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World Economy on the brink of Disaster

|Includes: Freddie Mac (FMCC), FNMA

Surely we have all been brainwashed by the surplus of media constantly battering us with the downsizing, rightsizing, and bankruptcies. It just never seems to end, banks buying out one another, mortgage companies delisting from stock markets, and the ever mounting credit from desperate borrowers seeking that extra help to keep their companies afloat. Now the question becomes, will we prevail?

It is easy to play the blame game in such hectic times: CEOs and upper management using bonuses to benefit themselves, or how about companies like FRE and FNM who couldn’t help themselves in giving out an insurmountable amount of mortgages. In America, we’ve all heard of the AIG, CITI, Lehman bros, Bear Sterns troubles to name a few, but it is important to note that our neighbors are feeling the pain as well. However they aren’t the only ones feelin the crunch, according to news within England and Wales, bankruptcies rose by over 12 percent compared to the previous quarter.

 

In fact, it has gotten so hectic that the Bank of England is being asked for major assistance in order to stop the major economic slowdown. How will they be doing this? The Monetary Policy Committee is aiming to reduce the cost of borrowing, a simple yet effective economical strategy. However time is of the essence and the longer the delay, the further the economy will continue to worsen.

Knockout punch to the individuals and small businesses

As with all recessions, a decrease in buying power is to be expected as unemployment continues to sky rocket. It is imperative to keep in mind that liquidity and cash at hand is the most valuable asset, as stated in my previous article Investment Tips during a Recession. Due to this, small businesses will continue to have an overall poor financial outlook.

 

The current economy feels worse than any previous recessions. Usually there are different segments within the market that outperform others; however this time around it doesn’t seem to be that case. The housing market is not out of the woods; it continues to decrease due to falling housing sales and the reduced equity values. The labour markets are on the radar as well. Fuel costs are also increasing.

What turns a recession into a Great Depression?

There were multiple causes for the first downturn in 1929, including the structural weaknesses and specific events that turned it into a major depression and the way in which the downturn spread from country to country. In relation to the 1929 downturn, historians emphasize structural factors like massive bank failures and the stock market crash, while economists (such as Peter Temin and Barry Eichengreen) point to Britain’s decision to return to the Gold Standard at pre-World War I parities (US$4.86:£1). Most argue there is a chain of events:

  1. Debt liquidation and distress selling
  2. Contraction of the money supply as bank loans are paid off
  3. A fall in the level of asset prices
  4. A still greater fall in the net worth’s of business, precipitating bankruptcies
  5. A fall in profits
  6. A reduction in output, in trade and in employment.
  7. Pessimism and loss of confidence
  8. Hoarding of money
  9. A fall in nominal interest rates and a rise in deflation adjusted interest rates.

 

However, we need not worry because hopefully we have learned from then on how to react to these desperate measures in a more reliable and effective way. Therefore, we should expect nothing more than a typical Economic Life-cycle. It might take a few years before we will all gain trust within the banking systems, mortgages and credits, but it will get there sooner or later. After all, what doesn’t kill you only makes you stronger.