Global Economy

Global Economy
US subprime crisis will soon celebrate its anniversary along with soaring oil prices, commodity prices, food shortages, spiking inflation and sluggish economic growth.
All banks and financial institutions with exposure to CDOs have been affected by the subprime crisis. Fannie Mae and Freddie Mac, the two US government enterprises that are chartered by the US Congress to provide a national market for mortgages, are the only financial institutions who are buying and scrutinizing the US mortgages. There are many central banks holding huge inventories of securities issued by these banks.
Considering the scenario mentioned above, Ben Bernanke, the Fed Chief, believes that US economic growth is “skewed to the downside” and he assures the US congress that improving the health of the financial markets is his top priority.

The Global Economy Problem

Since agricultural land is diverted for production of alternative energy sources, food prices have soared.
Prices of raw material like iron ore, etc. have soared as a result of the growing demand for natural resources from development economies like China. Oil prices have risen as a result of rising demand.
Adding to the problems, the weak dollar, besides pushing up US import prices, export inflation to all countries whose currencies are linked to the US dollar.
It would be difficult to say which way the global economy will go now, but amidst all the uncertainty, growth of emerging economies, whose growth according to the World Bank is estimated to be 6.5%, may pull out global economy from the recession in the world market.

Global Stagflation

US and Europe have been enduring financial doldrums and dissipating growth since mid 2007, which aggravated to recessionary environment in mid 2008. Britain’s economy grew by just 0.3% in the first quarter of this year, the service sector showing the weakest performance. In Japan, world’s second largest economy, consumer spending saturated as a result of soaring oil and commodity prices. This problem has adversely affected the growth of high-performing BRIC nations too.

Washington based World Bank, in its Global Development Finance report, predicts the world economic growth to decline to 2.7% in 2008 versus 3.7% in 2007. GDP in US is expected to grow at 1.1% in 2008 versus 2.2% in 2007, whereas GDP of Europe could grow at 1.7%.
Paris based Organization for Economic Cooperation and Development (OECD) foresees weak growth, around 1.8%, for most of its 30 members. They predict the US economy to grow at 1.2% in 2008, whereas both Europe and Japan to grow at 1.7%. Growth in China is expected to slow to 9.4% vs. 11.9% in 2007, South Africa from 5.1% in 2007 to 4.2% and India from 8.7% to 6%.
Inflation in UK soared to 3.3% in May, and inflation in Japan rose to a decade high of 1.5%. Inflation in Singapore is recorded as 7.5%, in Russia as 12% and in India as 12%.
Inflation results when the supply of money exceeds demand. Thus the Fed should be raising interest rates, but instead they have been decreasing interest rates to combat the subprime crisis.

The current inflationary situation is not because of an overheating environment but by the 3 Fs- fuel, food and financial speculators. So interest rate hikes alone would not fight inflation. Rising interest rates would cause more recession. As cost of money rises due to rise in inflation, growth will halt, and inflation, rooted in the 3 Fs, will continue to rise. The solution: lower fossil fuel consumption, raise food production, curb excessive speculation, stimulate investments, incentivize capacity addition, nudge productivity increase and adopt sustainable technologies.Massive public and private investments are needed to promote sustainable technologies. Hybrid automobiles with advances batteries, green buildings, carbon capture, cellulose-based ethanol, safe nuclear power and other advanced technologies can combat growing energy demands. Solar power is another alternative to global energy requirements. For food supplies, new drought-resistant crop varieties, along with new irrigation technologies, can help more food production in the changing climatic conditions.