Obama's Big Challenge - Tiding the American Financial Crisis

The recent euphoria of a new American president and the change in the color of the first family of the White House may take time to settle in. But, in this moment of celebration and "hope", what change can a new president bring about to shake the American economy out of it's floundering foundations.

It was great to hear a man of hope and youth reaching out to every American citizen promising the "change" and "hope" that every American was waiting for. The policies are clearly focused towards domestic reforms (economic & social/health policies) rather than foreign policy, which it should be. At this juncture nothing matters more than the state of affairs of the nation - it's economy, it's security and it's larger role in the scheme of the globe - if it wishes to continue leading the new world order.

The American economic crisis was not just about home mortgages going bad. That was merely a symptom. It was a consequence of the prevailing economic scenario. But, what really led to the economic conditions ?

The answer to this needs to be thawed out and addressed with the same resolve as has been exemplary in the speeches of the new Prez. Much like the bailout plan of approx. 1 trillion USD was exercised by the outgoing administration to keep the stock markets alive, Obama had promised (in his race for presidency) a bailout for the common man too - of the order of 150 billion USD.

Tax cuts and bailout plans sure sound good ! But, is that the real solution to the shaky economic foundations ? Are we sure that these bailouts would ensure that such a crisis would not recur ever again ?

As it turns out - the problem is much deeper... Here's the root-cause...

The American economy is a debt-driven, stock-market dependent economy.

* The percentage of households having direct exposure to a risky asset such as equity (the stock-market) is the highest in the world. Every, one-in-two families is invested directly in the stock market. Their retirals and pensions come from the Pension Fund Houses and Insurance Houses who are in turn invested in the stock market. This brings the cumulative percentage of exposure to high-risk equities to every two-in-three families !

* The incentive to save is all but absent. The interest rate on fixed deposits does not incentivise the common man to save with Banks in secure (zero-risk) securities. The low interest-rate is a dis-incentive for anybody to consider saving and forces them to look at other avenues of return on their hard-earned money - which incidentally turns out to be the risky asset class of equities.

* Any hope of saving was quashed with the advent of the credit-card. In fact, the American consumer is dared into spending more than he can earn as credit-cards offer credit limits which are 3-4 times the monthly income of households. Such a debt-driven economy is a pack of cards waiting for a waft of gentle breeze to bring it down ... crashing !

Considering the above facts, almost 50% of household earnings are exposed to fluctuating stocks. Asian nations which have a more conservative social fabric have always invested in bank deposits. Until recently, only 2% of household earnings in India was considered to be in stocks. This percentage has been increasing in the past 3-4 years to approximately 6%. Other Asian nations (like Japan) have similar conservative exposures to the stock markets.

Owing to the above fundamental flaws, the country's economy is in a questionable state. A few damage-control measures cannot save the country from a longer-term threat of another debt-driven crisis. The above flaws need to be set right before the situation gets out of control and another promise is held out until the next crisis strikes again.

Some solutions to the above problems which can be implemented in the US, derived from the insights of Asian nations which have a more conservative economic system :

* Have healthy bank-deposit rates to incentivise the savings of senior citizens (at least) and reduce their exposure to volatile equities.

* Reduce the credit-limit / income ratio significantly. This will reduce the aggregate debt of the country by many trillions of USD in one master stroke.

* Tax-cuts are temporary, feel-good responses in such a scenario. A more sustaining long-term solution would be to increase employment opportunities. Retrenchment may lead to cost savings by corporations but the common man doesnt' get to earn his bread. It's judicious to take a cut on the pay than to have no job. Bring back lost jobs on a lower pay-scale. This is likely to reduce input costs across industries which would translate in cheaper output thereby, translating in cheaper prices for products. This is a self-feeding circle. As long as the credit is under control, a low-cost / low-pay system can bring back employment opportunities and strengthen the American economy.

The above levers are the key to a long-term solution to the nation's economic upsurge in the near future. This is the "Change" that American needs and has been waiting for ...

As the Prez put it - Yes, we can !