:: Govind Talwalkar

How America lost its superpowers

Govind Talwalkar

The US economic stimulus plan proved to be a dud. The bailout plan might have helped the credit market somewhat, but the world is gripped in the fear of recession and possibly depression. This reminds one of the 1929 market crash and the depression, which followed.

Then, as now, the crisis began with easy money and speculation in real estate. Late Professor John Kenneth Galbraith in his book The Great Crash vividly described how easy money made people lose their heads. The speculators made huge profits but ultimately came to grief. Florida lands were in great demand and there was a rush to buy shares which, in few years, were reduced to waste paper.

Galbraith said many reputations were lost faster than the fall of the shares. The situation is the same now. One of the ardent advocates of the cheap money was Alan Greenspan, the chairman of the US Federal Reserve for 18 years. He was revered like a prophet, and enjoyed more credibility than US presidents.

It was not that Greenspan had no critics. Some had been warning against his policy of cheap money. Paul Krugman and several others were his trenchant critics. Anna Schwartz, who is now 92, co-authored with Milton Friedman a book — A Monetary History Of The United States. She said in a recent interview how she had opposed the cheap money policy and how Greenspan had refused to change. Greenspan has now proved to be a prophet with feet of clay. He has admitted to the Congressional committee that he made "some mistakes".

This cheap money policy created a false sense of security. As the market was booming, there was a massive amount of money the world over, which entered the US market. The Bush government raised money from public borrowings and the mounting deficit was covered by investments from Japan, China and Saudi Arabia among others. The Iraq and Afghanistan wars were not sustained by tax increases but by foreign money. Trade deficit piled up. The budgetary deficit in 2007 was $162 billion; but this year it is projected to be $455 billion, and next year it would rise further.

Banks and investment companies vied with each other to undertake mortgages. The CEOs made millions without regard to their performance. The gap between the earnings of an ordinary employee in a firm and a CEO was about 30 times some years ago but now it is more than 300 times.

The present turmoil might have originated in the US but the cheap money played a similar role in most countries, which offered sub-prime mortgages. It was a laudable idea to make houses affordable to a large number of people, but the regulators did not regulate. Consequently, many prople purchased houses they could not afford. In addition, the credit card facility made people behave like drunken sailors on a buying spree. A generation or two ago, the Americans used to save but now their savings are down to zero. In India it is 20 per cent, while in China it is 26.

As the world is reeling under this tsunami in the market, some observers expect a slow change in the national and international situation. In the US not only the TV channels but even retailers like Walmart impress upon customers the importance of saving. They tell how much saving could be made by cooking breakfast and meals at home. If Americans restrain their consumption habits, it would make a lot of difference. The people and the government have run amok and live on borrowed money, which is a deceptive prosperity.

The present tsunami in the market might also make some changes in international politics. Nationalism might be strengthened, as is evident by the French President’s appeal to see that foreign investors do not capture French companies. But globalisation cannot be reversed. That is why the French President and some other European leaders are compelled to adapt a unified credit policy.

It was President George Bush who humiliated western Europe by branding it as the old one, and calling east European nations the "new Europe". But it was the British Prime Minister who took the initiative to inject capital in the banking system and the US had to follow him.

Thus, the sole superpower was humbled first by the costly and futile war in Iraq and now by the economic meltdown. No country can arrogate leadership and dictate to the world and police it.

Russia recently was flushed with petro-dollars, so also were other oil-producing countries. With oil prices reduced by more than 50 per cent, all of them have no other option but to change their course and adopt a co-operative approach.

In this great turmoil, Japan was least affected. Its banking system and credit policies used to be constantly hammered by American commentators as being very rigid. Japan had suffered in the 90s because of too much regulations. It paid heavily for seven years. Then it recovered, as it made some changes. But the Japanese banks and investment companies are not allowed to lend indiscriminately. Moreover, the saving rate is quite high. That is why Japan has no problem of sub-prime mortgages. It is in a position to help countries which are suffering due to the credit crunch.

China is affected, but not like the US and Europe. It is true that it had to reduce the interest rate twice. However, unlike those in India, who once proclaimed China’s chairman as their chairman and now demand the UPA to snap relations with the US, the Chinese Prime Minister said in a recent interview that because of globalisation China would cooperate with other countries, including the US.

India is hit but the government and the Reserve Bank of India are able to save the country from utter chaos. Though the nationalisation of some banks was used, for some time at least, for political purposes, things improved later. These banks are guarantors to the depositors. Also, a large amount of capital was injected into the system.

But the coming election season might prove to be trying, as the states as well as the Centre might be tempted to offer all sorts of concessions. In some states parochial tendencies are becoming strong, and there is violence. The rise of sub-nationalism spells danger and might ruin whatever has been achieved in the last 20 years, if not 60 years.