In the past week, global stock markets regained some ground as the Geithner Plan to buy toxic assets from United States (US) banks seemed to ease the emotional paralysis which had gripped financial markets since last September. Thus, some analysts have concluded that there could be a turnaround in the global economy in the second half of this year. A more sizeable body of observers has, however, noted critically that this apparent rally of stock markets is more likely to be a case of 'dead cat bounce'.

The decision of the Federal Reserve to unleash the printing presses to the tune of US$1 trillion in an attempt to loosen credit markets would suggest that the latter view is closer to reality. By every indicator, the global economic prospects for 2009 can best be summarised by the Latin expression annus horribilis - disastrous year. Both the International Monetary Fund and the World Bank are now forecasting that global output and trade will shrink this year for the first time in over 60 years.

If truth be told, the world economy has been plunged into a deep recession, dragged down by a crisis in the international financial markets which can be traced to the meltdown in the US financial system. This is the first crisis of its kind in the globalised era, and is unprecedented in its level of destruction of wealth worldwide, and in America. Some estimates indicate that nearly US$50 trillion of wealth has been lost globally in stock markets, housing and other assets. And, since the onset of the crisis in August 2007, the US alone has seen over US$15 trillion of wealth destroyed (more than a full year's gross domestic product).

Capitalist system threatened

As the recession has spread, we have seen the collapse of commodity markets, plunging exports by most countries, and even by juggernauts like China, Japan and other Asian tigers, including Singapore. Investment has dried up in many countries and unemployment is rising sharply in the US and Europe; and in China, more than 20 million migrant workers have been laid off.

It is no wonder then that many Americans have a deep sense that the capitalist system itself is threatened. Daily, they are bombarded by news of government bailouts of financial institutions and automobile companies and the outcry for government action to rescue mortgage holders facing foreclosure. Europe has not fared much better as the United Kingdom government has had to come to the rescue of the country's leading banks; and the Bank of England, having cut interest rates to levels not seen in the over 300 years of its existence, is also firing up the printing presses.

The American economy, where the current crisis began, is troubled by deep-rooted structural weaknesses - manifested by its addiction to debt - which have developed over the last three decades, but have accelerated since the start of this decade. The immediate crisis can be traced to junk mortgages and the securitisation of these mortgages and other substandard debt instruments, the so-called toxic assets.

Will have to spend less

Fuelled by cheap money and overleveraging by unregulated financial institutions, the US economy was overtaken by simultaneous bubbles in the stock market and in the debt, commodities and housing markets, especially after 9/11, when the Federal Reserve ran a relaxed money policy for several years.

American policymakers and regulators somehow ignored the explosive rise in debt which saw household debt nearly tripling from US$4.5 trillion in 1994 to US$12.9 trillion in 2006. Home mortgages grew even faster, more than doubling, from US$4.92 trillion in the first quarter of 2001, to US$9.96 trillion by the first quarter of 2007.

By 2005, financial services accounted for 20.4 per cent of US gross domestic product (GDP), as against 12 per cent by the manufacturing sector, reversing the relative standings in 1970 when manufacturing's share stood at 23.8 per cent to 14 per cent by financial services.

In this environment of lax regulations and an economy pumped up by debt, it is not surprising that subprime mortgages proliferated and eventually undermined the entire financial system.

The long-term recovery of the US economy and strength of its financial system can only be assured if there is correction of the fundamentals of the system. This means that the savings-investment circle which had been broken for several decades, as the US became entirely dependent on debt financing, has to be restored.

While Americans had a positive savings rate of around 10 per cent of GDP in 1980, this had become negative by the time the financial crisis erupted. The paradox is that to restore a positive savings rate, Americans will have to spend less, as they are being forced to do now. But as consumer spending accounts for more than two-thirds of US GDP, the act of increased savings will hinder recovery of production in the immediate future. Further, American consumption is such a driver of the global production system that the restructuring of the US economy is going to have serious consequences for China and other emerging economies, developing countries like Jamaica, and other developed countries such as Japan.

Dennis Morrison is an economist. Feedback may be sent to columns@gleanerjm.com.