Wednesday, January 23, 2008

A layman's guide to the US recession

Analysts say the fed cut on rates will not totally save the US from a recession. Markets today recovered but most investors believe this is not enough to arrest the slow slide of the US economy.

How to explain the US recession

Its like this. Millions of Americans can't pay their mortages to the banks. Why? Because people don't have enough money to pay those mortgages. Why? Millions of them don't have work. Those who do have jobs scrimp for money to pay high interest rates.

Those millions who don't work are victims of globalization. Why? US companies don't need their services because most have outsourced their labour requirements elsewhere, like China, India and the Philippines where labour is cheap.

Those who have work, well, because of their low salaries, can't pay the high interest rates that the banks charge. Blame the Fed. They're the ones who charge high interest rates. Why do they need to charge interest rates? Because that's where banks earn. And when banks earn, they pay higher taxes. Those taxes keep the US economy afloat and prevent bankruptcy.

Since many are not paying their mortgages, banks can't pay taxes. And when banks can't pay taxes, the US economy loses valuable revenue. And when it has low revenues, government can't fund its projects. And when that happens, treasury suffers and even government can't pay for its commitments to creditors and companies. Why is the US treasury nearly bankrupted itself?

Because the US is spending heavily on the global war on terror. The US spends billions of dollars everyday just to sustain the fight against Al-Qaeda in Afghanistan and Iraq. Americans are suffering because Bush decided to spend their dollars allegedly fighting terrorists.

So, they need more dollars. Some would say, why not make them? Well, the treasury can do that but it would lead to deflation which is also dangerous. Americans can't flood their economy with billions of dollars more because it would further dilute the value of their currency. Remember that currencies, by nature, should be traded. If they are not traded heavily, they lose or dilute their values. For currencies to be traded, they need to be exchanged. And the only reason for them to be exchanged is if companies buy stuff from other countries. This can only happen if there's a robust economy and companies are trading heavily with other companies around the world.

And the US economy is not performing well. It can't keep itself afloat. That's why some analysts predict that anytime now, the Federal Reserve would announce an recession.

What's the effects of recession?

A recession would send the signal that the US will momentarily stop paying its commitments to creditors and banks. It also means a slower economic pace. When an economy slows down activity, it affects markets since companies will have to lower their growth forecasts to keep pace with a slower economy.

Slower activity means decrease consumer spending

Capitalist economies such as the US rely heavily on consumer spending. In a recession, companies produce less since they expect that fewer people will buy their products and services. Why produce more when lesser people will buy? When there's lesser people buying stuff, (its postulated in economics that during hard times, people tend to save more than buy)it affects hundreds or thousands of companies. Profits are lower. When profits are lower, company performance is also affected. When companies perform less, their stocks are affected. Fewer investors will buy stocks from companies' which profits less. That's why stock markets crash when trading slows especially when investors sell instead of buy stocks.

Markets affect people's lives

When stock markets slow down, companies get a lesser amount of capital to use for their manufacturing and production. So, its a cycle.

Who will be hit the hardest?

Globalization has effectively linked regional and global economies to one. The US economy is the mother of all capitalist economies. Economies such as ours depend on the US economy. In fact, our economy will be one of the most affected since many companies here export their stuff there. BPO's and call centers will also be affected since most of their clients are US-based companies.

I expect call centers to bear the brunt of the recession. Fewer US companies will hire call centers since US companies will try to think of ways to save money by cutting down costs. Customer services will definitely have to go. When that happens, thousands of Filipinos working in call centers will have to be retrenched.

Philippine export companies will also be affected since the US is one of their primary markets. A recession would mean a smaller market to sell their products.

Is the solution looking elsewhere, like China?

No. China is still a paper tiger. Its economy is still heavily dependent on the US. If the strategy of the Arroyo government is to decrease US trade and concentrate on Chinese trade, they're mistaken. The yuan is still an unstable currency. It is pegged to the US dollar. Fluctuations in the US dollar due to uncertainty will definitely affect the Chinese economy.

1 comment:

  1. This is a very enlightening read. Thanks for posting this one. I might just link to this one later on. Salamat!

    M

    ReplyDelete

Thank you very much for reading my blog. You inspired me. But if you intend to put your name "anonymous", better not comment at all. Thanks!