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In economics, the term recession generally describes the reduction of a country's gross domestic product (GDP) for at least two quarters. The usual dictionary definition is "a period of reduced economic activity", a business cycle contraction. The United States-based National Bureau of Economic Research (NBER) defines economic recession as: "a significant decline in [the] economic activity spread across the economy, lasting more than a few months, normally visible in real GDP growth, real personal income, employment (non-farm payrolls), industrial production, and wholesaleretail sales."
Causes of recessions
• • • • •
Currency crises Energy crisis War Underconsumption Overproduction
A currency crisis, which is also called a balance-of-payments crisis, occurs when the value of a currency changes quickly, undermining its ability to serve as a medium of exchange or a store of value. It is a type of financial crisis and is often associated with a real economic crisis. Currency crises can be especially destructive to small open economies or bigger, but not sufficiently stable ones. Governments often take on the role of fending off such attacks by satisfying the excess demand for a given currency using the country's own currency reserves or its foreign reserves (usually in Euros, United States dollar or United Kingdom Pounds). Recessions attributed to currency crises include the 1997 Asian Financial Crisis and the Argentine economic crisis (1999-2002).
An energy crisis is any great bottleneck (or price rise) in the supply of energy resources to an economy. It usually refers to the shortage of oil and additionally to electricity or other natural resources. An energy crisis may be referred to as an oil crisis, petroleum crisis, energy shortage, electricity shortage or electricity crisis. The 2008 Central Asia energy crisis is an ongoing energy shortage in Central Asia, which, combined with the severe weather of the 2007-08 winter (the coldest since 1969) and high prices for food and fuel, has caused considerable hardship for many.[ The abnormally cold weather has pushed demand up for electricity, exacerbating the crisis. The situation is most dire in Tajikistan. An international appeal has been made by the United Nations, NGOs, and the Red Cross and Red Crescent for around US$25 million to assist the government.The crisis has been ongoing and the UN has warned that millions face starvation during the 2008-09 winter.
Market failure is possible when monopoly manipulation of markets occurs. A crisis can develop due to industrial actions like union organized strikes and government embargoes. The cause may be over-consumption, ageing infrastructure, choke point disruption or bottlenecks at oil refineries and port facilities that restrict fuel supply. An emergency may emerge during unusually cold winters due to increased consumption of energy. Pipeline failures and other accidents may cause minor interruptions to energy supplies. A crisis could possibly emerge after infrastructure damage from severe weather. Attacks by terrorists or militia on important infrastructure are a possible problem for energy consumers, with a successful strike on a Middle East facility potentially causing global shortages. Political events, for example, when governments change due to regime change, monarchy collapse, military occupation, and coup may disrupt oil and gas production and create shortages.
Kuwait's Al Burqan Oil Field, the world's second largest oil field, will be depleted within 40 years. Crises that exist as of 2008 include:
Oil price increases since 2003 - Caused by continued global increases in petroleum demand coupled with production stagnation, the falling value of the U.S. dollar, and a myriad of other secondary causes. 2008 Central Asia energy crisis, caused by abnormally cold temperatures and low water levels in an area dependent on hydroelectric power. Despite having significant hydrocarbon reserves, in February 2008 the President of Pakistan announced plans to tackle energy shortages that were reaching crisis stage. At the same time the South African President was appeasing fears of a prolonged electricity crisis in South Africa. South African electrical crisis. The South African crisis, which may last to 2012, lead to large price rises for platinum in February 2008 and reduced gold production. China experienced severe energy shortages towards the end of 2005 and again in early 2008. During the latter crisis they suffered severe damage to power networks along with diesel and coal shortages. Supplies of electricity in Guangdong province, the manufacturing hub of China, are predicted to fall short by an estimated 10 GW.
War is the reciprocal and violent application of force between hostile political entities aimed at bringing about a desired political end-state via armed conflict. In his seminal work On War, Carl Von Clausewitz calls war the "continuation of political intercourse, carried on with other means." War is an interaction in which two or more militaries have a “struggle of wills”. When qualified as a civil war, it is a dispute inherent to a given society, and its nature is in the conflict over modes of governance rather than sovereignty. War is not considered to be the same as occupation, murder, or genocide because of the reciprocal nature of the violent struggle, and the organized nature of the units involved. 3
War is also a cultural entity, and its practice is not linked to any single type of political organisation or society. Rather, as discussed by John Keegan in his “History Of Warfare”, war is a universal phenomenon whose form and scope is defined by the society that wages it. The conduct of war extends along a continuum, from the almost universal tribal warfare that began well before recorded human history, to wars between city states, nations, or empires. A group of combatants and their support is called an army on land, a navy at sea, and an air force in the air. Wars may be prosecuted simultaneously in one or more different theatres. Within each theatre, there may be one or more consecutive military campaigns. A military campaign includes not only fighting but also intelligence, troop movements, supplies, propaganda, and other components. A period of continuous conflict is traditionally called a battle, although this terminology is not always applied to conflicts involving aircraft, missiles or bombs alone, in the absence of ground troops or naval forces. War is not limited to the human species, as ants engage in massive inter-species conflicts which might be termed warfare. It is theorized that other species also engage in similar behavior, although this is not well documented.
In underconsumption theory, recessions and stagnation arise due to inadequate consumer demand relative to the amount produced. It is an old concept in economics, going back to Thomas Malthus if not earlier. The concept of underconsumption had been used repeatedly as part of the criticism of Say's Law until underconsumption theory was largely replaced by Keynesian economics which points to a more complete explanation of the failure of aggregate demand to attain potential output, i.e., the level of production corresponding to full employment. One of the early underconsumption theories says that because workers are paid a wage less than they produce, they cannot buy back as much as they produce. Thus, there will always be inadequate demand for the product. This, of course, ignores other sources of demand, to which we return below.
Overproduction is the accumulation of unsalable inventories in the hands of businesses. Overproduction is a relative measure, referring to the excess of production over consumption. The tendency for an overproduction of commodities to lead to economic collapse is specific to the capitalist economy. In previous economic formations, an abundance of production created general prosperity. However in the capitalist economy,
commodities are produced for profit. This so-called profit motive, the core of the capitalist economy, creates a dynamic whereby an abundance of commodities has negative consequences. In essence, an abundance of commodities disrupts the conditions for the creation of profit. The overproduction of commodities forces businesses to reduce production in order to clear inventories. Any reduction in production implies a reduction in employment. A reduction in employment, in turn, reduces consumption. As overproduction is the excess of production above consumption, this reduction in consumption worsens the problem. This creates a "feed-back loop" or "vicious cycle", whereby excess inventories force businesses to reduce production, thereby reducing employment, which in turn reduces the demand for the excess inventories. The general reduction in the level of prices (deflation) caused by the law of supply and demand also forces businesses to reduce production as profits decline. Reduced profits render certain fields of production unprofitable. Reduced profits also causes some businesses to collapse.
Solutions for Overproduction
John Maynard Keynes formulated a theory of overproduction, which led him to propose government intervention to ensure effective demand. Effective demand is a level of consumption which corresponds to the level of production. If effective demand is achieved then there is no overproduction because all inventories are sold. Importantly, Keynes acknowledged that such measures could only delay and not solve overproduction
Effects of recessions
• • • • •
Bankruptcies Credit crunches Deflation (or disinflation) Foreclosures Unemployment
ANALYSIS US RECESSION
The origins of the current US recession lie in the sub-prime crisis and the consequent housing boom bust. Soaring oil prices have also added to the woes. The lessons for India are stark. Banks and FIs must follow strict prudential norms while advancing housing loans to prevent the boom from going bust, says ALOK RAY.
Economists define “recession” as falling GDP for two consecutive quarters. According to that definition, recession has not yet arrived in the US. But it is very much in popular mind. Further, policymakers can not wait for its announced arrival to take corrective action, as it would be too late to avert it. It may even be counterproductive. Fiscal and monetary policies take time to have their full impact. If the timing of stabilisation policies is wrong, it may aggravate the business cycle. For example, expansionary policy to fight recession may impact the economy at a later time when the economy on its own has started to move up. In that case, it may stoke inflation. At this time, many economists believe that the US economy is definitely going to go slow down for quite some time, increasing the unemployment rate and at the worst a recession may have already started. Mr Ben Bernanke, the Chairman of US Federal Reserve, has asked the US Congress for an immediate fiscal stimulus package to avert a recession. In addition, he has brought about the largest single-day cut in the benchmark interest rate (fed fund rate) in recent memory to stimulate the economy, on top of several rounds of smaller interest rate cuts.
How did the economic downturn come about? What are the likely consequences? The questions are important since what happens in the US economy would have significant impact on the rest of the world, including India. Moreover, do we have some lessons to learn from what happened in the US? HOUSING SECTOR The problem in the US started in the housing sector. For quite some time, greedy banks – with the help of officials and brokers getting hefty cuts from the deals – were pushing loans to people to buy houses. As a result, some people got more loans than would be justified by their credit standing. So, they bought more expensive houses with loan money than they could really afford. It helped create a housing boom. Inevitably, some of the borrowers failed to pay back the loans, especially when the interest rates were adjusted upwards under variable interest rate mortgages. Banks and other financial institutions now began to be saddled with bad loans. The housing bubble burst. When finally prices of houses fell below a threshold, the amount of loans advanced by banks could not be recovered even by selling the houses against which the loans were given. Financial institutions, faced with losses, were then forced to cut back credit not only to the housing sector but to other sectors as well. In addition, people became poorer as the market value of their wealth (houses) plummeted and felt the need to tighten their belts. The trouble originating in the so-called sub-prime mortgage market spread to the rest of the economy.
THE OIL FACTOR
Another aggravating factor was rising oil prices. As people had to spend more and more on transportation costs, they had less to spend on other goods. It pushed the economy further downhill. Now, the latest figures show a rise in unemployment rate in the US after a long time. Naturally as people lose jobs and income, they are forced to cut back spending. Even people with jobs, when faced with a greater chance of losing jobs, would try to reduce expenditure and save more for the rainy day. That is further bad news for business sales, production and jobs. The US stock market (Dow Jones index) has already fallen by more than 10 per cent since January 1. The jitters from the US market have spread to stock markets all over the world. One reason is that the risky sub-prime mortgage loans by US institutions have been converted by Wall Street investment banks into securities (in technical jargon, “derivatives”) under various fancy names in which financial investors from all over the world (like even the Chinese central bank) have invested. So, their positions too have become vulnerable and the full extent of their exposure is not yet publicly disclosed. The prevailing uncertainty is causing wide gyrations in global stock prices.
Meanwhile, US dollar has been steadily falling against Euro, Yen and many other currencies. As American goods and services become cheaper, US trade deficit may shrink, creating some net demand for US goods which would help the US recovery. At the same time, for foreigners, US is becoming an increasingly cheap place for buying assets. Using the opportunity of a cheap dollar and several major US financial institutions (involved in housing market loans) desperately looking for bailout money from anywhere in the world, sovereign (government) wealth funds from Asia and West Asia (like Singapore, South Korea, Saudi Arabia, Kuwait) are buying up significant stakes in flagship US financial institutions like Citigroup, Merrill Lynch and Bank of America. The US is facing a takeover of significant parts of its economy by agencies closely connected with foreign governments which a lot of American politicians view as security risks. The Fed Chairman has already gone for several rounds of interest rate cuts (monetary policy) which is under his control. But the expansionary monetary policy has not yet succeeded in averting the slowdown. In theory too, monetary policy works only with a considerable lag. So, Fed now wants to take the help of expansionary fiscal policy for a more immediate effect. But, cutting taxes or increasing government expenditures (fiscal policy) is in the domain of the US Congress. Both the Fed and the US administration at this moment are considering fighting unemployment to be the top priority (especially in an election year) even at the risk of some rise in inflation later. Now, enter politics and lobbying. Most economists agree that, dollar for dollar, temporary tax rebates to low income people and more government expenditures like higher unemployment benefits would stimulate expenditures more immediately and by larger amounts than tax cuts or investment credits granted to business. This is because poorer people would spend a larger fraction of any additional income than a richer person and it is doubtful whether investment credits can stimulate investment spending in a recessionary situation where already existing production capacity is remaining underutilized. Though many Democrats want a package that would include a rise in unemployment benefits and food stamp entitlements targeted mainly to the poor (their solid vote bank), many Republicans want tax concessions to business (their support base) as part of the stimulus package. Finally, President Bush has agreed to a $150-billion compromise package which gives temporary tax rebates to low and middle income taxpayers (the unemployed and the poorest families are not taxpayers and hence they would not get these additional benefits) as well as some business investment incentives. 8
The United States' sub prime crisis has turned out to be bigger than previously thought and has the potential to drag the world's largest economy into a recession. And although there are varying opinions on whether the US could slip into a recession or not, most economists do feel that despite the US Federal Reserve's rate cuts and the Bush administration's $161-billion economic aid plan, chances of a recession are high. Be that as it may, one thing is for certain: the losses from the sub prime that financial majors have incurred will take a long time to get Subprime losses till date over. Bank Losses Citigroup $18.0 billion Given below, in the table, are the estimated losses UBS $13.5 billion that some of the world's largest banks have Morgan Stanley $9.4 billion suffered on account of home loan defaults in the Merrill Lynch $8.0 billion US. The total figure adds up to over $76 billion HSBC $3.4 billion and does not take into account losses suffered by Bear Stearns $3.2 billion many other financial majors that had an exposure Deutsche Bank $3.2 billion to the crisis. Bank of America $3.0 billion Four Indian banks -- State Bank of India [Get Barclays $2.6 billion Quote], ICICI Bank [Get Quote], Bank of Baroda Royal Bank of $2.6 billion [Get Quote], and Bank of India too have big Scotland exposure to credit derivatives, with the spreads on IKB $2.6 billion these widening since international lenders turned Societe Generale $2.0 billion risk-averse following the crisis in the US subprime Freddie Mac $2.0 billion (or high-risk home loan) market. Wachovia $1.1 billion Credit Suisse $1.0 billion Credit derivatives are instruments for which the underlying asset is a loan or a bond. Marking to market means valuing a portfolio based on the prevailing market price. ICICI Bank has the highest exposure of $1.5 billion. SBI has an estimated exposure of $1 billion, BoI of $300 million, and BoB of $150 million. About 5-10 per cent of this figure could be the losses that these banks could incur.
UNDERSTANDING THE SUBPRIME CRISIS Just what is the sub prime crisis? And why is it having such a decisive impact on the Indian stock market? Let's understand it. Take, for example, an American who seeks a home loan, but does not have a very good credit rating. That essentially means that banks may not extend him a home loan. Enter, another American with stellar credit rating and the willingness to take on some risk. Given his good credit rating, banks are willing to give him a loan at a certain rate of interest. This individual the divides the loan into small lots and gives them out as home loans to lots of Americans, who do not have very good credit rating and cannot get a home loan from any bank. He gives out the home loan at a rate of interest higher than it is paying to the bank it borrowed money from. This higher rate is referred to as the sub prime rate and this home loan market is referred to as the sub prime home loan market. By giving out a home loan to lots of individuals, the individual ensures that even if a few of them default, his overall position is not affected much. But the individual giving out loans in the sub prime market does not stop here. He does not wait for the principal and the interest on the subprime home loans to be repaid, so that he can repay his loan to the bank, which has given him the loan. He goes ahead and securitizes these loans. Securitization involves converting these home loans into financial securities, which promise to pay a certain rate of interest. These financial securities are then sold to big institutional investors. The interest and the principal that is repaid by the sub prime borrowers through equated monthly installments is passed onto these institutional investors. The individual giving out the sub prime loans, takes the money that he gets from selling the financial securities and passes it on to the bank, he had taken the loan from, thereby repaying the loan. A neat plan. But then things went horribly wrong. The sub prime home loans were given out as floating rate home loans. So as interest rates increased, the rates on floating home loans too went up, and so did the monthly installments needed to service these loans. These high installments hit the sub prime borrowers with the terrible force. Many, given their poor credit rating to begin with, defaulted. Once, more and more sub prime borrowers started defaulting, payments to the institutional investors who had bought the financial securities stopped, leading to huge losses.
So how did that effect stock markets in India? Institutional investors who had invested in securitized paper from the sub prime home loan market, saw their investments turning into losses. Most big investors have a certain fixed proportion of their total investments invested in various parts of the world. Once investments in the US turned bad, more money had to be invested in the US, to maintain that fixed proportion. In order to invest more money in the US, money had to come in from somewhere. And this money came in from emerging markets like India, where their investments have been doing well. These big institutional investors, to make good of their losses on the sub prime market, have been selling their investments in India and other emerging markets. Since the amount of selling in the market far overweighs the amount of buying, Indian stock prices have been falling.
IMPACT ON INDIA
• • • • • • • • A slowdown in the US economy is bad news for India. Indian companies have major outsourcing deals from the US. India's exports to the US have also grown substantially over the years. Indian companies with big tickets deals in the US are seeing their profit margins shrinking. More people have sold the shares in the Indian share market than they bought in the recent weeks. This has added to the fall of sensex to lower points. One danger meanwhile is of a dip in the employment market. There is already anecdotal evidence of this in the IT and financial sectors, and reports of quiet downsizing in many other fields as companies cut costs. More than the downsizing itself, which may not involve large numbers, what this implies is a significant drop in new hiring -- and that will change the complexion of the job market. Many companies has laid off their staffs, the number of tourists inflow to india has come down, companies have cut down compensations and perks etc, government and other private companies are reluctant in starting new ventures and starting new projects etc. Projects that are halfway to completion, or companies that are stuck with cash flow issues on businesses that are yet to reach break even, will run out of cash. one of the casualties this time could be real estate, where building projects are half-done all over the country and in this tight liquidity situation developers find it difficult to raise finances If done sensibly, it would prevent a sudden tightening of liquidity, and also not allow the credit market to overshoot by taking interest rates up too high. Meanwhile, there is an upside to be considered as well. The falling rupee (against the dollar, more than against other currencies) will mean that exporters who felt squeezed by the earlier rise of the currency can breathe easy again, though buyers overseas may now become more scarce. Overheated markets in general (stocks, real estate, employment-among others) will all have an element of sanity restored. And for importers, the oil price fall (and the general fall in commodity prices) will neutralise the impact of the dollar's decline against the rupee. Overheated markets in general (stocks, real estate, employment-among others) will all have an element of sanity restored. And for importers, the oil price fall (and the general fall in commodity prices) will neutralise the impact of the dollar's decline against the rupee.
• • • • • • • • •
“When the United States sneezes, the rest of the world may well catch a cold....” Rich Miller.”
• • • • • • • • Tax cuts are the first step that a government fighting recessionary trends or a fullfledged recession proposes to do. The government also hikes its spending to create more jobs and boost the manufacturing and services sectors and to prop up the economy. The government also takes steps to help the private sector come out of the crisis. In the current case, the Bush government has proposed a bailout package. Initial estimates of the cost of the Treasury bailout proposed by the Bush Administration's draft legislation (as of September 19, 2008) were in the range of $700 billion to $1 trillion U.S. dollars. President George W. Bush asked Congress on September 20, 2008 for the authority to spend as much as $700 billion to purchase troubled mortgage assets and contain the financial crisis. The crisis continued when the United States House of Representatives rejected the bill. The bill was eventually passed by the Senate and the House but the stock market continued to fall nevertheless
We are in a situation where no one can actually help and there is no point in blaming the God or the circumstances for our situation. You cannot also blame the Government of your country or the company you was working for this situation. It is just a tough time where the Darwin law’
“Survival of the fittest”
will work and those country’s perfect with base economy will survive.
“we are not in recession. we are not going to be in recession. Recovery is on the horizon. The decks are clear. The economy is in direct drive.”
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