Every day brings more bad news about the state of the US economy, and indeed that of much of the rest of the world. Not only is America’s economy the largest in the world, its currency–the dollar–is also the global reserve currency with 63 percent of the world’s central bank reserves held in dollars.
The US economic meltdown began long before the collapse of Bear Stearns a year ago. Thereafter, it was a rapid downward spiral even as bank executives issued palliative statements and US officials talked about the soundness of economic fundamentals. Sub-prime mortgages, derivatives and hedge funds worked as termites hollowing the foundations of the economic system. President Barack Obama has thrown hundreds of billions into bail out packages and while there is much rage about the $218 million bonuses handed out to AIG executives that received $170 billion of government bailout money, it pales into insignificance compared to what is in store for the overall economy.
US budget deficit estimates for the next decade vary from $7 trillion (Obama’s) to $11 trillion (most economists). These are staggering figures. Nouriel Roubini, professor at the Stern Business School at New York University, says there is “a rising risk of a global L-shaped depression that would be even worse than the current, painful U-shaped global recession.” American and European officials, avoiding the word depression, insist it is merely a “severe recession”. Even in such dire circumstances, the US is trying to create a new system by working secretly with China and Britain and hope to ride the storm by printing more money. The US Federal Reserve Bank, a private institution, is printing $1 trillion to buy toxic bonds to shore up the economy. Will this work? Perhaps temporarily but most economists predict a sharp decline in the value of the dollar within the next five years. With too many dollars in circulation and a massive debt, the dollar will fall in value vis-Ã -vis other currencies. The Chinese have already called for a new global reserve currency to replace the dollar as it did to the British pound after the Second World War.
Four factors spur economic growth: consumer spending, investment, government spending, and a favorable trade balance. The US has relied on consumer and government spending for growth. US consumers constitute only 4.5 percent of the world’s population but they bought more than $10 trillion worth of goods and services in 2008 (Chinese and Indian consumers representing 40 percent of global population bought only $3 trillion worth). The demise of US productive economy as factories went offshore left it dependent on finance. With deregulation, this gave rise to ponzi (pyramid) schemes where dubious financial transactions were passed off as sound economic practices. These schemes ensnared not just US financial institutions but also those in Europe and Asia. In the fourth quarter of 2008, gross domestic product fell by 6.2 percent in the US, 6 percent in the euro zone, 8 percent in Germany, 12 percent in Japan, 16 percent in Singapore and 20 percent in South Korea. Even China that has nearly two trillion dollars in foreign exchange reserves is not immune from the US economic meltdown.
Chinese Premier Wen Jiabao has expressed grave concern about the US economy. He has reason to be; about $1 trillion of China’s foreign exchange reserves are invested in US government bonds and other securities. If the dollar declines in value, foreigners will no longer accept payment in dollars for their goods, accelerating its collapse causing much financial turmoil globally.