The U.S. debt crisis: causes and implications

U.S. Debt Crisis

Financial crisis is not a totally new concept. It is a fact that more than three quarters of the entire members of the IMF, whether they are developed or developing countries have been affected by a serious financial crisis ever since the year 1980, demonstrating the instability of the world wide global economy. The origins of the financial crises may be different, but what all these crises have in common is the fact that they were all preceded by a phase in which large amounts of foreign capital flowed into their country, and this resulted in the support of current account deficits. The stock markets soared downwards, the price of consumer goods fell and serious constraint in the government finances observed to have occurred all over the world. This phase demonstrates a decline in the imports of United States and simultaneously affecting the countries relying on exports to the United States. The national debt of United States is estimated at about $3 trillion, accounting for 30% of the U.S. GDP and presently increasing at 5% of GDP per annum. The actual cause of the U.S. Debt Crisis of the 1980's was the inevitable result of the build up of the external debts of the developing countries, when they accumulated huge debts and could not pay them off.

Several factors have influenced the U.S. Debt crisis. As a result of crushing of investors in the 'margin call' squeeze by the brokerage houses following bubble collapse a huge amount of capital funding suffered losses. Several causes were forwarded with regard to the bubble burst. The telecom bubble is observed to be the result of the easy money. Some analysts pointed out that the 'New Economy' has not been crashed despite collapse of the telecom and the dot-com bubbles. The September 11, 2001 attacks of the terrorism in United States were at a time when U.S. was undergoing serious economic upsets. The current corporate frauds in America have stunned the confidence of the investors. All these frauds may crumble the very foundations on which the stock market is based on and these must be contained as far as possible. The employment situation with most of the incentives have depicted a slower rate of improvement since the depression of the current cycle in November 2001 and perceived to slower even in comparison to that of 1990-91 incident. There is a definite need for regulations of every kind so that investors can be protected and the integrity of the stock market is maintained.

Introduction

Much has been heard about the 'debt crises' of the developing countries. However, the actual catastrophe lies in the national debt of United States. (The next international "debt crisis" is in North America) The current account deficit of United States per hour now accounts for $60 million. It was 28% more during 2002 at half a trillion dollar equating about 5% of U.S. GDP. This never before trade deficit resulted in amazing disequilibrium in the world economy. The national debt of United States is estimated at about $3 trillion, accounting for 30% of the U.S. GDP and presently increasing at 5% of GDP per annum. The United States is purchasing $1 million a minute more from the rest of the world than the rest of the world from U.S.. During 2002 the trade deficit was about 2% of the Gross Domestic Product of U.S.. The global Gross Domestic Product demonstrated an increase of 2% over that of the last year. This has the evidence of the contraction of the global economy. (Interview with Richard Duncan on the Dollar Crisis; Causes Consequences Cures)

The extremes of the 1980s and 1990s were considered to be unprecedented ever since The Roaring Twenties. The rate of public savings declined to the record lowest levels. Fast growth in the value of the properties due to inflationary trend made the American consumers to extract large amount of their home equity in order to maintain their living beyond their means. With the decrease in interest rates the economists predicted halt of rising home prices, stopping of equity extractions, fall in consumption and thereby initiations for the New Paradigm Recession. The two years of New Paradigm Bubble during the year 1999 and 2000 the imports into the United States increased by $307 billion which is 33% more than that of 1998. The U.S. imports fell by $79 billion in 2001 which is 6.3% less than that of the previous year. The influence of the fall of U.S. demand on the rest of the World was astounding. The growth rates of all the major trading partners of United States are observed to have declined unexpectedly. (Interview with Richard Duncan on the Dollar Crisis; Causes Consequences Cures)

The stock markets soared downwards, the price of consumer goods fell and serious constraint in the government finances observed to have occurred all over the world. The second phase of the recession is initiated with the consumers refraining from spending more than they earn. This phase demonstrates a decline in the imports of United States and simultaneously affecting the countries relying on exports to the United States. The annual public deficits have increased in the regime of President George W. Bush with introduction of tax cuts and increase in the defense expenditure. Moreover, the national debt was supplemented by the War on Terrorism and the huge expenditure involved in the reconstruction of Iraq. (Interview with Richard Duncan on the Dollar Crisis; Causes Consequences Cures)

Causes of the U.S. Debt and its remedies

The actual cause of the U.S. Debt Crisis of the 1980's was the inevitable result of the build up of the external debts of the developing countries, when they accumulated huge debts and could not pay them off. It was during the 1960's that the value of the dollar fell and this was because of the fact that when the U.S.A. discovered that it had spent more than it could make, it printed a large amount of currency in dollars and for oil producing countries this had an adverse impact. This was because the payment for oil was lesser than what they needed and as a result the prices of oil were hiked up, and the profits made were deposited in Western Banks. This was the beginning of the real trouble, when the interest rates fell and the banks were also faced with a financial crisis. To counter this the banks began to lend out money as fast as possible to the Third World countries, with low interest rates, without thinking of how these loans would be repaid eventually. In the 1970's these countries discovered that they were not getting the prices out of crops that they had expected, and at the same time interest rates and oil prices began to rise, and the developing countries were stuck in a trap wherein they were earning less and repaying more for the loans and the interest. (How it all began; causes of the Debt Crisis)

When some countries stated that they just could not repay the loan, the IMF offered to repay the interest, under the SAP or Structural Adjustment Program, that outlined certain strict conditions that stated that the loan would be repaid be smaller loans, and this pattern was repeated over and over again over the next few years. SAP showed the way out of the debt trap and this was by helping them increase exports and decrease imports. Some other measures that have to be undertaken by the government are to spend less on health and education of the masses, cut down jobs in government offices, to encourage privatization and increase exports. However, in the year 2000 a new proposal was brought out that said that loans must be cancelled for some of the world's poorest countries so that unlimited human suffering could be reduced. (Causes of the Debt Crisis)

How the debt crisis been improved over the past 20 years

The debt crisis has been improving over the past twenty years due to some important factors. Alan Greenspan, the Chairman of the Federal Reserve Board, said this about the debt crisis. It is a fact that free market economies that are in the stage of rapid development can often run into mistakes, as mistakes are really inevitable. (Financial Markets and Institutions Developments) The factors including the collapse of the dot-com/telecom bubble in 2000, the decline in equity market valuation as a consequence of the extended bear market and the accompanying decline in the value of real assets, the terrorist attacks of September 11, 2001, the accounting standards scandals, the fraudulent activities of stock brokers and their investment banking relationships, and the slow, jobless recovery since 2001 have served to erode investor confidence and put a hold on consolidation within the financial services industry and among non-financial companies have influenced debt crisis in America.

Collapse of the dot-com/telecom bubble in 2000

The Nasdaq stock market index demonstrated a peak on March 10, 2000 to 5048.62, which is more than double that of during 1999 as a result of dot-com bubble burst. (Dot-com) In consequence of Dot com Bubble collapse during the year 2000 that the concerns for capital funding in respect of various types of technology and Internet companies demonstrated significant reduction. As a result of crushing of investors in the 'margin call' squeeze by the brokerage houses following bubble collapse a huge amount of capital funding suffered losses. (The Dot Com Bubble Collapse of the Year) The deflationary trend was at its peak during 2001. It forced a majority of the dot-coms to stop trading after experiencing losses through their venture capital often even without making a gross profit and becoming dot-compost. Many of the companies related to the dot-com boom are being accused of or convicted of fraud. Several causes were forwarded with regard to the bubble burst. The first one was the six interest rate increases made by the Federal Reserve in 1999 and early 2000 finally catching up with the economy. (Dot-com)

The other reason was rapidly accelerated business expenditure in their preparation for the shift to Y2K. The boom on dot-com resulted in other economic problems on the basis of the theory of the dot-coms and the reachability to broadband that was expected to follow in its wake. Most of the people predicted that the quantity of the fiber optic and copper cable required to cater to the growing network traffic would go up multiply as a result of the continuing explosive growth of the dot coms. The investors had great expectations of their being involvement in the network traffic explosion sooner. Most of these networking companies faced difficulties before and after the bubble burst as a result of their debt burden and the downfall in the subscribers for the network. Some of them additionally were accused of being accounting scandals for showing them the illusion of making profits especially in periods actually when they were not. This compelled most of them to declare Chapter 11 or Chapter 7 bankruptcy. (Dot-com)

Moreover the telecom bubble is observed to be the result of the easy money. Competition was infused with the introduction of the Telecom Act of 1996 and the Internet and other new applications were fuelled intensively. This led everyone to predict that the telecom growth would continue forever. The words 'telecom' or 'optical' lured many venture capitalists, banks and the markets as a result of which money continued to flow into the hands of the industrialists. The Wall Street analysts formed financial models out of the growth trend so as to predict that these would grow like wildfire into the eternity. However, in the year 2000 with the easy provision of capital the telecom sector becomes fully constructed. The growth in the network capacity, and inventories produced by the equipment vendors, component suppliers and contract manufacturers were considered more than enough. (Housing May Mirror Telecom Boom and Bust)

Having such wide availability of capacity as well as equipments prices of the products crashed down. In order to continue the growth of sales the vendors are compelled to provide easy financing to the telecom service providers. (Housing May Mirror Telecom Boom and Bust) The analysts however, regarded the 'Dot Com Era' as the first phase of the Internet Revolution and predicted that several technological developments are still to come along in the broader Information Age Revolution. Some of the industrial observers pointed out this as a cyclical adjustment and not a secular trend in the market. Some analysts pointed out that the 'New Economy' has not been crashed despite collapse of the telecom and the dot-com bubbles. They anticipated the scope of engineering and strengthening of the economic and financial conditions of the new era. (The Dot Com Bubble Collapse of the Year)

Decline in equity market valuation as a consequence of the extended bear market and the accompanying decline in the value of real assets (plant, equipment, office buildings)

The bull market in the 1920's was very similar to the financial market of the present day. U.S. always stood apart from the rest of the world as a veritable powerhouse. European economies, in order to reduce the strain, began to siphon gold into the U.S., and the accommodative monetary policy of the U.S.A. made it easier to liquidate assets, and this excessive amount of liquidity affected both the economy as well as the stock market. The consequence was that the U.S. began to emerge as a growth machine with great advances in technology and productivity. Stocks had reached a plateau level at this time and soon stock value began to plummet; a loss of over 87% of value was seen in those few years. The book 'American Challenge' that was written about the economic crash and the debt situation of the 1950's to 60's bull market stated that American multinationals enjoyed an unfair advantage over the rest of Europe and that this had to be stopped in its tracks very soon. As predicted the American stock market happened to peak in 1966, after which there began a steady decline, until the 1970's. Imports of automobiles and electronics were making an influx and the technologically inferior American products, especially the real assets like equipment and office buildings began to suffer as a result. (Is a Bear Lurking Behind the Goldilocks Stock Market?)