US Economy Shock and Awe

The world’s largest economy, US, contracted 3.8 per cent, on an annualised basis, in the last quarter of 2008 deepening further from the third quarter of negative 0.5 per cent growth.

 

Economic growth is measured by the amount of goods and services produced domestically in a country during a period. If we strip away goods produced to build up inventory (which is not sold to end consumers) from the GDP growth number, then the GDP contraction would have been a worse 5.1 per cent contraction in the last quarter of 2008.

 

This is consistent with expectations that US economy is in deeper trouble. The US has officially been in recession since December 2007, some 13 months ago and economists in general are expecting that it will be worse in the next two quarters of 2009.

 

For all of 2008, the economy grew by only 1.3 percent which is lower than 2.0 per cent growth in 2007. This is the slowest growth since the last recession in 2001. (Source: AP, Bloomberg, Reuters, 30 January 2009)

 

Together with economic contraction, the unemployment rate for December 2008 of 7.2% demonstrated how the US has taken a serious beating. Because two-third of the economy is powered by consumer spending, the jobless rate does not augur well for a quick turnaround in the US economy and by extension the global economy. Singapore will certainly not be spared.

 

The President Obama’s proposed US$819 billion stimulus package is to help create jobs and stimulate economic growth for the US. In addition, US$700 billion Troubled Asset Relief Program (TARP) will also be spent to re-capitalise the financial institutions (including major motor vehicle corporations) in order to get the credits flowing again and to prevent major key corporations from failing.

 

The amount of US$1.519 trillion has to be funded. The question is how the US is going to get this money? The only way is to borrow this amount from the world’s capital markets by issuing Treasury Bills and Bonds. The US can borrow in a huge way simply because the US currency is a reserve currency held by almost all nations. Currently there is no other currency playing the major reserve currency role.

 

Huge borrowings will ultimately lead to higher interest rates and inflation round the world in the long term. Repaying US debts will take several years if not several generations. If debts continue to be the mainstay of the US economy, the fear is really a devaluation of the US currency in the future because the asset backing of US Treasuries or debts will be eroded if the US economy does not perform strongly over several years.

 

This is not good at all.

 

Written on 1/31/2009 11:14 AM

 

Copyright © 2009, the author known as LKT in Singapore.

 

The material presented is intended to be general and written in layman’s language as much as it is possible. The author shall not be liable for any direct or consequential loss arising from any use of material written. Please seek professional advice from your financial advisor or financial institutions on material written covering financial matters.

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