Tuesday, March 24, 2009

Whither the Global Economy Part II

The world awaits with abated breath the recovery of its economy, as nation after nation try to spend their way out of the recession which has emanated from the collapse of the US financial system and the excesses of the China economy.

The first order of business is to look for a bottom.

The bottom is formed when the stimulus is sufficient to overcome the forces of depression.

The forces of depression are:
(a) The end of mortgage lending as the real estate bubble burst.
(b) The end of consumer spending as the real estate bubble burst.
(c) The end of investment in real estate as the real estate bubble burst.
(d) The end of consumer spending as the stock market bubble burst.
(e) The end of investment in businesses as the economy collapses.

If the depressive force is 5% and the stimulus is 2% of GDP, then we should still get an economic contraction of 3%.

If there is no additional stimulus the next year, the economic contraction may continue.

This is why there is a certain urgency to get the banks to start lending again.

In the US, this involves:
(a) Recapitalising the banks. The capital and reserves are insufficient to cover the bad loans. Cash injection is necessary to boost capital to be sufficient to (i) cover the bad loans and (ii) have excess to support additional lending.
(b) Removing bad loans. Usually, the cash injection is underestimated because new bad debts keep coming up in a declining economy as unemployment spreads. The other method is to remove bad debts by having someone with a lot of cash (usually the government through bond issue) to buy and keep the bad debts which are usually real estate where value can be preserved in the long term.

The bottom will form when sufficient amounts of new money are poured into the banking system to take care of the bad debts and to form the new base for new loans.

New Lending Direction

The commercially viability of new loans depends on the new visions that bankers share with businessmen and government leaders.

The global economy needs to know where it wants to go in the future.

In the past, the world has merely been satisfied with producing cheap consumer goods to feed US consumers paid for with US paper money debts.

The world has paid for the senseless consumption with the massive abuse of its own limited global natural resources.

The global economy must go in the direction of productive investments with the purpose of relieving the misery of the majority of the human and animal population. There should be production and consumption but judiciously. These mean:

(a) There should be full cost accounting for agriculture production, which means eliminating the use of harmful chemicals on the soil.
(b) There should be full cost accounting for industrial production, which means putting in strict regulations on industrial emissions and effluences.

With the proper accounting of the cost of production, less volume but better quality should be produced. This should lead to a slower growth in world population and a better quality of life.

The world economy should slow down in growth, to take time to develop step by step, so that there is proper care in growth.

There is no point in hurrying to our own global demise. The only future the world has is in slowing down its growth so that it can preserve as much of its original natural self as possible. Everything that is man-made is a derivative.


de minimis said...

This is a seminal post. I marvel at the light brush strokes you apply to a highly abstract issue that many are flapping around to grapple with.

I don't want to editorialise your post which I feel is quite holistic and (free of charge) crystalises the key issues that still dog the US economic managers.

Suffice to say that you have made a contribution to the diagnosis and, offered a sort of way out.

hishamh said...

While I share your sentiments, I'm fairly certain that we will have to take it slower whether we like it or not.

The adjustment phase for the world to move away from US-centric consumption to a more equitable and sustainable distribution of production and consumption will take time, as resources will need to be reallocated.