The effects of the financial crisis originated from sub-prime lending on the overall broader economy is further compounded by the worries of global inflation, which is mainly responsible of the ineffectiveness of the stimulus package drawn by Fed in the beginning of the year.
The origination of the crisis can be traced back to the lax lending in property market, which was mainly fueled by easy monetary policies during the tenure of Fed Chairman Alan Greenspan back in 2001.
The worries were the possible downturn of the economy due to dot.
com bubble, and truly, the bubble were averted by the easy lending to property market; the bubble was short lived, thanks to the sentiment at that time buoyed by the increasing wealth and flush of cash due to the increasing price of property.
However, the speculation activities proved to be disastrous to the economy now, one may raise the question was the easy monetary policies justifiable in view of the crisis now; could the aversion of the dot.
com bubble and the benefits of it outweigh the economic problems we are facing now?Although the question is no longer relevant as the danger of bubble had been successfully extinguished and the main concern now is the present economic difficulties.
But when one sees and compares the episodes, the bubble and the mortgage crisis, both followed an easy monetary policies and both are postponing the core of the economic problems to the future.
In the dot.
com bubble, the worries were that the overall economy could be dragged down by it, thus the consumer spending was boosted by mortgage price.
This was done through encouragement and low interest rate by Fed, which had enabled the property boom in the years after the bubble.
It was the first time that US registered a big surge in house ownerships, this were mainly due to the easy lending spree by local lenders.
The cycle was created after that; the demand encouraged and propelled residential property market, more properties were built, more money was lent to the market to build and buy more houses.
While the high spiraling demand had made the consumers flushed with cash; the price of the house increased further.
This increase was mainly responsible for the aversion of the dot.
com bubble in 2001 and 2002, as the spending increased tremendously through refinancing of the houses, increased of spending in luxury items, travels and remodeling of houses, all were charged to the increased house prices.
Thus we can see while the encouragement by Fed to avert one problem, the dot.
com bubble, it had created another one, the mortgage bubble.
Rather than ruling into the indiscipline spending, the Fed had encouraged another round of speculative spending.
The mortgage loans were packaged and securitized with the world's most sophisticated financial tool, the CDO, which was then resold to the equity markets across the globe.
As long as the price of the house was stable and kept on increasing, the bubble presumably would not burst and the economy could keep on its wild spending.
Undeterred and encouraged by the central bank, lenders, speculators, investors, the home owners kept on borrowing money to finance their spending.
The trend reached its tipping point when the default rates unavoidably became apparent and the wide spread euphoria of the house price hike suddenly evaporated.
The herd suddenly changed its course when the whole system of this mortgage lending and borrowing to finance the spending collapsed.
The impact is not limited on the household's income, but the big bankers, monolines and also the Government backed mortgage lenders, Fannie Mae and Freddie Mac, and also the bakers and lenders as far as Singapore, were also hurt.
However, the spread is not constrained in financial industry, the overall economy also got the heat, the dropped in import and spending by domestic consumers had caused strain among exporters in China, Japan and other exporting countries.
However, the main culprit of all this is the market sentiment which was dropped to a record low since 1993.
The sentiment of non-real economy, the drop of positive sentiment among investors in equity market, has caused tremendous pressure on the real economy.
The drop of this sentiment has influenced the market price of the mortgage, triggered a spill over effect on overall economy; cut in spending and investment, credit crunch and drop in business expansion, lost of confidence and drop in the value of USD, global inflation and erosion of purchasing power of the consumers.
These effects are in fact reinforcing among each other, which brought the whole economy to the new downs.
The overall lost of growth momentum and possible recession is complicated by the global inflation.
In the mid of when the consumers are facing difficulty and cutting their expenses due to high debt level and reducing value of their property asset, their purchasing power is further being undermined by the global inflation rate; mainly due to the depreciation of value of USD which has caused dollar denominated commodities to skyrocket.
Thus the vicious cycle is obvious; the lost of confidence causes drop of purchasing power and income, which causes USD run among investors, which in turn causes drop in the USD value, which in turn causes imported inflation and the further erosion of purchasing power among consumers.
Thus the effectiveness of the stimulus package and the interest rate cut by central bank is limited to revive and reboost the economic engine; the aggregate demand.
It is obvious at this moment, that the economy is undergoing a critical phase and the policy makers have to take a fine line between to fight inflation and economic slowdown (as admitted by Feb Chairman that the economy is undergoing difficulties in the coming quarters, see news report in market watch).
In this course, the Fed is obviously favoring the policies to upstart the economy and leaving the inflation expectations at bay.
The recent economic slowdown is no more similar and easy to handle as in the previous slowdowns, as now the world is more globalised and the price of the commodities are now also determined by emerging markets, such as China and India.
Thus the hope that when the economy is revived, through easy monetary policies, and during which the depreciation of the USD would increase the export and reduce the unemployment and thus the overall economy, is no more as feasible as when the US dominated the world economy.
Right now, the effectiveness of the stimulus package and the interest rate cut by Fed are determined in some degree by foreign powers, which have been exerting tremendous effect on the world price of oil and grain.
Therefore, in view of the uncontrollable of world price of oil and grain and the ineffectiveness of the stimulus package by Fed, the easy monetary policy could cause another problem to the economy; high inflation while the recession becomes worse.
These two variables, the inflation and the recession, while the former is uncontrollable by Fed but its effect is very enhanced in the current crisis in eroding the purchasing power of consumer, and the latter is very much related to the former as the erosion of purchasing power may dwarf the effect of the stimulus package to revive the slumping economy, thus may drag the whole economy.
In this sense, the over easy monetary policy to revive the economy, which is not successful, may cause the whole economy to slump further due to the inflation.
The origination of the crisis can be traced back to the lax lending in property market, which was mainly fueled by easy monetary policies during the tenure of Fed Chairman Alan Greenspan back in 2001.
The worries were the possible downturn of the economy due to dot.
com bubble, and truly, the bubble were averted by the easy lending to property market; the bubble was short lived, thanks to the sentiment at that time buoyed by the increasing wealth and flush of cash due to the increasing price of property.
However, the speculation activities proved to be disastrous to the economy now, one may raise the question was the easy monetary policies justifiable in view of the crisis now; could the aversion of the dot.
com bubble and the benefits of it outweigh the economic problems we are facing now?Although the question is no longer relevant as the danger of bubble had been successfully extinguished and the main concern now is the present economic difficulties.
But when one sees and compares the episodes, the bubble and the mortgage crisis, both followed an easy monetary policies and both are postponing the core of the economic problems to the future.
In the dot.
com bubble, the worries were that the overall economy could be dragged down by it, thus the consumer spending was boosted by mortgage price.
This was done through encouragement and low interest rate by Fed, which had enabled the property boom in the years after the bubble.
It was the first time that US registered a big surge in house ownerships, this were mainly due to the easy lending spree by local lenders.
The cycle was created after that; the demand encouraged and propelled residential property market, more properties were built, more money was lent to the market to build and buy more houses.
While the high spiraling demand had made the consumers flushed with cash; the price of the house increased further.
This increase was mainly responsible for the aversion of the dot.
com bubble in 2001 and 2002, as the spending increased tremendously through refinancing of the houses, increased of spending in luxury items, travels and remodeling of houses, all were charged to the increased house prices.
Thus we can see while the encouragement by Fed to avert one problem, the dot.
com bubble, it had created another one, the mortgage bubble.
Rather than ruling into the indiscipline spending, the Fed had encouraged another round of speculative spending.
The mortgage loans were packaged and securitized with the world's most sophisticated financial tool, the CDO, which was then resold to the equity markets across the globe.
As long as the price of the house was stable and kept on increasing, the bubble presumably would not burst and the economy could keep on its wild spending.
Undeterred and encouraged by the central bank, lenders, speculators, investors, the home owners kept on borrowing money to finance their spending.
The trend reached its tipping point when the default rates unavoidably became apparent and the wide spread euphoria of the house price hike suddenly evaporated.
The herd suddenly changed its course when the whole system of this mortgage lending and borrowing to finance the spending collapsed.
The impact is not limited on the household's income, but the big bankers, monolines and also the Government backed mortgage lenders, Fannie Mae and Freddie Mac, and also the bakers and lenders as far as Singapore, were also hurt.
However, the spread is not constrained in financial industry, the overall economy also got the heat, the dropped in import and spending by domestic consumers had caused strain among exporters in China, Japan and other exporting countries.
However, the main culprit of all this is the market sentiment which was dropped to a record low since 1993.
The sentiment of non-real economy, the drop of positive sentiment among investors in equity market, has caused tremendous pressure on the real economy.
The drop of this sentiment has influenced the market price of the mortgage, triggered a spill over effect on overall economy; cut in spending and investment, credit crunch and drop in business expansion, lost of confidence and drop in the value of USD, global inflation and erosion of purchasing power of the consumers.
These effects are in fact reinforcing among each other, which brought the whole economy to the new downs.
The overall lost of growth momentum and possible recession is complicated by the global inflation.
In the mid of when the consumers are facing difficulty and cutting their expenses due to high debt level and reducing value of their property asset, their purchasing power is further being undermined by the global inflation rate; mainly due to the depreciation of value of USD which has caused dollar denominated commodities to skyrocket.
Thus the vicious cycle is obvious; the lost of confidence causes drop of purchasing power and income, which causes USD run among investors, which in turn causes drop in the USD value, which in turn causes imported inflation and the further erosion of purchasing power among consumers.
Thus the effectiveness of the stimulus package and the interest rate cut by central bank is limited to revive and reboost the economic engine; the aggregate demand.
It is obvious at this moment, that the economy is undergoing a critical phase and the policy makers have to take a fine line between to fight inflation and economic slowdown (as admitted by Feb Chairman that the economy is undergoing difficulties in the coming quarters, see news report in market watch).
In this course, the Fed is obviously favoring the policies to upstart the economy and leaving the inflation expectations at bay.
The recent economic slowdown is no more similar and easy to handle as in the previous slowdowns, as now the world is more globalised and the price of the commodities are now also determined by emerging markets, such as China and India.
Thus the hope that when the economy is revived, through easy monetary policies, and during which the depreciation of the USD would increase the export and reduce the unemployment and thus the overall economy, is no more as feasible as when the US dominated the world economy.
Right now, the effectiveness of the stimulus package and the interest rate cut by Fed are determined in some degree by foreign powers, which have been exerting tremendous effect on the world price of oil and grain.
Therefore, in view of the uncontrollable of world price of oil and grain and the ineffectiveness of the stimulus package by Fed, the easy monetary policy could cause another problem to the economy; high inflation while the recession becomes worse.
These two variables, the inflation and the recession, while the former is uncontrollable by Fed but its effect is very enhanced in the current crisis in eroding the purchasing power of consumer, and the latter is very much related to the former as the erosion of purchasing power may dwarf the effect of the stimulus package to revive the slumping economy, thus may drag the whole economy.
In this sense, the over easy monetary policy to revive the economy, which is not successful, may cause the whole economy to slump further due to the inflation.
Source...