A bit of history of economic crises

The current crises got me looking into the other economic downturns in the 20th century. Here are my findings:
We all know about the great depression in the early 1930s, but I was actually surprised by the number of recessions in the world since. Here are the major ones:

1. Latin America's woes
Latin America has long endured economic problems like currency crises, hyperinflation, banking failures etc. The lack of prudent governance and macroeconomic populism continued till 1980s, when the economic reforms were introduced. These measures included:

• State - owned firms were privatized
• Import restrictions lifted
• Budget deficits trimmed, inflation became a priority

These measures led to efficiency, investor confidence and large inflows of money. But soon there was a recession in Latin America (esp. Mexico and Argentina) in 1990s, the exact reason for which is still not understood well by economists. Some of the causes were:

• Impending devaluation of Mexican pesos not handled well
• High government spendings and
• Wide spread corruption and dollar-loan exposure

This crisis was finally controlled by huge loans provided by the United States, Canada, and International Monetary Fund(IMF).

2. Japan's downturn
Japan suffered laggard economic growth and recessions in the most of the 1990s (also known as the lost decade. The crisis started in Japan in 1989-90 and the reasons were:

• Loose financial regulation, bad debts.
• Bubble in stock markets and real estate from 1986-1990

Japan has suffered economic paralysis for such a long time. The country's economy was investment driven and this recession caused investments to flow outside the country. The falling interest rates (at one point the interest rates were zero also) inhibited spending. This low consumption led to a deflationary spiral which was only strengthened by rising unemployment levels. The central bank has also dithered far too long where it alternated between public spending and budgetary control.

3. South East Asia's crash
South Asia till late 1990s was a tremendous success story. The region saw extended economic growth and was a role model for many. All that changed in 1997 when the many south Asian economies were caught in a currency crisis: Thailand, Malaysia, Indonesia and South Korea to be precise. Again economists disagree over exact reasons for this crisis, generally the following factors are considered to be the culprit:

• Started with currency collapse of Thai Baht, which was long under attack from speculators and hedge funds. Government finally floated Baht leading to its fall.
• Crony capitalism where in these economies there was a collusion between government and big business players.
• These economies had relatively free markets and light regulation, which led them vulnerable to the vagaries of foreign investors.
• This crisis led to slumping currencies, stock market devaluations and precipitous private debt

4. Internet bubble of the 21st century
Also known as the dot com bust, happenned in 2001. There was a considerable bubble in the stock markets of western economies from 1996-2001. The bubble was caused by inflated valuations of stock markets, especially internet and technology related firms. These firms in turn had flawed business models, where in all of them were rooting for growth over profits working under the assumption that finally profits will come once the markets are captured.

Results of Stress tests - who sailed through and who needs more capital

The results of the SCAP were out on 7th May 2009 and the 19 Bank Holding Companies will require an additional 74.6 billion dollars to make the financial system sail through without collapse if the economic situation worsens.
Here's the summary of results:

Bank	Additional capital needed (billion dollars)
AmEx	0
BofA	33.9
BB&T	0
BNYM	0
CapOne	0
Citi	5.5
FifthThird	1.1
GMAC	11.5
Goldman Sachs	0
JPMC	0
KeyCorp	1.8
MetLife	0
Morgan Stanley	1.8
PNC	0.6
Regions	2.5
State Street	0
SunTrust	2.2
US Bancorp	0
Wells Fargo	13.7
Total	74.6

Deflation in Japan may lead to a deeper recession

The economic woes for Japan, world's second largest economy after US, had deepened with the GDP for the last quarter of 2008 falling sharply, down by 3.3% from previous quarter and 12.7% annualized. This is the sharpest decline since 1974 oil crisis. This was the third consecutive quarterly decline in GDP. Japan has high dependence on exports and because of ongoing financial crisis in the US and European countries exports have fallen considerably.

Japan has been facing tough economic situation since more than a decade. It had seen consistent deflationary periods from 1999 to 2006. However GDP growth had picked up since 2003 and stood at a decent 2% in 2007. The year 2008 saw a fall in growth rate to 0.3% and in 2009 it is expected to be -2% (JCR projections).

The fall in global commodity prices has put downward pressure on inflation. According to the official data, the consumer price index for Japan in December 2008 was 101.3 (base year 2005=100), down 0.4% from the previous month, and up 0.4% year-on-year. A fall in prices will add on to the slowdown of economy. A period of deflation generally results in lower savings and investments. It may also lead to deflationary spiral in which fall in prices lead to lower production activities and hence lower wages leading to decreased purchasing power and lower demand. In history this kind of viscious deflationary spiral occured during the Great Depression.

Economic Fundae - Business Cycles

Macroeconomics as a discipline is about the study of national economy, total output level, the general trend in employment. All this not only nation wide but also with respect to the global economy. I write this article as the stock market tanked 4000 points roughly about 20% in two days in reaction to the global recession- economic downturn. In the past century we have seen years of boom and bust between years, which is called the business cycle. What is happening today in the stock markets can be only a fraction of the impact which was there during the Great Depression- stock market crash of October 1929, but we can immediately strike a relationship in these events. But why is there business cycle, and what are reasons for the recession? This is a subject we are currently dealing with.

In fact we all would agree to the fact that the salary we get today is at least twice as much as our parents. This even after adjusting for inflation- which is the rise in the price level of goods and services have grown phenomenally. This is attributed to the long run growth of an economy. We are trying to address the issue of growth in the long run and the intermediate recession and expansion.

For an engineer turned management graduate like me trying to understand this phenomenon of recession would immediately associate with the unemployment, the effects of aggregate output and the government policy on these issues.

Looking at the issue of unemployment- the percentage of total number of people in the labour force who are unemployed. In general we have higher unemployment rate during recession and lower during expansion. The policy measures which are undertaken to stabilize the severity of the recession or to rein in the expansion are the Monetary Policy - which involves changes in the money, interest rates etc. & the Fiscal Policy- which involves changes in the tax policy or government spending etc.

Before going further to the discussion of recession, we will define what an open economy means. Until 1991, India had the policy of restricted trade regime, which essentially is the closed economy - the economy which does not trade goods or services with other countries, self sustained. This principle goes against what Adam Smith in his book mention of division of labour. A country should try and maximize its production in which it is generally good at. It is more of a focused approach rather than channelizing to all what an economy needs.

After 1991, India opened its economy to the world because of the crunch and the request by IMF to do so. Hence an open economy is one which trades with other countries. This is different from the closed economy dynamics with the exchange rates - which is discussed in the previous article.

There are numerous reasons for recession and it is measured by looking into the amount of business activity which is happening- Unemployment, industrial production etc. One should remember the effect of the "Paradox of thrift" - which is the reduction in spending forecasting a economic hard time actually leads to a slump in the economy and the business begins to layoff.

There were enough cues this time for the U.S economy slowdown and one article in our blog addressed the issue of "Merrill Lynch faces huge loss due to bad mortgage write-downs".

Long run growth is about the general increase in the standard of living. But remember we are all dead in the long run!!!

Goldman Sachs & Merrill Lynch comment on recession of US economy

According to a report from Merrill Lynch, US economy is already in recession. It refers to the employment report as an confirmation of recession. The unemployment rate of 5% in December was supportive of this view. The housing market is already falling and consumer spending is also lower.

While Goldman Sachs declined the recession in the US economy, it predicted that recession is very close and US economy may see it in 2008.

Goldman Sachs beleives that the slowdown in the US economy will affect the interest rates, since Fed bank may choose the option of lowering rates from 4.25% to about 2.5%

Goldman Sachs cautioned the investors to stay away from banking and finacial sector and increase their holdings of healthcare and consumer-related stocks.