Thursday, November 4, 2010

Is the WEST on the Road to Recovery?`

Paul Krugman, the winner of the Noble prize for Economics in the year 2008, says “Much of the past 30 yrs of study in Macroeconomics was spectacularly useless at its best and positively harmful at its worst”..!!  

My concern is that, despite this fact, the WEST fails to recognize the failure of extreme consumerism and its largely appreciated spending driven economic model, more so because it is trying to correct its mistake by obligating the same mistake all over again.  

Well, now let us understand the economic model for growth and development the west has been relying and advocating for decades.  Shop for growth, spend for development was the sole mantra of the US government, the policymakers and the so called intellectuals were literally running a campaign “Shop for America”.

As an extension to this, the Fed started to cut down the interest rates to near zero levels.  In the 1980’s the US prime rate was as high as 21.50% which has dwindled to 3% for now.  The policymakers were encouraging the alarming trend of not just spending, but even went to the extent of propagating “borrow and spend”, it is with this intention the interest rates were curtailed and brought down to near zero levels. 

There is absolutely no incentive for the people in the US to park their savings in the Bank since his or her savings would yield a negative return (if inflation is taken into consideration).  The then Fed chairman, Alan Greenspan once in his speech said that people save in the 3rd world Asian countries because of the reason that they felt insecure of their future and the government of such countries were not capable enough of providing social security to the poor, unemployed and the aged.  

Mr. Greenspan failed to recognize the fact that in countries like Indian and Japan unlike the west, it is the family and the society which forms the basis for social security and not the government.  In India, the father takes care of his unemployed son till he is on his own, the son takes care of his aged parents, and the disabled siblings are taken care of by the family, the orphans and the left alone oldies are taken care by the society.  

Therefore people in India SAVE, they do so not because they are insecure of their future but to support their family and the society.  A father saves because he has to fund his son’s education and daughter’s marriage; a son saves because he has to take care of his aging parents.  This family and society driven economic model is the structural difference between the West and the East.

In the West the families are disrupted, 51% of the 1st marriages end in divorce, 65% of the 2nd marriages end in divorce and a whopping 70% of the 3rd marriage end in divorce, thereby there is no ownership or obligation for the citizens towards their family, neither a necessity to save. 

The savings to GDP ratio is a stunning 35% in India which is one of the highest in the world, whereas the savings to GDP is negative in the America.  There is absolutely no necessity for the Indian government to rely on foreign investments to fund its fiscal deficit or infrastructural, industrial development.  I would like to state the fact that it is a mere 2% of India’s investment which is funded by the FII’s and the FDI’s the rest 98% is generated from within the country by the domestic household savings, while the West is compelled to borrow money from India, China, Japan and other emerging economies to lend its citizens who are used to the trend of borrowing and spending.

With a national debt of $ 1 billion in the beginning of the 20th century, the federal budget deficit accelerated, topping out at $290 billion for 1992.  The total deficit for fiscal year 2009 was $1.42 trillion, a $960 billion increase from the 2008 deficit.  The US fiscal deficit is projected to touch a staggering $9.05 trillion in the next ten years forecasting the social security and healthcare commitments.



It is this attitude of extreme consumerism which is the prime cause of the current economic mess which the America has successfully exported to the world.  The consolidated Fiscal deficit of America runs to trillions and still growing, the US has been selling treasury bills and printing money to fund its deficit which is clearly an unsustainable model.  The US treasury bills which are considered the safest instrument in the world are not safe anymore as there are no real assets to back these bills.

Any rational economist would call for a structural change in the economic model to come out of the vicious cycle, now that would mean inculcating the habit of savings to its citizens, but the Fed and the policymakers don’t seem to even realize their mistake, forget rectifying.  That is why I said at the beginning of this post that the US is trying to correct its mistake by obligating the same mistake all over again.  

Trust me "the worst is yet to come", read on.

The US has been pouring billions of taxpayers money into the so called “Too big to fail Banks”.  Too much of fiscal stimulus does no good to an economy; rather it pulls down the sovereign rating as a result of increased Deficit to GDP ratio.  As a result people, banks, financial institutions and the world economy by and large would have lost faith in the US treasury bills and that would be the trigger for the 2nd round of recession (well, not necessarily depression).

 I just burst into when Obama said that his Government had succeeded in stabilizing the US economy.  Nothing is going to change unless and until the people of the US start saving, they can’t go on a borrowing spree as the model in itself isn’t sustainable.  The government must incentivize savings by way of hiking the interest rates, now that calls for a paradigm shift in the way the US economy had been operating for decades.  Yes, it would lead to chaos in the short run as the consumption would take a hit, but it will be a blessing in disguise since people would learn to live within their means.

For decades the people in the US have been net borrowers, and to make debt available to its people the Fed borrows from other countries by way of selling treasury bonds.  When it comes to India, China or Japan the government borrows from its own people, it is the net savings of the people which funds the deficit of the government and not outside borrowings.

Therefore I am sure of the fact that the US is in deep trouble and the bubble can burst anytime, this time the reason for the muddle would be treasury bubble as it was the real estate asset bubble in 2008.

My words are highly influenced by Shri. Gurumurthy Ji, a charted accountant, economist, columnist and an investigative journalist.  

Your comments and thoughts are most welcome.

4 comments:

  1. As usual I am afraid your article is one sided and is not fully true.
    In USA as I know there are inflation protected bonds floated by US Govt, itself; though the yield is less , if there is price increase the yield would also increase.
    In India, suppose I have deposited Rs.10 lacs with a Nationalised Bank @8% per annum , the return would NOT increase even if inflation is 13% or 14%.
    Again in UK/ USA/ Germany etc. there is unemployment dole , which would be proportionate to the income you were earning before losing the job;again this was for 36 weeks only prior to recession; now it is 90 weeks, that is nearly two years.
    In our country is there unemployment allowance for everybody? Evrything is bearaucratic and subjective.
    Mr.Obama has successfully passed a medical benefit bill by which every citizen gets FREE medical aid wef 2011. This is a boon to those who cannot afford a medical insurance.
    In India or China , even if you have a medical insurance it is difficult to get 100% settlement.
    These apart there is abolutely NO CORRUPTION at all @ Govt.Depts.Even in Malaysia and Singapore corruption is NOT there.
    We know where we stand.
    Lastly we are far less patriotic than an American or British.They put their country first.
    Here even flats meant for Kargil War widows are allotted to the powerful and influential.
    Public servants do not want to lay even proper roads and the public won't keep the roads laid tidy and clean.
    We are far behind not only the West,but also our Asian peers like Japan/ Singapore/ malaysia etc.
    Believe me , USA is fast recovering; they would be out of woods soon; ofcourse if they wage one more war , the problems may resurface.

    Keep posting your views.

    M.N.Swami

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  2. Let me categorically respond to your comments.

    Yes, it is true that the Fed floats inflation protected bonds, but who are the takers?? Do the people have any surplus to invest in bonds? It is the Banks and the MF houses who subscribe to these bonds and not households, even if that was the case, the proportion would be negligible.

    I agree the fact that there is an unemployment allowance to the unemployed, this is similar to social security and I consider it as an unwarranted burden on the Government. In India it is the family which takes care of the unemployed youth till he finds himself a JOB, there is no need for the government to intervene.

    As Gurumurthy ji says, in the WEST, the families are NATIONALISED and the government is PRIVATIZED.

    I completely agree to your views expressed on Corruption, nepotism which invariably are the biggest threats to the growing India.

    With all due respect, I am astounded by the way you have questioned the patriotism of an average Indian just because of the misdoing of a few politicians or bureaucrats for that matter.

    Whether we believe it or not.. the 19th century was that of the Europe, the 20th century was that of the U.S.A and the 21st century is that of the Asians.. and you cannot simply eliminate India as a growing economic power, it is just that we should stick to our basics and not try to copycat the west..

    I am open to your thoughts and comments..

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  3. Bala, I agree to your comments expressed above but this is one sided picture. This true that due America's so called liberal policies to bring growth in "everbody's" life brought nightmare to all over world. But I have only one inquisition that when India is majorly depending upon its own savings then why it doesn't happened yet that INDIA is not on top of the world? We don't lack anything here, starting from different types of resources till the manpower which is the most important ingredient for any country to make the correct utilization of those resources for the ultimate growth and development of the country.

    This is really very saddening part of INDIA. And as above expressed by Mr. Swami, the corrupt politicians are solely responsible for this situation. It is not like that India has not developed at all but it pinches much when "Aam Adami" like us can feel and see that there is much more potential in the child to grow and that is not happening.

    As just now came across Paulo Coelho status message which is being pasted here: "Knowledge without transformation is not wisdom."

    It totally goes with the above blog.

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  4. Bala, I will not comment.
    Just found an exact-reply-article for your views.
    Read on....

    Japanese save a lot. They do not spend much. Also, Japan exports far more than it imports. Has an annual trade surplus of over 100 billion.
    Yet Japanese economy is considered weak, even collapsing.

    Americans spend, save little. Also US imports more than it exports. Has an annual trade deficit of over $400 billion. Yet, the American economy is considered strong and trusted to get stronger.

    But where from do Americans get money to spend? They borrow from Japan, China and even India .

    Virtually others save for the US to spend. Global savings are mostly invested in US, in dollars.

    India keeps its foreign currency assets of over $50 billion in US securities. China has sunk over $160 billion in US securities. Japan's stakes in US securities is in trillions.
    Result:
    The US has taken over $5 trillion from the world. So, as the world saves for the US - It's The Americans who spend freely. Today, to keep the US consumption going, that is for the US economy to work, other countries have to remit $180 billion every quarter, which is $2 billion a day, to the US !

    A Chinese economist asked a neat question. Who has invested more, US in China, or China in US? The US has invested in China less than half of what China has invested in US.

    The same is the case with India . We have invested in US over $50 billion. The US has invested less than $20 billion in India .

    Why the world is after US?
    The secret lies in the American spending, that they hardly save. In fact they use their credit cards to spend their future income. That the US spends is what makes it attractive to export to the US. So US imports more than what it exports year after year.
    The result:
    The world is dependent on US consumption for its growth. By its deepening culture of consumption, the US has habituated the world to feed on US consumption. But as the US needs money to finance its consumption, the world provides the money.

    It's like a shopkeeper providing the money to a customer so that the customer keeps buying from the shop. If the customer will not buy, the shop won't have business, unless the shopkeeper funds him. The US is like the lucky customer.

    Who is America 's biggest shopkeeper financier? Japan of course. Yet it's Japan which is regarded as weak. Modern economists complain that Japanese do not spend, so they do not grow. To force the Japanese to spend, the Japanese government exerted itself, reduced the savings rates, even charged the savers. Even then the Japanese did not spend (habits don't change, even with taxes, do they?). Their traditional postal savings alone is over $1.2 trillion, about three times the Indian GDP. Thus, savings, far from being the strength of Japan , has become its pain.

    Hence, what is the lesson?
    That is, a nation cannot grow unless the people spend, not save. Not just spend, but borrow and spend. Dr. Jagdish Bhagwati, told Manmohan Singh that Indians wastefully save. Ask them to spend, on imported cars and, seriously, even on cosmetics! This will put India on a growth curve. This is one of the reason for MNC's coming down to India , seeing the consumer spending. 'Saving is sin, and spending is virtue.'

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