Global Meltdown-the beginning:
The origin of the present crisis in the west lies in abandoning sound economic principles which were introduced by Irving Fisher, also known as the great neo-classical economist and he is termed as mathematical economist. He was credited with among other things for he great concepts named after him like fisher equation, equation of exchange, price index, fisher separation-theorem and his famous equations relating money and price and his theory of interest and capital and his theory of real and nominal interest rates and inflation.
The famous among them is his explanation of relation ship between interest rates exchange rates and inflation.
In order to understand this crisis we have to first go through what is named as sound economic principles of business.
Business is run with the capital either own or borrowed, and capital attracts interest. In order for the businesses to make profit they have to earn more than interest commitment and inflation.
Inflation:- it is defined as an increase in price index in a given duration of time, mostly one year.
So now, for the business to earn actual profit, they have to earn enough that it is more than inflation and interest combined.
Other expenses might be their but it is not considered in this discussion because they are mandatory any ways.
Not only profit but the interest on capital should be more than inflation.
An example is that, if the interest on capital is 6% and the inflation rate is say 3% and if a business wants to make 10% profit ,then it should make a total of an extra 9 % in order to get its 10% profit.
This is the sound economic theory that must be known to understand the global meltdown.
What is global meltdown actually:
Trillions of dollars simply vanishing from the corporate houses and public in a span of 6 months beginning from jun to Dec. 2008. In America alone it was close to 8.5 trillion dollars. In India it is close to 10 lakh crores. This resulted in laying off of hundred and thousands of jobs and reduced economic and business activity, common people losing all their life time savings, and affecting in India the very promise of becoming an economic superpower. What went wrong??…this is what I'm going to explain.
Reasons for meltdown:
1). Artificial low interest rates :
Since 1950, in the USA, the business have forced the govt. to reduce the interest rates on capital to below inflation rates.
In order to do this inflation rates are manipulated to keep them artificially low.
2).LBO (leveraged by-outs):The money thus borrowed was invested in buying other companies than using it for productive purposes.like manufacturing, extraction..etc.
Along with that the business corporation America encouraged consumers to borrow and spend rather than earn save and spend. In order to achieve this they loaned money to consumers again at below or on par with inflation rates.
3).Consumer spending through debt:
People started borrowing and spending on consumer goods than on fixed assets. You may ask whats wrong with that, but the thing I the money which is spent from savings doesn't carry interest, where as the borrowed money carries interest. When you are borrowings go beyond your earnings total, then your whole earnings are spent on paying interest only.
Apart from that since 1980, a new concept emerged in America which is called sub-prime mortgage lending and securitizaiotn of debt.
4). Sub-prime mortgage
Mortgage means taking loans to buy houses. Loans carry interest rates which are required to be more than inflation rates. But who knew that this simple concept of owning a dream house led to one of the major global financial economic crisis.
The reason is greed.
5). Securitization of debt-Inside trading and stock market failures.
3.Dishonoring credit payments
4.Liquidity crunch (no money present any where..with people, and companies)
5.Govt. bailing out (printing of money)-leading to high inflation once again
What to do:
At an individual level:
The main thing that we can do Is firstly be aware of whats going on., invest in hose companies which you know will have sound rise and increase. Be smart enough to judge the annual balance sheets. Increase savings invest in those which will not loose its values like jewelery, gold, real estate.
At govt. level:
We need development but not at the cost of public's wealth. Govt. should also thoroughly the effects of liberalization on other countries before implementing those western ideas blindly on India.
At corporate level:
Indian corporates should be more transparent and responsible towards the people from where they are getting the money support.
They should be sensitive towards public money keeping in mind that it's the money from the people their playing with.
Govt. should not save big corps. If they fail to the tune of lakhs of crores, instead do what America did, that is allow the companies to fail and then bring them back by setting up strict rules as to how to use peoples money.
The present situation:
The present meltdown has caused such a damage, which may be irrecoverable for a few years but still India(govt. and corporates) has not realized to go back to the sound principles of business and instead foolishly still repeats the mistakes again.
Companies constantly on govt. money dependency,Wanting lower interest rates,etc.
Ex.Tata has requested 5% interest loans, on around 25 thousand crores when the official inflation rate is at 10%.