It is almost a week since the USD 700 bailout was announced but the stock markets continue to slide all over the world. This is despite the best efforts by various governments to stem the tide. Why is it happening ? What could be the reason ?
The reason is that the stock markets were overheated and artificially priced. The various economies which were inflated like balloons through malinvestments are going for correction. Hence, the stimuli are not working. About a year ago the Dow Jones index was above 14000 mark. It has slipped to around 8990 now. This effectively means that USD 9 to 10 trillion has been wiped out from the global economy. This amount is part of the deficit financing the various governments gave for malinvestments through various financial institutions. The estimated global debt is around 25 to 30 trillion dollars. What we are witnessing is a typical business cycle due to Malinvestments.
Instead of realistic expansion for future needs, the businesses were making Malinvestments--a term coined by Austrian economist Ludwig von Mises. The process of Malinvestments can take several years, as an inflated supply of money courses through the economy and borrowing is easy. Meanwhile, prices rise. But the explosion of consumerism never happens. Consumers never voted with their money, by means of savings, to underwrite an excessive expansion. The expansion was due to an artificially inflated money supply.
Most business cycle theories fall into one of the two categories. Some economists assert that economies have basic flaws which, for some reason, lead to cycles. Other economists insist that only some form of outside interference can cause swings from high to low unemployment. Unemployment and business failures are the most visible and characteristic signs of a recession .Those who accept the flawed economy theory usually insist that economies are far too large and complex to operate without a significant degree of government guidance and regulation. Those who hold the opposite view believe that economies are not inherently flawed and that there will be no business cycles as long as there is no outside interference from governments or other sources.
The recent developments confirm the belief of the second group which holds the view that no outside interference should take place. Unfortunately, all the governments have been interfering with economies for more than 50 years after the great depression. They are now in a position where they have no choice except to take corrective action by bailing out banks and cutting interest rates. It is the case of good money chasing bad money. They just do not have the time to leave the economies to arrive at an equilibrium on their own. The problem is due to lack of public savings and other imprudent policies of central banks. All nations must have atleast 20% of their GDPs as public savings to underwrite business expansions. People must not put all their savings in the stock markets, even though they offer mind boggling returns. People must remember that their entire savings can be wiped out in crisis's like this.
Cutting of interest rates, without sufficient public savings to underwrite, is the root cause of the problem. Expecting people to spend without savings will invariably lead to malinvestments by businesses and insolvency of individuals. Governments must encourage people to save the barest minimum. Otherwise we will continue to have such crisis's. Thrift is a virtue for individuals, organization and governments. To put it simply, we must spend less than what we earn and keep some amount as savings for the rainy day. Savings are just postponed consumption.
© Copyright, Oct 11-08 . Without prejudice. All rights reserved
Falling stock markets - To learn more about this author, visit Madhavan T Gopalachary's Website.
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Madhavan T Gopalachary
(Visit Madhavan's Website)
Madhavan Gopalachary, nick name "madgopes"
(g pronounced as in go) given by IIT
classmates, is a Mechanical Engineer and
an alumnus of Indian Institute of
Technology, Madras having passed out
specializing in IC Engines &
Thermodynamics.
He has nearly 35 years of experience in
the Corporate World. He started off as a
trainee and handled sales, marketing,
manufacturing, product management, profit
center management, strategic planning and
corporate development including R & D in
various organizations and at various
levels before becoming a CEO. His last two
professional assignments were at CEO level
before embarking to start management
consultancy business on January 01, 1998.
He has worked for British, Swedish MNCs as
well as very large Indian business houses.
He has spent a large portion of his time
from June 1998 till date in East African
Countries practicing as an independent
Management Consultant.
More details can be obtained at the
following web sites:
mmg.name
/mtg.html;
mmgconsu
lting.biz/
Madhavan's articles can be accessed at www.madgopes.com
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