Pedigree of American Recession

The present recession in the USA has a complicated pedigree.

The story begins with the tragic events on September 11, 2001. The dastardly attack on the USA by Al Qaida shook the soul of America as never before. The earlier major national traumatic experience was Japanese attack on Pearl Harbor in 1941. But it was peanuts in comparison with what took place on 9/11. Al Qaida pierced the very heart of America. Japanese had used their own aircraft as weapons at Pearl Harbor. In 9/11, Al Qaida used the American aircraft to stress the humiliation heaped on American psyche.

The 9/11 attack kicked-off a chain of events. It triggered off invasion of Iraq as the American government believed on the basis of the evidence available to it that the next attack on the United States, possibly nuclear, might come from Iraq. Iraq war was a huge military success in the initial phase, but since then it has dragged on interminably. The military activities are over in Iraq, but a huge contingent of troops continues to stay there. It continues to drain the American treasury.

There are various estimates as to the cost of Iraq war. The Bush administration understandably downplayed the cost. We must take into consideration not only the upfront cost incurred on the military deployment and operations but also the staggering social and economic costs which might not be obvious. According to Linda Bilmes and Joseph Stiglitz, in a scholarly article published in the Washington Post on March 9, 2008, the total cost of Iraq war might exceed 3 trillion dollars. Even if we assume that their estimate was liberal by a factor of 2, in a 14-trillion economy, a wasteful and entirely non-productive outlay of 1.5 trillion dollars is bound to be impactful.

Even before the Iraq war, the federal budget of the United States had a huge deficit. The war opened the floodgates of expenditure. This expenditure was met with the borrowed money of national debt, which was soaring by about $1 billion a day, thanks to the heavy purchase of the debt by China and other exporters to the United States. Iraq War, along with Afghanistan war, made its own contribution to the recession which is plaguing the United States and therefore the world, today.

The balance of trade between China and the USA has been continuously rising in favor of China since 1986. During recent times, it has grown from $203 billion in the year 2003 to $266 billion in the year 2008. Cumulatively it adds up to about one and a quarter billion dollars over the last six years. Quite a good chunk of this money has been used by the Chinese in purchasing the US national debt. Can we, therefore, not say that Chinese-American trade also played a role, albeit indirectly, in deepening the financial crisis?

However, the greatest and most visible contribution to the recession was made by so-called subprime landing. These were the loans granted by bankers for buying houses, cars and other assets without checking the paying capacity of the borrowers. Most of the borrowers of such loans did not have adequate capacity to service their mortgages. Such mortgages were then collated by the first lenders in various bundles, securitized and sliced suitably in the form of attractive looking bonds at high coupon rates and sold to greedy investors who believed they were too clever to go for the traditional form of investments. Thus banks created assets for themselves some of which were ab initio non-performing assets or toxic assets. The ultimate value of such bank assets depends upon whether the mortgages taken against those bonds are repaid or not.

The bubble burst, as it was destined to, and the people ran for cover. The value of the assets based on such securitized bonds fell freely as though under gravity. Value of stocks of banks and other corporations in the share market plummeted. It severely restricted the capacity of banks to open fresh lines of credit. In turn, this made the entire economic system totter on the brink of uncertainly, if not sure disaster. Moralists feel it all happened due to human greed. Economists say it was all due to lack of adequate regulation and overseeing of the financial system.

Consumer spending has got steeply diminished. The 14-trillion dollar American economy depends at least 65 per cent on consumer spending, both on goods and services. Demand of goods and services is falling and and people have lost jobs in consequence. According to Bureau of Labor Statistics, the payroll employment has declined by 3.6 million since December 2007. Imagine the misery it must have brought to so many households. People are finding it very painful to survive.

The fundamental strategy to address this grim scenario is to boost demand, which can only be done by injecting huge outlays in the system. Food stamps and unemployment benefits are sure shot as the recipients are bound to spend the money as soon as possible. Tax cuts to the low income groups is another way to inject expendable money in the system. President Obama has creative ideas like going in a big way building infrastructure like new roads and schools. Giving money to states is also a good idea as it will stimulate social security programs like Medicaid. Banks should also get huge chunks of money so that they are able to reactivate their lines of credit to the borrowers who might be willing to invest in productive ventures.

At this point of time it is difficult to say what should be the nitty-gritty of stimulus package. Time alone can say to what extent Obama administration will succeed in averting the economic disaster.