire economy strives. The emergence of a parallel financial system must be prevented as the traditional system will essentially suffer.

 There is a revival of the Keynesian economics which had been subsided with emergence of neo- classicalism. But today the Keynesian concept of physical stimulus, i.e., investment in infrastructure is inevitable. The government expenditure should be channelised in a way that it generates employment and thereby income, which in turn will increase the aggregate demand.


REMEDIES

The American economy arrived at a solution of bailing out the financial giants with the money of the taxpayers. Henry Paulson has introduced the Economic Stabilization Act of 2008 which has been described by Nobel Laureate Paul Krugman as ‘Cash for Trash Policy’. The Bush administration has issued a huge sum of $700 billion to bail out the banks. Globally around $3 trillion has been spent on the same. The IMF which is today insisting on bailing out took a totally different stand during the Asian Financial Crisis of 1990s. The blame was put on their own economic mismanagement.

• The present solution resolved to in America is like taming a giant who in course of time is going to swallow the entire economy. With the bailing out packages, they are privatizing the profits and socializing the costs.
• On the contrary the British economy is in the process of nationalizing the banks which is better solution as both profits and costs are socialized.

Keynesian view of increasing the public expenditure is yet another solution for this crisis.
Y = C + I + G + (X – M)
Here ‘G’ has now become a crucial factor as all other components largely depend upon the magnitude of public expenditure.

There ought to be a reduction in size of the pay packets, received by the youngsters, which will in turn lead to consumerism and greed among the young generation. There must always be a ratio between the productivity and the remuneration. If there is a mismatch, then, definitely a greedy generation will emerge running behind consumerism, thereby, leading the economy to future economic crisis.

There must be a restructuring of the international financial institutions like the International Monetary Fund and World Bank. The position of the developing economies in these institutions should improve. The emerging economies like China, India, Brazil and Russia must be allotted desirable roles.

There should also be a rethinking of economics. The fact remains that the true solution to the Global Financial Crisis lies in somewhere between the Keynesianism and the classicalism. An analytical thinking of the situation will definitely bring about a reliable new theory.

Also there is need for a global currency which can be used as a global tender. It is the excessive reliance on US dollar and Euro which has imported the economic crisis which began in the developed economies to the developing world. To prevent the world economy from once again falling into a financial crisis the introduction of this global currency is feasible.

It will not be wrong to say that Mahatma Gandhi was a great economist. Prior to any financial crisis he suggested that what we need is ‘Development Without Destruction’. True to the words of Gandhiji,

“Earth has enough to satisfy human wants not to satisfy human greed.”

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Posted by asha at 8:24 AM