US Financial Crisis Lessons For India

Nilotpal Basu

YES -- the beans now stand spilled. The worst apprehensions have come true giving rise to a nightmare regarding the global financial system. That the protracted period of deficit financing by the United States through the surplus that other economies had with it cannot go on forever was a foregone conclusion. But the mandarins of international finance capital were selling the dream that the almost 60 year long boom of the US economy cannot go bust.

That the US financial crisis is not a figment of imagination of the Left or Keynesian 'doomsayers' is evident. One of the whiz kids of the financial world George Soros has come out with a prognosis that bares the deep corrosion that has afflicted the system. Soros has observed, "Every time the credit expansion ran into trouble the financial authorities intervene, injecting liquidity and finding other ways to stimulate the economy……The system was so successful that people came to believe in what former US president Ronald Reagan called the magic of the market place and I called market fundamentalism. Fundamentalists believe that markets tend towards equilibrium and the common interest is best served by allowing participants to pursue their self-interest. It is an obvious misconception, because it was the intervention of the authorities that prevented financial markets from breaking down, not the markets themselves."

It is a matter of record that this 'market fundamentalism' not only became a mantra but was used as an instrument by the US to suck up the savings of developing world. That is how globalisation progressed with the US consuming more than it produced. It is most ironic that these very ideologues who were forcing hapless developing countries to pull down regulatory barriers through active intervention of the all powerful US government were actually walking on thin ice -- from the government to citizens borrowing became a national habit. The credit expansion driven profligacy has led to the fiscal deficit which is evidently unsustainable and threatens the very integrity of the financial system. What is noteworthy is that while the US policy makers were embarking on this course domestically, they were aggressively pursuing the governments, particularly those in the third world, to disengage from economic affairs and drastically reduce fiscal deficit by practising what one may be tempted to call 'fiscal fundamentalism'.

TIP OF THE ICEBERG

Therefore, what had started as a sub prime crisis in the housing sector was just the tip of the iceberg. From the mortgage to the debt market to the insurance and finally to interbank lending -- all sectors of the financial system have now become vulnerable. A recession is an unavoidable eventuality. That is why a pall of gloom descended on Davos where the captains of global finance met recently.

The systemic nature and 'market fundamentalist' ideological roots of the crisis, however, is yet to be recognised by the Bush administration. And, not only the administration -- as we have found out from the eminent economist and columnist Paul Kragman -- even the Democrats do not have substantial differences with the 'bailout package' that has been unfolded. The bipartisan consensus in the US polity does not factor in the fact that the bailout will be handed out to such people who will not necessarily spend -- and will not, therefore, have any significant impact in arresting the recession.

That there is no holistic comprehension is also borne out by the fact that a conventional approach of bringing the FBI to nab the errant market players is on the cards. Reuters has reported -- "But while the market's bears pulled in their claws for the time being, a new potential danger emerged for bankers and brokers involved in the housing price bubble that burst months ago, triggering the present credit crunch.

"The FBI said it is investigating 14 corporations over possible accounting fraud and insider trading violations in a crackdown on subprime lending. The companies were not named.

"The agency said they include developers, lenders and financiers that securitised ordinary home loans into exotic investment instruments, as well as banks that held them.

"The FBI said it is cooperating with the Securities and Exchange Commission, which has confirmed opening at least three dozen investigations related to the subprime mortgage market."

While it is quite possible that entities in the market have breached the law which contributed in the bursting of the housing 'bubble', but what is of far greater significance is that, but for the 'market fundamentalism' driven economic philosophy and the criminal abdication of responsibility by the regulators, the financial crisis could not have exploded the way it has happened.

DOLLAR RELUCTANCE

Given these circumstances, in facing the prospect of a recession, what has also become quite apparent is the inability of the financial authorities of the US to kick prime the economy due to the reluctance of the rest of the world to accumulate additional dollar reserves.

The signs of such reluctance are also glaringly visible - may be with different overtones. While president Hugo Chavez hosting a Latin American summit gave a call for withdrawing billions of dollars in international reserves from US banks -- "why does that money have to be in the North?…. You can't put all your eggs in one basket", others like China or Middle Eastern oil rich kingdoms have initiated their own Sovereign Reserve Funds. The whole world has now quite well understood the vulnerabilities of the US financial system, with imminent inflationary pressures pushing oil, food and commodities, the US Fed's capacity to undertake anti-recessionary measures is constrained, lest the dollar crashes.

That the prognosis of George Soros is finding resonance with respected economists like Joseph Stiglitz is not a chance coincidence. Stiglitz has pointed out that the breakneck speed of the rise in international oil prices which was triggered by the invasion and continued occupation of Iraq is now having its lethal impact. Chinese growth expansion and its capacity to absorb investment, lowering interest rates (which led to the housing bubble) and the workers all over the world being forced on a lower real wages and a smaller share of GDP - all these factors can no longer check the soaring oil prices.

We have seen in the past that economies manage to ward off recession with a bit of inflation. At times, economies have to bear with huge recessionary pressures to avoid unsustainable inflationary pressures. But often economies end up with the worst of both the situations -- a stagflation. And, that is precisely what Stiglitz is forewarning nations of the world and their Central Banks.

INDIAN FM's GLIB TALK

Notwithstanding this grim global financial landscape, it was strange that when the Indian capital markets have been in a tizzy in the midst of an apprehension about US driven global recession, the Indian finance minister Chidambaram was indulging in glib talk. In Davos, he shared his mind -- "I think the US economy may bounce back and there is no conclusive evidence of recession in that economy". The finance minister had directed all financial institutions to infuse funds in the turbulent market. Earlier the rising dollar had affected labour intensive exports taking away thousands of jobs. But the worst is yet come.

Perhaps, it will also be pertinent to remind the finance minister about the candid observation of Simon Johnson -- the head of the research department of the IMF -- the big daddy of the global finance system. Johnson stated that it was still 'too early' to say what impact the recent financial market turmoil will have on India for no country is going to be 'exempt from the global slowdown'.

Johnson made a more pertinent point while sounding little more optimistic on India's prospect in mitigating the global recessionary crisis and the inevitable slowdown. He observed -- "India has relatively less trade exposure than some other countries. So that will limit the effects. India also appears not to have been drawn in through the financial mechanism. We don't think there is substantial exposure there". With all humility, let the finance minister be reminded of his government's overzealous enthusiasm for making the Indian rupee convertible on capital account. One shudders at what havoc that would have spelt for the Indian economy in the light of these current developments. The lessons of the East Asian crisis of the nineties forgotten, let at least the present scenario persuade the finance minister, once and for all, that 'discretion is the better part of valour'.