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Crisis Focus
Special
UPDATED: December 6, 2008 NO. 50 DEC. 11, 2008
Into the Abyss
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The United States, facing its deepest financial crisis since the Great Depression, has spared no efforts to save its economy from falling off a cliff. But its federal bailout program has appeared flawed given the country's mounting fiscal deficits. Will the government's rescue efforts be a panacea for the ailing markets? Will the U.S. economy drift into a prolonged recession? Dong Yuping, a researcher at the Institute of Finance and Banking under Chinese Academy of Social Sciences, discussed these issues in a recent article in China Finance magazine. Excerpts follow:

Since 2006, the real estate price crash in the United States led to a subprime credit crunch that has played out to be a heavy blow to the country's real economy. The U.S. Federal Reserve jumped into swift action to counterbalance the credit contagion. But the situation is still spinning out of control, defiantly. With its pillar industry--the financial system--reeling, the real economy of the United States is almost certain to face a serious recession.

The consumer market, also a key driver of the broader economy, is being depressed by several factors such as asset devaluations, the credit crunch and high unemployment. Since the economic contraction continues to cast a pall over the real estate and stock markets, households have been forced to trim their spending budgets, in turn eroding the powerhouse for economic growth. The labor market is also sending worrying signals with the unemployment rate striking a record high since 1994.

On the investment front, private investors are curtailing their capital activities amid worsening economic prospects. The U.S. Government, still struggling to finance its massive rescue programs, is also less able to stimulate the economy by increasing public investment.

The government bailout plan is expected to cushion the market gloom that is taking hold. But it will do little to help shake off the current downturns for the following three reasons:

1. The Fed's massive liquidity injection is less likely to restore confidence in the credit markets. Since financial institutions have been reluctant to lend amid a dark outlook for the economy, the capital infusion will not be able to effectively unclog the frozen parts of the credit markets. The credit debacle has even passed through an array of other sectors, such as the financially-distressed auto markets.

2. The bailout plan paid little heed to the core ailment of the U.S. economy-excessive consumption and over-investments in the real estate sector. Worse still, the heavy transfusion will not be sustainable given that the U.S. Government has been debt-ridden.

3. The housing market may stumble into an even bigger crisis. The economic recession may further burst the housing bubbles inflated during 2000-06, further depressing house prices. In that case, a large number of homeowners will have to default on their mortgage payments, leading to dizzying bad debt for many financial institutions. The International Monetary Fund has recently estimated that the possible bad debt loss of the United States may amount to $1.4 trillion if housing prices continue their downward spiral.

As a result, it is believed that the subprime crisis has shaken the U.S. economy to its core and will eventually lead to a restructuring of the global financial system.



 
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