Tail Wags the Dog; A primer regading Financial crises

These days I have been reading a lot of commentary about the actual cause of the inflation. Everybody seems to form an opinion about inflation by just concentrating on a particular aspect of the problem. However, nobody was concentrating on explaining how all these opinions are addressing the same issue from different perspectives. This article is just about trying to connect all those disparate viewpoints.

Origins:

The present crises seem to have originated in 1978. That was the year China opened itself to the world for business. However, the world didn’t seem to recognize China for a long time inspite of consistent growth of 9% every year. The late 80’s was the time for various historic moments. China’s growth story was lost trying to capture the historic realignments happening in Europe.

The First gulf war forced India to open up for business in 1991. However, nothing much changed in India till 1997 till India restructured its financial industry. The world started looking towards India and China more seriously after the 1997 Asian Financial crises. India and China were the least affected economies due to the crises. Western economies trying to recover from the Asian crises started ramping up manufacturing facilities in China to reduce their risks. Indian economy at the same time was growing at a rapid pace due to Information Technology industry.

Causes:

The dot com bust and the unfortunate events of 9/11 accelerated the outsourcing of backend office tasks to India and the bulk manufacturing industries to China. These events led to lot of development in those countries and thereby improving their local economies.

The Federal Reserve of United States at the same time wanted to revive the US economy, hence started reducing the interest rates. This led to increase in liquidity thereby Banks were competing to fund all kinds of exotic financial products.

The subsequent wars in Iraq and Afghanistan absorbed all the excess liquidity of the Federal government of United States. Hence, United States of America was walking a very tight rope in managing its economy while funding for the wars at the same time.

Effects:

The outsourcing of manufacturing to China and back office tasks to India reduced the Job opportunities of US citizens without a college degree.

Most of the issues were not given enough attention since the housing market with access to cheap credit was masking all the problems. All the issues came back to hit the US economy at the same time due to the unraveling of the housing market which started in Apr 2007 but actually made news only in Aug 2007.

The housing market’s bust led to multi billion dollar losses in the financial industry forcing financial firms to raise money from investors outside of United States. This caused severe devaluation of the dollar.

The devaluation of the dollar caused many other currencies to fall in value too as those currencies were tied to the dollar. This caused many of those countries to increase prices on their exports to make up for the loss of the dollar value.

Financial firms which suffered huge losses due to housing crises started getting into the commodities markets to cover up their housing losses.

Emerging economies like India and China with years of tremendous growth suddenly found themselves with lot of liquidity among its citizens. These Indian and Chinese started to live the life of the western countries due to their new found riches. This along with the Indian and Chinese government’s policy of shielding their citizens from the global pricing of commodities through rebates is leading to every increasing price of commodities.

Conclusions:

The globalized economies must take a hard look at their business models to overcome the present crises.

The emerging markets must remove the market distorting rebates to their citizens so that the commodities demand decreases. The market distortions are keeping the prices so low that there seem to be no decrease in demand for commodities.

The developed countries must also take some hard decisions and try to increase the value of dollar to reduce the inflation in commodities.

However, the urgency to make hard choices is presently with developed countries than the developing countries. Hence,tail wags the dog instead of the other way around