Wednesday, August 17, 2011

World Economic Prospects

The issue of the US loss of AAA credit rating on last weekend is not over end yet. International credit rating agency Standard and Poor's warned that there is one-third probability that the agency will further downgrade the US credit rating in the coming half to two years. The US economic prospects are gloomy in view of the country's debt crisis. In addition to the spread of the European debt crisis, the global stock markets crashed again on 8 August. G7 and G20 finance ministers and officials called for emergency meetings to find ways to solve the problems.
Great Depression-Like Situation
The global stock market disaster has also caused turmoil in foreign exchange markets. Another round of depreciation of major currencies is expected. Moreover, the US credit rating may be further downgraded. Bad news comes one after another. Many are worried that the situation may be worse than what happened in the 1930s and that there may be a repeat of the Great Depression. What measures the Malaysian government would take to deal with this crisis? This is another matter of concern.
First of all, the current global economic problems, especially the US debt crisis, are very tricky. Almost all economists are at their wits' end as to how to solve these problems. One and a half year ago, with the exception of Prof Paul Krugman, almost no economist or research institute foresaw and warned the possible serious debt crisis in the United States. They also failed to predict that the United States would lose its AAA credit rating or have its credit rating downgraded to an even lower level. Europe, which is now plagued by the debt crisis, was the most severely stricken area in the first round; whereas Asia and Latin America were seriously hit in the second round. Almost none of the countries in the world can escape the crises.
Rise of Unemployment
The two rounds of financial crises have affected each other and now Asia is deeply plunged into the economic recession. The signs of this economic recession are the drastic fall of stock markets and depreciation of currencies. In medium and long term, we will see the decline of economic growth, rapid rise of unemployment rates, drastic drop of actual wages, and inflation. In other words, the degree of the current economic recession in the world, especially in Europe, is not far from the Great Depression in the 1930s, or even worse.
Finance ministers of G7 countries have recently met to discuss how to prevent the financial markets from plunging into turmoil as a consequence of the European debt crisis and the downgrade of the US credit rating. At this moment, an appropriate measure for the governments is to adopt expansive currency and financial policies in order to increase the total demands. However, Japan has already suffered economic downturn for seven years. During this period, the country suffered another severe setback caused by the earthquakes and tsunami. Japan has repeatedly adopted the measure of tax cut and expanding public spending. The country's interest rate has even dropped to the unprecedented 1 percent. Still, these measures have been to little avail. In other words, the economic problem of East Asia (Japan especially) has failed almost all economists. Both the governments and academicians have not been able to come out with any effective solution. At the same time, China may also find it hard to protect its own interests. Thus, it is not practical to expect China to come to the rescue. People are becoming more and more pessimistic over the economic prospects.
Second, the major economies in the world are now in different phases of the economic cycle. This is a rare and special phenomenon and has made the problems even more complicated. The United States has gone through more than seven years of expansion period since its economy started to recover in 2001 and has slowly declined from the peak. Now the United States is deeply plunge d in the debt crisis and its economic growth dropped drastically. The slowdown in the growth of the corporate surplus clearly proves this. The US debt crisis has also dragged the whole world into trouble. After this round of serious recession, the world economy may have to take a long time to gradually recover.
Third, the chaining effects in the current international trade and finance have increased a great deal. For example, the deterioration of the European debt crisis may cause serious losses to French bank Société Générale and the biggest bank of Italy and may be accompanied by the so-called ‘competitive’ depreciation. The plummet of the US stock market had also instantly led to the crash of stock markets worldwide. All these cannot be explained by fundamental economic theories. The European and US governments are still at their wits' end in handling their debt crises. As the interest rates, stock markets, and foreign exchange markets see drastic rise and fall, hindrance is expected in the financing of international trade and investment, and multinational capital because the risks have risen substantially.
International Policy Coordination
We can foresee that in the coming few years, there will be an obvious decline in international trade and investment as well as capital movement. This is of course greatly disadvantageous to the global economic growth. The turmoil and unrest in the global financial markets indicates the necessity for comprehensive reforms of the international financial system.
The key international currency, the US dollar, will become extremely unstable. Although governments of countries worldwide understand the importance of the ‘international policy coordination,’ they rarely walk their talk due to their selfish consideration. This has substantially weakened the stability of the international economic and financial system as compared to the past.
Future Scenario
We do not see any reliable and feasible solution for the debt crises in the near future, yet. The negative impacts on small economies like Malaysia are also obvious. One good example is that the economic growth of our country for this year is projected at 4.5 percent only. We foresee that various economic indicators will further decline in the second half of the year. It seems the recession is inevitable. As the demands from overseas declined drastically, expanding domestic demands will no doubt help to stabilize the economy in short-term. However, whether it is done through increasing budget for public projects or implementing incentives for rental cut, it will invariably lead to a soar of budget deficit. If the government rushes to implement some public projects, the quality and economic benefits of the projects may be affected easily.
Considering that the increase of the private investment had reached 24 percent in the first quarter of the year, it is indeed necessary to think twice on whether the government should introduce new measures in stimulating investment. In view of the bad and unfavorable external economic environment, economic stability is more important than economic growth.

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