Economic Analysis Essay

The enthusiasm, as well as the anxieties that is generated by the working of the economy of the United States is not just US economy generates is not just obvious but also easy to understand. The United States, with a GDP of 13. 2 trillion USD, and a population of 300 million (with an average yearly per capita income of more than 44,000 USD), is the largest economy of the world (CIA Factbook, 2008). Its currency, the US dollar, even in the throes of its greatest financial crisis, is the world’s preferred currency, and its markets the world’s biggest. In diversity and amount, the natural resources of the country are greater than those of most other countries. Many US industries are global leaders, and it remains the favorite marketing target for companies from across the world. With the US being the largest trading partner for numerous north and south countries, a large portion of the global economy relies upon US consumption for survival; significant changes in its pattern can lead to global euphoria or gloom. The performance of the US economy is influenced by an assortment of local and international factors. Distinguished by particularly low government control, a guiding principle that was first chosen by the founding fathers and followed painstakingly ever since (Oppenheimer, & Reddaway, 1989). Although the government stipulates regulations and ensures inviolability of contracts, most microeconomic decisions are taken by private firms and corporations. (Rowe & Silverstein, 1999) Governmental and Federal Reserve activities occur mainly through the modification of tax policies, changes in interest rates, and control of money supply; their endeavor being to push the economy in chosen directions rather than to compel it to take up preferred paths. (Oppenheimer, & Reddaway, 1989) The last two decades have been particularly turbulent for the economy, marked by sharp expansion, occasional slowdowns, and the occurrence, in 2008, of a slump of dimensions sharp enough to affect the economic fortunes of numerous nations and millions of people. This assignment aims to assess and analyze the performance of the economy from 1990 until the present day, taking up various economic developments, the reasons behind the same, and their local and global impact. Commentary Overview of 1990 to 2001 The economic performance of an extremely intricate and influential economy like that of the US relies upon various local and global developments like investments, agricultural, manufacturing and service activity, exports and imports, global and local commodity prices, currency strength, disposable incomes, and consumption patterns. It is also influenced by fiscal and monetary measures like changes in tax policies, interest rates on loans, and reserves of banks, as well as by ongoing developments like price rises, job levels, and induction of fresh participants into the work force. Whilst the United States is one of the leading exporters of coal, wheat, corn, and soybeans, its continuous and strong economic growth has increased its dependence upon other countries for oil and many other raw materials. In fact the country had become a leading consumer of practically every sort of raw material by the 1960s and growth continued to rise thereafter. The 1970s and the 1980s, the decades that preceded the 1990s, were difficult ones and were distinguished by slow economic growth and inflation. While the period was marked by the entry of Japanese industry onto the global stage, the oil price shocks, and the forced bailout of Chrysler, it also witnessed the emergence of the service industry and the numerous small businesses in the United States. Whilst the 1980s saw a reduction in inflation rates and the creation of millions of jobs, such developments were accompanied by drastic increases in military expenditure, Medicaid and Medicare costs, corporate debt and household borrowing (Julius, 2005). Thousands of banks failed because of a combination of reasons that included high inflation and interest rates, bad loans to developing nations and speculative real estate ventures. The total national debt reached a figure of 290 billion US dollars, the highest till then. The US economic recovery commenced in 1991 and continued for the rest of the decade; it was distinguished by a long period of constant growth and by strong performance in key economic indicators like growth, inflation, unemployment and interest rates. Real growth in GDP stayed at around 3 % for the whole period with a low of 2. 5 % and a high of 3. 9 % in 1998. Unemployment fell from a peak of 7. 5 % to 5. 6 % by the middle of the decade and to less than 5 % after 1997. â€Å"America’s labor force changed markedly during the 1990s. Continuing a long-term trend, the number of farmers declined. A small portion of workers had jobs in industry, while a much greater share worked in the service sector, in jobs ranging from store clerks to financial planners. If steel and shoes were no longer American manufacturing mainstays, computers and the software that make them run were. † (The 1990s and beyond, 2008) Inflation, which had reached dangerously high levels in the 1980s also moderated significantly and remained below 3 % for most of the decade. The only area that witnessed volatility was the stock market, with stock prices rising by more than 60 % in the closing years of the decade on the back of low unemployment and good growth figures. The Dow Jones Industrial Average, which had stood at around 1,000 in the late 1970s, went up to as much as 11,000 in 1999, adding substantially to the wealth of many Americans (Julius, 2005). Whilst Clinton, who occupied the Presidency from 1993 to 2000, declared the era of big business to be over in the United States, he worked to strengthen market forces in areas like long distance telephony, reduced the size of the federal work force and ensured the continuance of most of the New Deal innovations (The 1990s and beyond, 2008). The economy was also helped greatly by the collapse of the Soviet Union and the consequent enlargement of trading opportunities. Technological advances led to the introduction of a wide assortment of sophisticated new electronic products. Numerous innovations in telecommunications and computer networking led to the development of a vast IT industry and revolutionized the operating methods and ways of numerous industries. â€Å"After peaking at $290,000 million in 1992, the federal budget steadily shrank as economic growth increased tax revenues. In 1998, the government posted its first surplus in 30 years, although a huge debt — mainly in the form of promised future Social Security payments to the baby boomers – remained† (The 1990s and beyond, 2008) The Economy in the 21st Century Whilst such developments led a number of economists to believe that the United States was entering a period of sustained economic growth, economic growth came to a halt in the early 2000s. Much of this was due to the slowing down of the investment boom and the economy went into recession in the second half of 2001, cutting a ten year period of economic growth. Along with slowdowns in investment and the widespread crashing of dotcom organizations the economy was terribly hurt by the World Trade Center attacks worsened the economic situation. The recession was short lived and lasted for a period of 8 months and whilst the labor force continued to grow, its rate moderated significantly. Whilst the actual recession was short lived the following years were ones of slow growth. Growth in GDP, which was estimated at 2. 5 % in 2002 continued to be slow in 2003 and unemployment rose significantly in 2003 (Julius, 2005). Huge corporate scams, like the ones at Enron and WorldCom led to erosion of domestic confidence and the recovery process remained slow and sluggish. The downturn in the US economy, which had spurred global economic growth during the 1990s led to a worldwide economic downturn, not just in Europe but also in Japan, Latin America and Southeast Asia (Julius, 2005). Consumer spending increased only after the commencement of the war in Iraq and was accompanied by the improvement of most economic indicators. The movement of the economy in the 2000s can be broken up in three distinct sections, the recession of 2001 followed by sluggish growth in 2002 and 2003, sharp economic growth from 2004 to 2007 and financial crisis that enveloped the economy after the housing crash and the mortgage disaster of 2007 (The 1990s and beyond, 2008). The years following 2003 witnessed a recovery powered by consumer spending as the Federal Reserve lowered interest rates and the government reduced taxes. The economy grew at an average annual rate of 3. 1 % during this period, a rate not much lower than that achieved during the growth phase of the 1990s. The economy was also bolstered by a USD 500 billion spending on homeland security and the wars in Afghanistan and Iraq, a jump of 4 trillion USD in household debt and a 50 % increase in prices of real estate (The 1990s and beyond, 2008). With the Fed engineering finance at low interest rates, consumer debt, credit card, and vehicle loans went up from 7. 9 trillion USD to 12. 2 trillion USD, and US consumers went on a spending spree that had no precedent. Inflation was fuelled not just by increasing demand but by sharp increases in oil prices, which went up from 28 dollars a barrel in 2001 to the mid 60s in 2006 and finally to USD 148 a barrel in 2007 before the current crisis brought it crashing down. â€Å"The rise in GDP in 2004-07 was undergirded by substantial gains in labor productivity. Hurricane Katrina caused extensive damage in the Gulf Coast region in August 2005, but had a small impact on overall GDP growth for the year. Soaring oil prices in 2005-2007 threatened inflation and unemployment, yet the economy continued to grow through year-end 2007. † (CIA Fact Book, 2008) Tragedy struck the US and global economy in 2007 in the form of the mortgage crisis when economists were predicting a boom the likes of which the world had never seen before. The majority of the problems impacting the US economy have come about because of the development of housing crisis. Whilst housing and construction activities had grown sharply since 2004, they slackened significantly in 2006 after successive interest rate increases by the Federal Reserve made monthly housing loan repayments substantially more costly for home mortgage holders. With loans having become far more expensive to service, the housing industry went into a slump in 2006 with far lesser home sales on a Year on Year basis. The continuation of this phenomenon into 2007 led to a sharp economic slowdown and was in many ways responsible for the precipitation of the mortgage crisis. The sub prime mortgage financial crisis in the USA first evidenced itself in 2006, and assumed global proportions in mid 2007. With a combination of a number of economic causes like increased monthly repayment figures and declining home values restricting the inability of mortgage holders to meet their repayment terms, mortgage lenders, who until the had ridden the wave of real estate expansion, were hit with huge cash deficits and the inadequate securities to make good their losses (Bernanke, 2007). The emergence of the sub prime crisis led to the opening of a virtual Pandora’s Box of wrong and risky banking practices, and the financial bankruptcy and mortgage foreclosures of thousands of borrowers. It also led to the bankruptcy of huge financial institutions like Lehman Brothers, the virtual collapse of a monolith like Citibank, the collapse of stock markets, the extinction of stock market fortunes of thousands of Americans and finally to a tremendous crunch in availability of funds and credit. Apart from creating havoc among financial institutions the crisis has also led to tremendous slowing down of economic activity, the loss of thousands of jobs, increasing unemployment, contraction of GDP and enormous economic uncertainty. The sub-prime crisis has put a huge doubt over broader economic functioning by choking spending and by impacting the progress of the building sector. Whilst most impartial observers are likely to attribute the sub prime crisis to the greed of borrowers and lenders, the lax policies of regulatory authorities is seen by many to be a major contributory factor for the development of this crisis. Laxity in the activity of the Federal reserve, which reduced interest rates in 2001 and kept them low for five years, is considered to be a major reason for the reckless borrowing and lending practices that finally led to the sub prime crisis. The collapse of major banks and financial institutions has led to the development of an enormous credit crunch, with banks unable to lend money to businesses and to individuals. â€Å"So far this year, 15 banks have failed, compared with three last year. And Wall Street’s five biggest investment firms were swallowed by other companies, filed bankruptcy or converted themselves into commercial banks to weather the financial storm† (Bush: Bailout Plan †¦, 2008). With losses not being confined just to mortgage lenders, many banks lost billions of dollars in the bad mortgage debts that they had bought from mortgage companies. This in turn led to sharp reduction in the money available with them and made them unable to engage in any further lending activity. Businesses across a wide spectrum of industry and service sectors find it difficult to obtain funds for operations and growth, a phenomenon that is seriously affecting their regular working, and leading to contraction of business activity, reduction in production and sales, and to reduction of workforce. Thousands of people have been laid off in the banking sector and job losses are now increasing across the spectrum of business companies, not just in the United States but across the world. Reduced employment figures, accompanied by lesser money availability with people who are fortunate enough to hold their jobs, is also leading to sharp drops in demand for a range of products, including automobiles and household goods, and leading to crisis conditions in various sectors of the economy. The US automobile industry, which has been going through a bad patch for the last few years, has been particularly badly hit, with mostly all companies announcing production cuts and job terminations. Conclusion The duration and severity of the current financial crisis has led many analysts to compare it with the events of the Great Depression, when 9,000 banks failed. Others however feel that while the current crisis is undoubtedly severe it is far away from reaching the levels of economic grief that characterized the depression of the 1930s. Contracting money supply, tax increases, and protectionist tariffs, factors that were associated with the Great Depression are not present today. Unemployment levels, while rising today are also far below the levels of 25 % that were breached in the 1930s. Today’s problem remains associated with the crisis of banking solvency, as is evident from the bankruptcies, forced takeovers and virtual nationalization of large private sector banks. Banks are desperate to first balance their banks and are looking for funds to stay afloat and manage their existing obligations rather than in providing fresh credit. The government of the United States has come out with a bailout plan that was first estimated at 700 billion US dollars and has now come up to nearly a trillion dollars, a figure equal to the GDP of many prosperous West European economies. The bailout plan envisages the provisioning of hundreds of billions of dollars that the treasury can use to for the purchase of distressed assets, particularly mortgage backed securities and for making capital injections into banks. The purpose of the bailout plan is to protect banks, stabilize the economy, improve liquidity, restore confidence in financial markets, and encourage consumption. The Federal Reserve has in recent weeks joined with other major central banks to reduce interest rates and the world’s top economic powers are getting together to take concerted action. Such efforts are yet to show significant results and stock markets continue to remain depressed. â€Å"Slowing consumer demand, labor productivity and, potentially, trade growth worsens the prospects of a mild recession. If the bailout does not soon restore financial stability-and many economists doubt that it will-bailing out the broader economy will require additional public funds and increase burdens on future taxpayers† (Gokhale, 2008) Economists also estimate unemployment to increase to hit 7. 5 % by next year and most are in agreement that while the current crisis may not prove to be as severe as the great depression, economic recovery does not appear to be immediately visible and that the economy will remain difficult even if financial markets were to stabilize. In the meanwhile Americans will most probably have to live with shrinking salaries and reducing net worth at least for 2009.