gems twt essay ca2

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A New Crisis Awaits: Another Global Recession Within The Next 3 Years

Back in 2007, the world was in for a shock when the US housing bubble burst. Major US banks

became saddled with bad debts and huge losses. The American inter-bank lending system

froze and liquidity quickly dried up. As a result, surviving banks drastically cut back on loans to

save themselves from bankruptcy. Households and firms in the US no longer had easy accessto credit, consumption and investments plunge. Within months this contagion quickly spread

around the world and highly globalised Singapore experience what was dubbed the ³Great

Recession´.

In this age of globalisation, low cost production centres produce the goods that are delivered to

consumers worldwide (Xie, 2010). This concept forms the basis of what is international trade

today. Singapore¶s economy is highly dependent on this international trade. In fact international

trade accounts for 310% of Singapore¶s Gross Domestic Product (GDP) (Central Intelligence

Agency, 2011). As such anything that happens to the world economy is going to affect

Singapore, one way or another.

The world economy is dominated by 3 main economic entities the US, China and the Europe

(International Monetary Fund, 2010).Collectively, these 3 regions account for more than 50% of

global GDP. Consequently if major economic problems transpire in any of these 3 regions, the

global economic recovery will relapse and the world will experience yet another economic

downturn. I believe these problems will manifest within the next 3 years and they exist in all 3

economic giants. Here are the reasons why.

First, China¶s huge property bubble is a ticking time bomb. Its average price-to-rent ratio across

major cities stands at 39.4 (America¶s price-to-rent ratio stands at 22.8 just before its housing

meltdown) (Armitstead, 2010). The price-to-rent ratio indicates how overvalued/undervalued

property prices are. The higher the ratio, the more overvalued the property is considered (GlobalProperty Guide, 2011). As such, property prices in China have risen beyond economic

fundamentals and are now driven by rampant speculation resulting from excessive liquidity

(Armitstead, 2010). This means that real estate assets can be easily converted into cash and

vice versa (Dictionary.com, 2011). Moreover, Chinese banks are heavily exposed to the

property market (Armitstead, 2010). However, once liquidity dries up when Beijing tightens its

monetary policy to curb inflation soon, property prices will crash. Speculators will inevitably

default on their mortgages and Chinese banks will accumulate bad debts. Thereafter the same

thing that happened in the US in 2007 will occur in China, albeit on a less severe and more

localised scale.



Second, what the world has witnessed in Europe¶s sovereign debt crisis is the just the tip of the

iceberg. Greece and Ireland were given bailouts by the European Financial Stability Fund

(EFSF). Yet it only served to heighten fears of a bailout of Portugal and Spain (Pylas, 2011).

Regardless, there exist a major flaw in the bailout package itself, the excessively high interest

rate charged. Both Greece and Ireland cannot afford to service the hefty 5% interest rate for the

money received (Lynn, 2011). In fact, the reason a bailout was needed is because the recipientcountries cannot service the high interest rate demanded by the market. Therefore, recipient

countries will eventually be forced to default or restructure on their bailout package. When that

happens, the European financial system will suffer a meltdown and the contagion will spread to

the whole of Europe, plunging the whole continent back into recession.

Last but not least, there is the problem of policy ineffectiveness in the US. The US government

strives to stimulate economic growth through a series of fiscal stimulus and monetary measures.

These measures include lowering the discount rate, financial asset purchases and increased

government spending. However there is the problem of µstimulus leakage¶, whereby the benefits

of stimulus spending such as GDP growth leaks to other countries (Li, 2010). The same concept

applies to monetary policy as well. As a result the extra liquidity and stimulus money providedby the US government flows to other nations, and these nations enjoy the benefits of GDP

growth and job creation, not the US (Li, 2010). Unless there are measures to prevent this

leakage, any benefits (if any) provided by US government policies will be short-lived.

However, skeptics would like to point out 2 concurrent trends that contradict my arguments.

First, leading economic indicators in the US are showing positive signs. As of January 2011, the

Consumer Confidence Index has risen to 60.6 (The Conference Board, 2011) and the

unemployment rate has fallen to 9.0% (Bureau of Labor Statistics, 2011). This indicates that the

US economy is growing, enabling many countries (including Singapore) to export their products

to the US and avert the possibility of another worldwide recession. However, these are short

term effects by unsustainable fiscal and monetary measures. Once these measures end due to

inflation worries (Laffer, 2009) or a burgeoning budget deficit (MSNBC, 2011), the façade of

economic growth will collapse and put the US at risk of another recession.

Next, the BRIC (Brazil, Russia, India and China) countries are expected to grow in economic

clout (O¶Neill & Stupnytska, 2009). Moreover, with their estimated economic growth rates

averaging above 5%, these countries are expected to drive global economic growth in the future

(Agence France-Presse 2010 cited in IndustryWeek, 2010). Nevertheless, these predictions

disregard the fact that the BRIC countries are dependent on exports for economic growth (Dale,

2010). End consumer demand remains rooted in the US and Europe and when these countries

slow down economically as stated above, exports from the BRIC will decrease and these

countries will be adversely affected economically.

In conclusion, the global economic outlook is bleak. Major problems exist in economically

important countries such as the US and China. However, there is hope still. In order to avoid

another recession, changes have to be made. Firstly, China has to deflate its property bubble

gradually to avoid a financial crisis. However, such a task is exceedingly difficult to execute.

Secondly, the US has to impose capital outflow controls. This will ensure stimulus money and



liquidity stays in the US and set off a self-sustained cycle of economic expansion. Thirdly, the

interest rate on bailout packages has to be lowered to levels recipient countries can afford to

service. If these changes are not implemented, we could experience another global recession

within the next 3 years.



References

y Agence France-Presse, 2010. BRIC Nations to Drive Global Growth. Agence France-

Presse 19 May.

y Armitstead, J., 2010. Hedge fund manager Mark Hart bets on China as the next

'enormous credit bubble' to burst. The T elegraph, 29 Nov.

y Bureau of Labor Statistics, 2011. Em ploy ment Situation Summary . Washington, DC:

Bureau of Labor Statistics.

y Central Intelligence Agency, 2011. E ast & Sout heast Asia:: Singapore. Washington, DC:

Central Intelligence Agency.

y Dale, M., 2010. The BRIC E conomies Are They a Safe Invest ment for t he Future [online].

suite101.com. Available from: http://www.suite101.com/content/the-bric-economies-

a197416 [Accessed 6 February 2011]

y Global Property Guide, 2011. Price/Rent Ratio - C hina Com pared to Continent [online].

Available from: http://www.globalpropertyguide.com/Asia/China/price-rent-ratio [Accessed 4 February 2011]

y International Monetary Fund, 2010. Report For Selected Countries And Subjects. W orld

E conomic Outlook Database [online], October 2010. Available from: http://www.imf.org

[Accessed 4 February 2011]

y International Monetary Fund, 2010. Report For Selected Country Groups And Subjects.

W orld E conomic Outlook Database [online], October 2010. Available from:

http://www.imf/org [Accessed 4 February 2011]

y Laffer, B.A., 2009. Get Ready for Inflation and Higher Interest Rates. The W all Street

Journal , 11 Jun, A15.

y

Li, H., 2010. Why stimulus packages don't work effectively in the U.S.: economist.International Business T i mes, 25 Aug.

y Lynn, M., 2011. Portuguese Bailout W ill Make E uro Crisis W orse [online]. Bloomberg.

Available from: http://www.bloomberg.com/news/2011-01-18/portuguese-bailout-will-

make-euro-crisis-worse-commentary-by-matthew-lynn.html [Accessed 4 February 2011]

y MSNBC, 2011. CBO: U.S. budget deficit to hit $1.5 trillion [online]. Available from:

http://www.msnbc.msn.com/id/41272983/ns/politics-more_politics/ [Accessed 6 February

2011]

y O¶Neill,J & Stupnytska, A., 2009. The Long-T er m Outlook for t he BRICs and N-11 Post

Crisis. Global Economics Paper No: 192. New York: Goldman Sachs Global Economics,

y Commodities and Strategy Research.

y Pylas, P., 2011. Portugal bailout talk weighs on markets. Bloomberg Businessweek , 10

Jan.

y The Conference Board, 2011. The Conference Board Consumer Confidence Index®

Increases. New York: The Conference Board.



y Xie, A., 2010. C hina Swallows Obama Sti mulus Meant for U.S. E conomy: Andy Xie

[online]. Bloomberg. Available from: http://www.bloomberg.com/news/2010-08-17/china-

drains-obama-stimulus-meant-for-u-s-economy-commentary-by-andy-xie.html [Accessed

15 February 2010]

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