FROM SCRATCH NEWSWIRE

SCAVENGING THE INTERNET

WHY US HOLDS KEY TO GLOBAL RECOVERY

Posted by Gilmour Poincaree on December 8, 2008

8 Dec 2008, 0000 hrs IST, ET Bureau

Editorial

PUBLISHED BY ‘THE ECONOMIC TIMES’ (India)

The conventional wisdom holds that economic ups and downs are transmitted across THE TRACKS OF A TROPICAL CYCLONEcountries by financial and trade flows. This does not seem sufficient to explain why, when the US economy fell of a cliff after October, other emerging market economies are falling off a cliff too. The bankruptcy of Lehman brothers was a watershed in the US. It suddenly created fear of counter-party risk, and financial markets of all sorts froze out of fear.

This freeze hit the real economy: producers could not get credit, and consumer credit plunged too. Fear of recession led consumers to cut spending, producing a sharp slump in GDP that still has some distance to go. Now, we in India were blase‚ when the US subprime mortgage problem arose in mid-2007. Our banks had virtually no subprime exposure, and the high leverage of the US financial sector had not been repeated here.

GDP growth continued strong, averaging almost 7.7% in the first half of the financial year. This was seen as evidence that our economy had decoupled from the west’s in substantial measure, though not wholly. That now looks a complete illusion. Since October, emerging markets have collapsed almost simultaneously with the US economy.

How do we explain the instant transmission of the US collapse globally? Had the transmission mechanism been trade or financial flows, we would have seen a time lag. In fact there was no time lag because of a new channel of transmission — fear. When Indian bankers heard that markets in the US had frozen, they feared the worst in India, and so virtually froze lending here too.

Consumer fear swept across the world, and Indian consumers slashed spending as in the US. INDONESIAN FARMERS PROTESTING IN JAKARTA - 2007The internet, TV and other electronic channels transmitted fear from the US to the rest of the world instantly. The lesson: recovery from the recession is likely to be transmitted by global mood change too. Optimists think the recovery will begin first in a string of emerging markets like China and India. Maybe so, but the last two months suggest that the epicentre of economic transmission remains the US. Bernanke may determine our recovery more than Subbarao.

CLICK HERE FOR THE ORIGINAL ARTICLE

PUBLISHED BY ‘THE ECONOMIC TIMES’ (India)

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