Ten years ago by this time – that was early 2008 -, people in the US were living happily, earning more than a quarter of the world’s total income. They were also the biggest consuming nation in the world; their household consumption alone accounted for 30 per cent of the world total. In fact, it was much more than what they earned.
They had another reason to be happy: They can print dollars or dollar-denominated assets and present to the rest of the world as collateral for loans and, import what they want to consume.
As a result, the US has been maintaining massive trade deficits. Their exports were only little more than half of their US$ 2 trillion imports. Excess imports were financed by borrowings from abroad. Everybody else in the world loves to lend to the US and accumulate US dollar assets.
More money from others’ money
The US was not only borrowing, but making more money out of borrowings. Banks and financial institutions knew how to make money by multiplying credit. The wheels of their money-making machines (which were free from regulatory barriers, thanks to financial liberalisation), were revolving fast and getting accelerated.
The government (federal, state and local), the household sector, the financial business sector, and the non-financial business sector; all these sectors of the economy had been borrowing.
In fact, private debt grew faster than government debt. Money economy was growing too big in terms of funds, investments and credits so that all who play with money were happy. Since there was no “real” backing for part of the growing money, the money that grew were just the numbers in computers.
Smart guys leave
A few years before 2008, some smart fellows who were playing the game foresaw the money and credit bubble blowing too big. If the “money economy” was growing faster than the “real economy” and, if it was due to “debt piling up”, then a tsunami was nearby. During the Great Depression times in the 1930s, total US credit market debt was about 250 per cent of GDP; but this time it had gone up to 350 per cent of GDP already by 2005.
Those smart fellows started shifting their investments (in stock market, bond market, derivative markets and, other so-called toxic assets markets) to futurist commodity markets. Demand shifted to gold so that gold prices started soaring. Part of the demand shifted to fossil fuel so that the world fuel price hike was also contributed by soaring demand for futurist options. For multiple reasons, fuel prices and food prices move closely. Thus as fuel prices were rising too high (reaching $150 a barrel in 2008), food prices started soaring too.
Birth of global economic crisis 2009
Only a few can leave a money and credit market at once, but not everybody. Finally the tsunami – US financial crisis – swept the market in late 2008 as everyone wanted to leave at the same time; panic depositors, investors and lenders all wanted their money back on the one hand and, borrowers were unable to repay their loans at that rate on the other hand. The intermediaries – banks, funds, and all types of financial institutions – mediated between the two parties as they were in trouble facing a liquidity shortage (no money in the market) and a credit crunch (no one in a position to lend to each other).
The money that grew in the computers evaporated overnight! Together with that consumer prosperity was gone! Almost overnight people became poor and, financial institutions were bankrupt. Financial crises soon turned out to be an “economic crisis” on the one hand and, transformed from a US crisis to a “global crisis” on the other hand.
Bankrupt US financial institutions saw their global operations and investments collapse. People who were poor now had to cut down their spending so that aggregate demand fell down. Countries that exported goods and services had to cut down their exports. Global production and trade fell down. As the global economy was shrinking, people lost jobs and work and, consequently their incomes, making the crisis worse day by day.
When the US sneezes…
The world economy had its worst performance in 2009 ever after the so-called Great Depression in the 1930s. With 1.7 per cent negative rate of growth, the world economy lost $1 trillion real GDP from what it had in the previous year 2008. Interestingly, almost the entire loss was in high income countries by a negative 3.4 per cent – $1.5 trillion from their real GDP.
Now here is even more surprising news: During this time, Asia was growing fast and, precisely East Asia was the fastest growing region in the world. Economic growth in Asian developing countries recorded a little slowdown, but it did not turn to negative growth rates. This is contradicting what we have learnt to believe: when the US or the rich Western countries experience a problem, developing countries have to suffer more. Yet this time it was not so; why?
It was because the slowdown of the West and the rise of Asia, both to a great extent are the two sides of the same coin.
Roots of the crisis
Most of the writings on the causes of the crisis were basically concerned with either policy failures or market failures or speculative problems, as we have already seen above. If you dig deeper into the root causes, however, you might be able to conclude that all these are bits and pieces of the core issue – the big waves of the world economy.
Economic growth of the high-income countries gradually slowed down, while that slowdown started much earlier than the time of the crisis since the 1980s. Crisis was the end of the problem. During the period of a slowdown, capital investments in high-income countries started flowing out seeking new locations mostly in developing Asia. World foreign direct investment (FDI) outflows that amounted to about $200 billion about 25 years ago has surpassed $1,000 billion a few years before the crisis, and remained around $1,700 billion now.
While capital moved away in recessions, that process itself made the recession faster, as the countries started losing part of the output, income and jobs. Precisely, this is what the Trump administration in the US is now trying to reverse. It was many Asian countries which attracted the outflowing capital in the West.
As Asia was growing and expanding, they could also expand their market share in the region for their expanding trade. All these divergent new forces converged at the end of the day, enabling many Asian developing countries to grow fast in the midst of economic recession that ended with the crisis in the West.
About 200 years ago the world economic power was with England (which was subsequently shared by some other countries in Western Europe as well). About 100 years ago, the emerging economic power of the US superseded England. About 30 years ago, Japan was about to overtake the US (in fact, it did in terms of higher per capita income than in the US in the 1990s), but missed the opportunity as Japan was plunged into a long recession. Today, in the early 21st Century, that world economic power is moving into developing Asia.
By the way, you may have an important question to ask: Where does little Sri Lanka figure in this whole equation? My short answer is that we are not yet ready to go with the fast-moving Asian countries. It is true that most of the fundamental conditions of development are already in place. But we need to be patient as we have other issues to be sorted out first, before taking the development matter into consideration.
(The writer is professor of economics at Colombo University. He can be reached at email@example.com).