Economic Crisis in America

By Hubert H. Lee

The world's largest economy has began to show weakness and drift as a result of a collapse of the housing market, the subprime mortgage turmoil, a severe credit crunch, high oil prices, and the deep devaluation of the dollar.

The broad international stock sell-offs on Monday and the prospect of a steep decline in the U.S. market raised fresh concerns that a looming recession in America could have global repercussions.

Already share prices in Japan, Europe, China, Hong Kong, Britain, France, and Canada already fell on average 5 percent, reminding us of the 1990 Asian financial crisis. The tumble in Wall Street resulted from the massive losses on loans made to U.S. homebuyers will cascade through the world financial system.

Investors have been lured to overseas markets with the promise that surging growth and solid economic fundamentals in Asia and the Middle East would insulate them from the economic recession in America. When U.S. economy is sick as President George W. Bush acknowledged, those emerging nations are free from economic malaise?

In an effort to boost consumption and investment, the Federal Reserve Board lowered its the benchmark interest rate ― the federal funds rate ― by three-quarters of a percentage point to 2.25 percent on Tuesday and is expected to taker further action in the month to come when there will be no reaction from the sectors of consumption and investment.

The recent report on profit loss by Citicorp, Merrill Lynch, and the Bank of America are scaring enough to spread fear around the globe.

Citicorp and Merrill Lynch each reported $10 billion loss of profit, causing massive layoff of 21,000 employees while the Bank of America also joined to lay off 1,100 employees that will be followed by many Fortune 500 corporations soon.

Economic recession resembling the gloom of 1992 market is characterized by decline in housing market, bleak outlook of job opportunity, skyrocketing oil prices, a stock market collapse, a fall in asset value, and the huge federal government deficit and the trade deficit of almost $800 billion.

Rising health care costs reawakened additional fears for the middle class. In a high cost economy in terms of energy, health and financing ― while the equity value declining on average 20 percent if holding the level of income constant ― disposable income of consumers obviously falls.

Furthermore, the decreased value of houses will bring a negative wealth effect (Pigou Effect) to home owners and property owners, which apparently blow a devastating impact on their level of consumption.

The subsequent reduction in consumption and investment will impose a negative multiplier effect on the aggregate demand. California, Michigan, and Florida are already experiencing economic recession.

How much the short-term monetary remedy by tinkering with interest rates will be effective upon lifting up the dampened economy will remain to be seen.

Meanwhile, the possible outflow of foreign capital invested in America may be counterproductive as interest rates continue to be lowered. As the U.S. economy deepens into recession, more foreign capital is needed to make up shortage of national saving.

It is very encouraging to learn that Merrill Lynch and other financial institutions are inducing foreign investment into the U.S. from Kuwait, Saudi Arabia, South Korea and Japan.

Securing liquidity in times of economic recession will be absolutely necessary to salvage the ailing American economy, along with the lower interest rate policy coupled with tax rebate.

Although the huge losses from bad loans and corporate earning losses will spur fears for economic woes, partial governmental intervention in the failed market economy hopefully builds up confidence on the part of consumers and investors. Thus consumers continue spending and investors are strongly motivated to increase investment expenditures in response to the falling interest rates.

The central bank's stimulus package combined with tax rebate proposal by President Bush will determine the degree of a recession threat for 2008.

Whoever will be elected president this coming November, a federal budget deficit and trade deficit reduction, an increase in investment supported by increased saving, the leadership in building a strong confidence on consumers and investors will turn around the pessimistic economic mood mired by recession.

Hubert H. Lee is chairman of the Korean American Foundation, USA (KAFUSA). He is also an economist at Benjamin Hubert Group. He can be reached at drhlee@frontiernet.net.