The Capitalist | US economy: the last throw of the dice?

The Capitalist | US economy: the last throw of the dice?
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First Published: Wed, May 20 2009. 10 33 PM IST

Updated: Wed, May 20 2009. 10 33 PM IST
Numbers indicate that the US is playing out its last gamble. At stake is the value of the dollar, the financial edifice which allows for global transactions to take place.
The biggest economic depression the US, and much of the Western world, saw was from August 1929 to March 1933. During these 43 months, the US economy shrank an agonizing 27%. After trial and error, the US government injected a monetary stimulus amounting to 3.4% of the GDP and a fiscal stimulus of 4.9%. Together, they accounted for 8.3% of GDP in real terms.
Also See The Other Recessions (Graphics)
Eleven recessions have plagued the US since then, some lasting just six months and some as many as 16 months. All of them have seen the GDP shrink—ranging from 0.2% to as much as 3.4%. All involved a stimulus which has normally been around 2-4% of the GDP. The highest it reached was during the eight months of March-November 2001 when the stimulus accounted for 7.2% of real GDP.
But that record looks a molehill when compared with the current stimulus package. In the past 15 months, real GDP has declined 1.8%, but the monetary stimulus is estimated at 18% of the GDP and the fiscal stimulus at 11.9%. This brings the total stimulus to an unbelievable 30% of the GDP.
This whopping injection of money into the economy uses the same tools—excessive liquidity—which caused the booms and busts in the US in the first place. Moreover, S&P 500 earnings, after adjusting for inflation, have plummeted 90% in the past 20 months, making this the biggest decline on record.
Could all this be reversed? Only this time, the stimulus is so large that the consequences of such liquidity could do one of two things.
According to some, the US is gambling on two things. First, that the mammoth stimulus will shorten the period of the recession. Second, that the stimulus will actually result in a GDP growth, especially through technological innovations in biotechnology, energy management and non-conventional energy.
But if the gamble does not pay off, be prepared for two possibilities. First, hyperinflation.
True, this can be neutralized by sucking in an equivalent amount of cash from the system. But that could result in higher taxes, or cause the US economy to shrink quite violently over the next few years.
Another possibility could be a meltdown in the value of the US dollar. Be prepared for extremely high interest rates as well!
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Need for a correction
Now that the elections are over, and the word is out that P. Chidambaram might not become finance minister once again, his successor will have to undo three glaring problems with some of the tax measures.
First, the new finance minister will have to rationalize service tax. Either abolish it or include legal services within the ambit of service tax as well. The former finance minister allowed lawyers to get away without paying this tax. This aberration needs to be corrected.
Second, the distinction between speculative and non-speculative profits needs to be addressed, leaving no scope for arbitrary interpretation. Most market observers believe that all capital market gains are speculative. They can be either long-term or short-term. The only ones which are not speculative are bank deposits.
Currently, in the absence of any such clarity, tax-assessment officers are free to decide what should be considered speculative and what non-speculative. This subjectivity can lead to harassment and corruption. Third, many of the tax laws yield less than the amount spent on monitoring them. One example is the fringe benefit tax , which yields little but results in a lot of work for accountants and assessing officers. It benefits only tax lawyers.
One hopes the new finance minister looks into these matters.
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Reinsurance
One industry that appears to be doing well during these difficult times is reinsurance. This is because, as the latest issue of ‘Institutional Investor’ magazine explains, primary insurers are buying more reinsurance because capital is tight and they are more averse to risk.
“The non-life insurance sector in the US lost about $90 billion (Rs4.3 trillion) in capital last year, close to 20% of the total available before the onset of the global financial crisis, according to Hannover Re. At the same time, with their own investment income dwindling, reinsurers are demanding—and getting—higher underwriting fees,” the publication says.
R.N. Bhaskar runs a company with significant interests in distance learning and examination certification and writes on corporate and business policy issues. Comments on this column are welcome at capitalist@livemint.com
Graphics by Ahmed Raza Khan / Mint
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First Published: Wed, May 20 2009. 10 33 PM IST