Vicissitudes of global economic history

When we turn back the pages of economic history, we come across major events that have jolted the course of global economic growth. Although, these events were region specific, the ripples of "economic turbulence" could be felt worldwide due to the interlocked nature of balance sheets. Below, I have given a brief account of events which have proved to be a watershed in the history of global economy.

The Great Economic Depression: A major downturn in global economy leading to a prolonged phase of economic recession. A cycle of events which transformed US from "bread basket" to "dust bowl". Skyrocketing production of goods followed by fall in demand resulted in unemployment which inturn resulted in further fall in demand and cycle continued. Let me explain. The US industrialists were among the richest 1% Americans. Remaining population comprised of agriculture labourers and middle class who did not have enough wealth to accommodate increased production due to low agriculture prices and low wages. As a result, demand fell; fall in demand meant fall in price of goods; production of goods was curtailed and yes, less production meant less labour requirement leading to rampant unemployment. More unemployed meant further less demand of goods thus jeopardising the revenue of major industries. Gradually, the industries were put in dilapidated condition with mass closures all around. Consequently, the share prices of industries began to fall. The shareholders/investors began selling all their stocks afraid of perpetually falling stock prices. Mass fall of stock prices resulted in steep fall of stock market indices- commonly called the stock market crash of 1929. The market turned "bearish". It took years to restore normalcy when finally after the second world war, Bretton Woods Agreement led to the establishment of Bretton Woods twins- IMF and World Bank to bolster the global economy.

US sub-prime crisis: Also called the "mortgage crisis" of 2008 was an outcome of popping of the "Asset bubble" largely backed by sub-prime lending. In US, housing (asset) prices were ever increasing. Borrowers with healthy credit history called as "prime borrowers" began mortgaging houses on credit from banks. Banks pooled together the various mortgages into mortgage backed securities or collateralised debt obligations (CDO) with credit ratings assigned to distinguish "safe" and "risky" investment. The institutional investors such as mutual funds, pension funds, hedge funds began investing in the asset backed security/CDO hopeful of getting high returns on investment because of continuous rise in housing prices. Everything seemed alright till date! The problem started when banks began lending sub- prime borrowers with poor credit history. What prompted them to do so?? The belief that even if these borrowers defaulted on credit, houses could be sold to recover the amount (assumption that housing prices would never fall). No step was taken to limit the number of sub-prime borrowers thus widening the basket of risky investment. Initially, there were handful of defaulters but gradually the number multiplied and to such extent that there was more number of houses in the market than buyers!! Remember basic concepts of Microeconomics where excess supply of goods results in fall of prices. The same happened. Soon the asset bubble burst as prices slumped. Further diminution in price was attributed to the fact that prime borrowers refused to pay the interest they were already paying which was higher compared to market conditions and wanted to sell off their housing property. This aggravated the situation leading to crash of major financial institutions in US- the most notable of those being fall of Lehman Brothers, an investment bank turned bankrupt!!

Eurozone crisis: Commonly known as the "sovereign debt crisis" of 2011 which had staged in the backdrop of exorbitantly high sovereign debt by five fragile economies of Europe- Greece, Ireland, Spain, Cyprus and Portugal. The sovereign debt was extensively used to meet high fiscal deficit of the country and bail out of ever worsening banking system. Over a period of time, the size of debt increased to an extent that it was greater than the size of economy as a whole!! Soon, the lenders realised that credit worthiness of government has taken a backseat and feared of credit default. As a result, they categorised the investment as "risky" and charged high yield of returns on debt. Unable to pay off the previous debts due to sluggish economic growth, the government was compelled to take more debts to finance its expenditures and prevent its economy from turning dormant. Thus, the government was caught in the vicious cycle of debt. Capital infusion from International Monetary Fund and European Central Bank proved to be effective in curbing this malady. 

Thanks to the robust monetary policy of Reserve Bank of India backed by strong financial system that helped India withstand economic turmoil in the past. However, the stark reality looming large before us is the mounting NPAs(Non- performing assets). Today, Indian banking system which is regarded as the balancing wheel of financial system is reeling with the problem of bad loans. "Bail out" policies of goverment and bank mergers have been only partially successful. Solving the NPA problem is a herculean task to be accomplished soon, else Indian economy will head towards its doomsday.

Crisis presents two situations- "Danger" and "Opportunity". Choice is ours!!