Double Dip

Well writing about one’s interest is always nice, and I am doing this after quite some time now.

In economics I had studied a concept of business cycle known as “The double dip depression” – a phenomena which has rarely happened in the global financial world. Unlike the regular sinusoidal curve of business cycles where a recession is followed by a phase of growth, the double dip recession is an economic condition where a recession is followed by a short spike in economic growth and then is followed by a prolonged depression.

I think you will be a bit surprised as to why I am talking about depression when the world economy is on the recovery path? I too wish a quick and healthy recovery of our financial world, after all my finances are also at stakes. Unfortunately, I have my concerns on the way things are unfolding.

In the early 2008 the global economy plunged into a financial mess which I think all of us are well aware of. The governments across the world came together and pumped taxpayer’s money in the economy to restore order. In a matter of 2 to 3 quarters, we started seeing signs of economic recovery; things became rosy as if the events of 2008 were nothing more than a bad dream. Today the confidence levels are high and we are almost convinced that the dreadful past is over.

I fear that we are missing out on the fundamentals of economic processes and this may cost us dearly. In my opinion the financial crisis was not just a crisis of business confidence or money supply. It had roots into the fundamental ways the world economy (esp the western economy) was progressing. The recession was a result of unviable economic behavior of western and emerging world. This crisis wasn’t built overnight, mortgage and swaps were not the root cause of this crisis, but were the effect of an underlying economic shift which was happening over a period of time but was being contained by the unviable economic policy of major trading blocks of world.

The governments acted to control the panic by increasing the money supply; this was the treatment for the symptoms and to be true this was necessary to control the fire at that time. The easy money was supposed to cushion the fall of economic system which had to be re-built later. This re-building exercise has to start by the acceptance of the new terms of trade and re-distribution of wealth. On the contrary, and more so out of panic, the central banks gutted the financial world with an easy money policy. The bailouts package crossed the thin line which distinguished good from bad.

I believe the overhang created by easy money supply has put us face to face with the famous dilemma of economics. On the one hand is Inflation and the other end is the growth. The artificial demand created by easy money has gradually fuelled Inflation in the major economies across globe. The movement of global crude, commodities and metals prices (Gold is inching to the level of 17k) in the past quarter is an indicator that easy money has acted as a feed to the inflation monster. Sooner the governments across the globe will have to wake up to the reality of taming inflation and will have to take the decision to shut this tap of easy money flow. Once this flow is tamed, it will impact the interest rates and a high interest rate regime will result into reduction in the global growth rate.

Unlike 2008, where the recession started from the financial sector and went on to impact the manufacturing (or to say the primary sector) of the economy, this time around, I believe the fall will start from the primary sector and will slowly go on impacting the other sectors of the economy. An increase in the interest rates will shoot up the cost of doing business, especially for the SME and micro enterprises. This segment has struggled a lot in the past couple of year and today when they see a ray of hope in the form of increased demand, however, the tightening of money supply will limit the amount of disposable income with individuals. As a result the consumer demand may dip. The dual problem of demand crunch and over supply is a perfect situation for the economy to spin into depression mode.

The western economy has a greater risk of falling into this trap add to this the dependence of BRIC on these economies for sustaining their own growth; the result could be a downward spiral for all of us. The current expectation is that BRIC countries will propel the world economy out of the possible depression. No one can say for sure, as to how much the BRIC economy will be able to propel this growth. Its not that the emerging countries can’t achieve this but then, they have their internal pulls which are difficult to negotiate in the immediate term.

Well, I don’t want to paint a completely pessimist view of the things to come. The above scenario, if at all comes, will not be as difficult to handle as it seems provided the government’s across globe show the same level of solidarity in fighting the inflation as was shown last year while fighting the monetary crunch. The debate has already started among the policy makers as to whether this is the right time to pull the lever. Indian prime minister, finance minister and RBI governor has already sent out feelers, that it’s the time for government to pull out and its impact was seen on the bourses the next day. Asian Development Bank has already warned that this might not be the right time for governments to come out, but then no democratically elected government take the risk of allowing the inflation monster to grow and eat into common man’s wealth.

I am not certain to whatever I wrote above, I wish this all turns out to be false, but I do think its necessary to have a word of caution while we plan our immediate financial planning. The way things are progressing over the past few weeks makes me uncertain a number of times, but then you can never judge the economy at a point of time in isolation, its always over a period of time that we come to understand the movement.