Wednesday, January 23, 2008

The myth about world economy's independence from US economy

The steep Asian and European stock market fall seriously challenges the recent wisdom that the global markets have finally become independent of and immune to any slide in the US economy. If anything, the panic on the Asian and European stock markets only underscores how seriously misplaced this assertion was.
The subprime loan crisis, which is devouring America's real estate industry, was considered a local problem by many outside the US until they discovered how many major global players in fact stood quite close to the fire - thanks to complex deal making that goes on behind such mortgages.

As late as Monday, many in the US believed that the Federal Reserve, which sets the country's monetary policy, would prefer to let the subprime market crisis sort itself out. However, the scale and spread of the market panic in Asia and Europe reversed that view practically overnight with the Fed, as the Federal Reserve is known, intervened on Tuesday with the biggest interest rate cut of 0.75 percent since October, 1984.
It is true that the dramatic market fall was caused as much by the perception of a weakening and perhaps even recessive US economy as the early reality of it. What is surprising is that the global markets remained unaffected by the problems in the US for so long. What is even more intriguing is that after surging ahead for months the global markets took an about-turn as if they had just chanced upon the challenges in the US.
The red hot economies of India and China, one growing at nearly nine percent and the other between 11 and 12 percent, and overall strengthening of other Asian economies such as Japan, created the impression among many observers that finally the world economy was significantly reducing its dependence on the US.
On the contrary, as it turned out in the last couple of days, the world still remains inextricably attached to the fortunes of the US economy.
That is where the uncertain politics in the US come into play in so much as they impact the rest of the global community. With less than a year left for the Bush administration and it having lost most of its initiative on any substantive issues, especially the economy, it is seriously doubtful whether there would be a turnaround any time soon.
In a sense the US economic management is caught in the vicissitudes of electoral politics. The Bush administration is practically into its lame duck period where the president no longer sets or controls the agenda. On the other hand there is no one other than George Bush who at least theoretically has the power and the platform to intervene by the sheer virtue of still being president. The dichotomy is that the platform has lost its effectiveness.
The global fall put the US Federal Reserve in a peculiar spot. If it was contemplating a hands-off approach, as many had speculated, it had to change gears suddenly in the aftermath. A hands-off approach may have been a strategy to send a signal to the rest of the world that the problem is not as serious as the markets had concluded. However, on Tuesday the Fed reversed that strategy and delivered a dramatic three-quarters of a percentage point cut. Obviously, the hope was that such a big cut would calm frayed nerves on the Wall Street. But it had the opposite effect as the Dow Jones fell irrespective of the announcement.

The Federal Open Market Committee seemed to foreshadow recession that in so many words. It said, "Appreciable downside risks to growth remain" without really succeeding to hide that it was concerned about recession.
"The committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets," it said.
The announcement of a $150 billion stimulus package by the Bush administration coupled with the interest rate cut to bolster the US economy are measures that could well ease some of the pressures but at this stage it is anybody's guess when and if the global markets will be able to internalize the problems in the US without any significant loss.
Indo-Asian News Service

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