In the whole discussion below we will be looking into the reasons of the American recession. Before knowing the reasons we need to understand some basic concepts of economy & world trade. The whole presentation is in simple terms so that the essence of the issue is understood better.
What is economy?
Economy in general terms is nothing but the whole money being present in a nation,
Irrespective of who holds the money. In an economy the most of the money is hold by the banks. It may be in only one bank as large quantity or in many banks as small quantities.
How does trade happen between countries?
Again trade in general terms is nothing but exchange of goods between countries, it’s not through exchange of pure currencies notes (as we do in our daily life). One country produces a particular item & sells it in the international market. And the country which buys the item in return pays back through selling its product to the other country. The quantity of goods exchanged between the countries depends on the value of the goods exchanged.
Reason given for the recession by the American govt:
i. Sub-prime crisis
We will look into what exactly the sub-prime crisis is all about.
It is the crisis caused due to the people defaulting (not paying back) on the loans which they have taken from the bank. As per business standards these are the people who are not eligible for loans. The bank losses money from its account, since these sub-standard people didn’t pay back to the bank. So the loss incurred by that bank is called as sub-prime crisis
Note: Here we need to remember that money is only lost by the bank. But not by the market or economy. Because the money is not vanished from the bank but it has just been transferred from one bank to the other.
Let’s look into the detail of the micro-economics that goes into housing loans.
Looking at the diagram given below. We can understand where exactly the money is generated for the end buyer to get a housing loan. It is the people around the world who do the basic investment for entire money in the housing loans. These people investment in Provident funds, Mutual funds & Insurance companies around the world. These funds are then diverted to the Investment Banks. In turn to Large Banks & then to the Small Banks (At each level each entity will add their share of profit %). At the end this liquid cash will be handed over to the end buyer who tries to avail a housing loan.
Then with this money (liquid cash) he buys a house. So the money is now transferred to the builder & material supplier from the buyer. Here we need to know that the money is just transferred into the builder’s & material supplier’s account. The money is still in the market. It has not vanished.
Let’s see what a builder & material supplier does with this money, they have to buy raw materials from other sources for the house construction. So here the money is spent in the same American market, since most of the raw materials required for the house construction are produced within America.
Now, if you look here we can clearly understand that the money is not lost by the market or economy, but just transformed into the houses & consolidated with builders & material suppliers. So this tells us that money is still within the American economy. It never lost it. It just makes you feel it’s lost.
We may have a question then why are so many jobs lost? Here, only the banking sector is affected in sense of liquid cash. Its liquid cash is now turned into physical assets (because of buyer defaulting the house is bought under the bank now). Due to lack of liquid cash in hands the banks are not able to pay the salaries to the employees & investors back (most of the investors are from “rest of the world”). So because of this banking sector jobs must be affected not the other sector jobs. Others sectors must not be affected because the money that is transformed into physical assets is not so large when compared to the entire economy. Just for the sake of making things look big they are restricting the flow of liquid cash in the market.
More over it’s within the American economy so I guess American economists are capable enough to normalize this crisis. But they are not doing it for some other possible reason which we will be discussing now. This sub-prime crisis reason which they give us is not true as they show it to the world. The true possible reason is THE AMERICAN DEBT TO CHINA.
To understand this you need to understand the how trade happen between countries. For this I have given briefing at the start of the summary. American govt vows a huge amount of money to the Chinese govt, since many (or almost) of the American products are made in china by using there manual labour, natural resources. In turn for these services the American govt has to pay back to Chinese govt, but fortunately the Chinese govt doesn’t buy any American products. So the payback doesn’t happen & American govt is debt to Chinese govt.
Then how does the American govt pay or Chinese govt get its money?
For this the international agreement is that if a country is not able to payback another country then the credited country can demand gold from the debited country or else the sovereignty of the debited country is lost. So the American govt may loose its sovereignty if it doesn’t payback to Chinese govt.
You may have a question saying, why the Chinese govt doesn’t buy American products?
The Chinese govt knows that the American products are worth (cost of production) of 1$ but sold to the world at 10$ dollars. And the Chinese want to save the 9$ dollars by not buying them.
And why doesn’t the American govt pay to Chinese govt?
Since the American govt cannot payback to Chinese govt through their products or services, it’s really tough for a govt to pay in terms of gold. As the gold volume is reduced the country’s value in the international market is reduced.
At this point of time the American govt got a brilliant idea of escaping the payback to the Chinese. And it is possible only by saying that the American economy is in shamble. And say that there is no money with America.
Because of this the Chinese govt is forced to buy the American products (i.e. to open the Chinese markets for American products). By achieving this American govt can payback Chinese govt only 1$ for 10$ dollars, by selling their products.
All the above discussion is one side analysis of the present situation. This discussion is not for pointing out anyone/nation but just looking at the international political & economical strategy played by the nations.
At last let’s wait and see what the American govt will finally do, declare a financial aid to the market. But no one should ask from where the money came all of a sudden, which was given an illusion as lost?
