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World crisis reasons and lessons

The problem of economic crisis is quite evident nowadays; nevertheless this event still remains to be very vague and unstudied. To predict precisely the outcomes of such a dreadful happening it must be carefully studied, so all the counter-measures against it will have a sufficient background for development and establishment. Moreover than that, all the precautions will involve less risk-taking, as all the possible outcomes will be revised and analyzed the most careful way. Of course this report contains only primary, superficial information, but I believe this “small step” can become a precondition for a “giant leap for mankind”.
The solution of any problem should be thought in its root. Therefore I propose to start analyzing the problem with finding out potential problems that have caused such event. To my mind, there are 3 main fields, which have contributed the most to nowadays reality. They are: overconsumption, mortgage policy failure and speculation power.
The first point to be considered is general overconsumption in the World. It has all started with John Maynard Keynes and his “Paradox of Thrift”. He proclaimed that if the population of the country will start to save less, consequently increasing their consumption, which shift withdrawals (savings) function to the right, and shift injections (investment) function upwards, a new higher level of equilibrium will be reached, so that people will have more disposable income in future, so the actual level of future savings will be higher.
Nevertheless, Keynes was wrong in his considerations, for he did not include in his analysis the power of consumer credit and the following consequences.
People, driven by the paradox of thrift to the need to spend more and more consequently started to save less and less. In the USA it actually resulted in the dissaving of the population in the United States. In the year 2005 it the US savings function has finally fallen below the zero line, meaning that people, since then, started to spend even more than they earned. This could have only been done with the help of the consumer credit. Now let us think what happens with the economy, the lending power of which is “wasted” on consumer credit. First of all, as the money is driven from the banks to the consumer and household side there is a liquidity crisis for the enterprices and companies, as they can’t take the saved money from the banks for investment. In this situation consumers hold additional demand for the goods and services, as they “need to spend more” because of the paradox of thrift, on the other hand, companies can’t match their supply with growing demand, so the price level will be increased. In a couple of years (from the year of 2005 it will give us preciesly nowadays) the prices will continue to grow and people will be forced to take extra credits to maintain their past level of living. The created dissequillibrium will inevitably shift the total output backwards causing economy to go into severe crisis.
The second point, which also influenced the appearance of the world crisis, and has probably contributed the most drammatically into it is the mortgage policy failure. The beginning of this drastic event took its place in the USA again, where Fannie May and Freddie Mac companies exercised their mortagage policies, in particular they were offering mortgage credits to the lower-middle class of the US population. Their approach,however, included very peculiar policy of arrenging the liabilities of their clients into special “packages” and then offering those “packages” as securities on the financial market. Therefore they have established a cycle of money circulation: the money received after purchasing of banks and financial institutions of the securities were used to buy real estate and then resell them on the mortgage credit terms. The cycle was a brilliant invention for the whole population as more and more people became able to buy real estate for themselves. Such policies then become very popular even among the international level and were exrecised by the governments of many countries including Russian Federation.
But, like any other cycle, this one has a very distinctive disadvantage: if one stage of the shain goes wrong, the whole chain is going to be destroyed. It happened so, that with extra demand for real estate from the side of the lower class Fannie May and Freddie Mac decided to expand their policy to this segment as well. The grwoing demand has brought a new problem however. With rising speculation power of the market, the price changes has become unpredictable and very volatile. It turned out so, that the prices of the real estate dramatically fell as the result of speculative pecularities. People, who underwent the mortgage policy became than unable to cover their liabilities even if they have resold their apartments. The consiquences have been and are tragic: the securities value, which have been sold throughout the world via Lehmann Brothers bank became pretty much equal to zero. This ruined the Lehmann Brothers bank, as well as many others basing their policies upon trading of the mortgage securities.
The 3rd point, which can be called the moving mechanism of the crisis is the speculative power of the market. According to the survey held in the USA by the Bloomberg company the number of the market partiecipants in the USA has grown from 2005 to 2008 by 18% , from which the 76% growth was performed by the non-governmental represenatatives. This means that the market has become 76% more speculative, and so it can be concluded that the price corridors for all traded goods has broadened by twice their size and became very hard to predict.
Those 3 specified above factors have caused the most dreadfull affect on the present day economy, acting in “tandem” and therefore have multiplied their effect. Now, being aware of the problem, which became the prerequisites of the nowaday crisis we can develop a sufficient set of strategies to diminish the effects of this crisis or even elliminate them.
But before adopting any specific measures to solve the world cisis, we should take into our consideration the oppinion of the experts concerning this problem. Of course there is variety of scenarios concerning the future of the crisis. In our considerations we shall bear in mind tree groups of decisions, which have been proposed on the Russia Forum 2009. The first group is the optimistic view on the present day crisis. The experts proclaimed that the crisis is to end during this year. It would have been so because of the following factors, whcish they supplied as their proof. The first stage of the crisis is the liquidity crisis connected with overconsumption. There would be a slowing dynamics of economical development ending in periodic stagnation. This conditions will force the government to issue extra money and face severe infaltion. Nevertheless, it will give a push for economy to enter the recovery stage. But as the experts of the second group think, this scenario is hardly probable, because of severe rate of redundancy and russian pecularity in economics concerning emission of extra money. Such practice proved to be ineffective and even destructive for our economy. People of the second group suggest that it will take approximately 3 or even 5 years for our economy to recover from the crisis. There is also so called pessimistic group, which suggest that due to future social instability, the time needed to recover from crisis will be much more than 5 years. However, our government has very big authority in the eyes of our population, so this scenario has a much smaller chance to come to live in Russia in comparison withother countries.
But no matter by which scenario the crisis is going to develop there are a lot of things that can be done to decrease the timeframe of the crisis and lower its depth.
To recover from such dreadful event as the World crisis I suggest the adoption of the following sheme. First of all I should mention that all the precautions against the crisis should be done by government in Russian Federation as the market mechanism is not capable of fixing itself in our country. Our history knows some very dreadful examples of “classical school theory adoptation” which has resulted in default. Besides market partiecipants are very isolated from each other and therefore cannot syncronize their actions, moreover they are not even willing to do so. The best policy nowadays is “grab the money and run for it!”.
So all the further guidelines are dedicated to our government, which, fortunately, is already starting to implement some of them.
First of all I suggest that the financial sector has to be taken care of first. For it was the financail sector which provoked the whole event. So the most adequate measure would be to start with it. The major problems of the financial sector as it has been stated adove several times are the overwhelming speculations power and “toxic” securities on the market.
The problem of specualtion power can be solved in a following way. The governmant should increase its share in all the markets by injecting extra money into it. It can be done with the help of the stabilization fund, which has grown a lot with the depreciation of the ruble in comparison with US dollar. With extra money injected into the markets (for example forex market) the government will gain the price-creation power as its decidion on the market will become major. By buying or selling goods, services, securities or currencies in huge amount it will generate deficite or proficit on the market,so the price will go upwards (in case of deficite) or downwards (in the case of proficite). This way government will gain the control over the price fluctuations.
Of course the number of private partiecipants on the market should be limited. It is no good for an economy to buy and resell the good million times before actually selling it to the final consumer.
The other very important thing to do is to organize special weekly government announcements concerning the situation in the financail sector, to decrease the power of expectation on the market, which has grown immensible since the appearacne of too many private partiecipants, or at least to become able to predict it and control somehow.
As far as “toxic” securities are concerned, there are a lot of oppinios, concerning hendling the problem with this matter. I think that it is up to government, to help banks get rid of those securities, issued by Lehmann Brothers and Fannie May & Freddie Mac. The one way it can be solved is by acuiring all of those securities by Centrobank, offering adequate benefits in return. I think that the Centrobank should offer non-monetary benefits for the banks of Russia, for example taxation indulgence for a period of time. Thus this securities will gain new vakue, as some banks would prefer acuiring them at the moment to gain some future benefits from them.
Having made all the possible things to help the financail sector of our economy we should draw our attention to the transmission mechanism.
There has always been a lot of peculiar features of russian transmission mechanism from financail sector to the real sector. The main one is the lack of confidence in our real sector, which suffered much because of irrational monetary policy. This is also a very good reason for real sector representative to have no confidence in the financail one. Therefore interconnections between the economical sectors is very likely to be very unstable and temporary. For example our banks in majority of cases would rather deposit their money into other bank rather than investing into the real sector. It creates a very big disbalance in the economy,as, money, being trapped inside only financail sector will generate extra and extra value of money, but on the other hand the real sector without sufficien monetary support will create less and less goods and services, so the real value of money will defenitely diminish. It is one of the reasons of high rate of inflation in our country.
To help the economy such chain of event has to be stopped. Our government has to make sure that the money, especially the one government has given the banks to help fight crisis has to be invested into the real sector only, rather than sticking with the interbank credits. In the conditions of crisis money will not only lose its value, but increase the rate of inflation.
Nevertheless, there is another very imporatnt problem of our economy, which is money allocation. According to the latest surveys in our country the amount of money saved outside the banks is evaluated as preciesly 70% of total savings. That leaves only 30% to the amount stocked in banks. Such situation causes the economical growth to slow down very drammatically, as the money outside the banks “does not work”, not creating any added value to the economy.
Why it happens so? To my mind the answer to this question lie in the wrong message banks tend to put into their advertisements. The main considerations of the banking policy is to provide mximum possible interest rate for the prospective depositors at all costs. Nevertheless, such policy can and defenitely will result in bank’s failure in long-run, because some day the competition will force them to offer interest rates higher, than those, which can be covered by other banks’ activities. In our case I think that the idea of sustainability of the bank has to be underlined. It is due to the fact that the policy of offering something extraprofitable always looks like a trap for credulous. And in the conditions of crisis people are eager to take extra precautions. So the main theame of the banks’ advertising policy should underline the idea that keeping a deposit with the bank is safer than keeping your money at home.
If our banks will be able to gather monetary funds more effective and efficient and than allocate it into the real sector, that will resolve the majority of the problems burdening our economy for ages.
Having made sure the transmisson mechanism works as it should, we have to draw our attention to the real sector itself, for there are several problems which must be seen to.
With the resent swift rise in prices of oil the taxation rate for oil processing industry has been increasing as well, but nevertheless, when there occurred a sharp decline in the prices of oil the tax rate has remained unchanged, which made it impossible to decrease the prices of petrol in Russia. It should be said also, that all the affairs in the field of natural resources and raw materials lacked transparacy. I think that if a country wants to respected by the international community and by its own citizens in the first place, it should make its affairs more simple and clear for understanding. In any way, to support our basic economical field, our government has to reduce the taxes for all the industries, especially for the oil and gas extracting ones.
The second point for our government to see to is the availability of the industrial credit in the banks. At it has been already mentioned our banks are not eager to give huge summs of money to the real sector representatives, preferring it to interbank crediting. Such policy has to be stopped, and our government has to become an active agent on the market, offering the cheapest credits for industrial consumers. This will generate competition in the field of industrial credits – which are considered to be very profitable for the banks, and of course it will help generate extra business activity in our country.
The third point returns us bacj to the most important and vital spheres of russian economy, which are oil and gas industries. It is not a sectret that particularly all the production in our country is dependent upon either of these two spheres or att least dependent upon the electric power industry, which can be considered the derivative of the oil and gas industry. To make situation more stable in all the spheres of our economy our government has to establish certain price corridors for oil and gas products. This can be done by becoming an active international market partiecipant, buying or selling huge amounts of both products to affect the aggregate supply and thus influencing the price changes, making them more stable and predictable at the same time. Even if the market power is too high to oppose, our government has to offer oil and gas on the territory of Russian Federation within the limits of pre-established price corridors.
The 4th point is very urgent and demanded in our economy and especially in the condition of the crisis: it is the subsidies. The latest achievement was the increase in the amount of subsidies given to the small-scale business. Unfortunately, it is not enough. Our government has to support russian producers more, but do it more accurately. I suggest a reestablishment of the innovation-based subsidies. If a company has a very solid and sustainable plan for future development, than this company must be subsidised by all means, because with the appearance of each new company in our country, the economic growth increases its pace, which consequently will generate extra working places, additional income of the population, better money gatering and allocation and even more “fair” distribution of income. And of course each new company contributes by satisfying the aggregate demand to the well-being of the society.
Provided that all of the specified above policies work and correlate with each other well our counry can achieve the following results:
1. More rapid crisis recovery due to the increased economical grwoth speed and simplicity of our economy
2. The economy itself will become more transparent, making it possible for average citizens to understand it and contribute somehow into it.
3. The economy will become more mamageble for our government, which will enable it witt the power to prevent future crises.
Of course the world economic crisis is a global event, which has been caused by several factors, correlating in such way, that situation nowadays can be considered very depressing and pessimistic there are ways for the global economy to recover from it in quite a short period of time by implementing specific policies. This is also true for any country, operating on its own, and for Russian Federation in particular. I think that if our government will succeed in upgrading the financail sector, the real sector and the transmission mechanism, coped with the increase in transparecy of our economy it will lead to the specified above results and of course it will lead us to a very optimistic furute of our country.

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