SIMES October 2011 Newsletter

www.simeconomicsociety.org

Also in this Issue:  SIMES: What’s on this year’s Economics Week? Why you should join

us.

 Review: Dr Yip’s Seminar on Global Economy  Evaluating the existence of the Eurozone  Understanding the US debt crisis  An Economic Profile on Brazil

Keynes vs Hayek How should the US Economic Crisis be handled?

For Internal Circulation Only

contents

OCTOBER 2011

page8

page19

page12

page10

page23

more inside

page 3

What’s on this Economics Week 2011? + Why you should join us as an EXCO.

7

Review: Dr. Yip’s Seminar on Global Economy

9

Keynes .vs. Hayek - Who can save us?

11

Eurozone Dilemma— To be or not to be

18

US Debt Crisis: A bumpy road ahead

22

An economic profile on Brazil 2

fromtheeditor The world economy is in a state of chaos and transformation that can leave one bewildered and excited all at once. With the changing dynamics in play, SIM Economics Society thought it appropriate to make the theme of our Economics Week 2011 as ‘Global Economic Prospects and Risks’. Find a more detailed description of all that Economics Week has to offer in this newsletter.

In reflection of what are being discussed during Economics Week, the SIMES Editorial team has taken a deeper dive into grappling global economic issues. We engage with the theoretical views of legendary but opposing economists on managing the US economic crisis. A report on the Eurozone evaluates and questions the formation of the monetary union. Finally, moving away from the gloomy cries of the West and towards the bustling emerging markets scene, we take a closer look at Brazil’s economic potential.

The global economy has certainly shown the world a less-familiar face that we are all still trying to figure out—turn over these pages to start on that journey of discovery.

To those interested in sharing their views on the articles in this issue, and/or those interested in contributing to our upcoming SIMES January newsletter, kindly email to: sruti.rao@gmail.com. We really appreciate your feedback.

Sruti Pegatraju

Access our SIMES website by reading our QR code (displayed at the back of this issue ) with your smartphone. Download the QR Code reader at your App Store.

3

SIMES & Economics Week 2011 I would like to extend a warm welcome to the readers of our annual economics publication which is in line with our society’s major event Economics Week 2011. It will be a week-long event starting from 21 Oct to 28 Oct. There will be a series of economics-related activities and events throughout Economics Week and I would further elaborate on them in this article. The society’s vision is to provide an environment for learning economics beyond the classroom context and understanding the applications of economics to the world around us and Economics Week is the living embodiment of our vision.

The very first event and the main focus of Economics Week is lunch seminar by Dr. Ravi Balakrishnan, IMF Resident Representative on 21 Oct. The theme of the seminar is “Global economic prospects and risks” which is very much in line with the current economic outlook of uncharted risks and potential opportunities. This is a prestigious seminar and SIMES is honoured to have our invitation accepted by such a distinguished speaker.

We will also be showcasing our economics exhibition throughout Economics Week at the atrium. Find out more about the global economic outlook through our exhibition the culmination of months of research by our fellow SIMES EXCO members.

4

For this year we will be having a brand new event namely the economics forum. It will be on 27th Oct from 2:30pm to 4pm. It is an opportunity for participants to hone their research and presentation skills with guidance from our SIMES editors, and also to benefit from the input and feedback from our SIMES advisor cum senior lecturer in economics, Dr. Seet Min Kok. All work and no play makes Jack a dull boy, and therefore we invite you to enjoy a game of SIM-conomics! It is an economics-inspired, life-sized board game version of the famous “Game of life�. The game will take place at the atrium on 24th, 25th, 28th Oct from 2pm to 4:30pm. We will also be holding daily quizzes cum crossword puzzle at the atrium on 24th, 25th, 27th, 28th Oct from 11am to 4pm.

Challenge your intellect beyond classroom learning. (Hint: Look at our economics exhibition for clues!)

I would also like to take this opportunity to invite members who are interested to be the next batch of EXCO to come forward and make your intention known to us. Being a leader in SIMES is tough work but it also brings a great sense of satisfaction. So if you feel that you can help elevate our club to greater heights, we welcome you to contact us at sim.economics.society@gmail.com The following article is the reflections on SIMES experience by our former Secretary, Chong Chee Wee and I hope you will draw inspiration from it. Thank you.

Jerry Siak President (Acting) of SIMES 5

Reflections on the SIMES experience

By Chong Chee Wee

Former Secretary and Finance Head for SIM Economics So‐ ciety, Chee Wee is a valuable and beloved member of the SIMES family. Recently securing an SIM scholarship, he shares his experiences with SIMES and how the organisa‐ tion helped him carve out his current success.

To quote Anthony J. D'Angelo, “Develop a passion for learning. If you do, you will never cease to grow,” I believe Singapore Institute of Management has provided ample opportunities and platforms for students to cultivate their passion for learning. In SIM Economics Society (SIMES), I had found not only a platform pursue my interest in Economics, but also a medium to promote the subject among the student population.

The club has provided me ample opportunities for personal development which will aid me in my career. Because of three CCAs I have in school, I have learned to manage my time to cater to my academia demands. Furthermore, as the Secretary and the Finance Director of SIMES, I had the opportunities to interact with distinguished Chief Executives Officers and established managers during the seminars organized by the club. In addition, I have become versed in fostering business relationships with external suppliers. Through these experiences, I was able to enhance my interpersonal and communication skills. In addition, the diversity of students in SIMES has provided me the chance to work with friends from different cultures, and create greater awareness in cultural differences. Apart from individual grooming opportunities, 6

SIMES has also given me pleasant memories and established friendships during my two years in the club.

Securing a scholarship to finance my study was a goal of mine since my enrolment into University at Buffalo. Despite my unsuccessful attempts in achieving the scholarship in two attempts, I have remained focus on that goal. One of the most important lessons I have learned from SIMES is to overcome obstacles in achieving success. I was able to draw on my experience and finally receive the SIM GE Scholarship this year.

I will like to take this opportunity to thank Dr. Seet Min Kok for his tutelage. Your guidance has allowed me to mature as an individual. I wish SIMES the best and hope the club will enjoy continual success in spreading the passion for Economics among the student population. Â

7

Global Economy after the Financial Tsunami A seminar by Dr. Paul Yip Review by Ethan Lim On a regular basis, the SIM Economic Society (SIMES) sends its members to attend external seminars to gain insights on important economic issues.

Participants can share the lessons learnt through these seminars with fellow students in SIM through the SIMES publication. As one of such members, I attended a seminar by Dr Paul Yip, which was organised by the Economic Society of Singapore. Dr. Paul Yip’s (Associate Professor in Economics, Nanyang Technological University) seminar was on Global Economy after the Financial Tsunami: Risk of Severe CPI Inflation, Asset Bubble, Exchange Rate Cycle and then a Crisis in Asia and Singapore. The seminar, held on 25th August 2011, was an enriching experience and taught me a great deal especially about the untold dynamics of the housing crisis.

Dr. Yip introduced the subject by noting that in a housing industry, the big developers always have the bargaining power. As such, supply and demand analysis is said to be the wrong model for the property market, due to market structure problem, indicator effect and other factors. Since developers are the price setters, an informal cartel occurs through the practice of 3050% profit margin for each housing project. This indirectly forces all other industry players to follow suit, thus inflating the price. Indicator effect from price of new property to price of second hand property, using price of new property as the indicator, blows housing prices out of proportion as new launches keep pushing property prices up. As such, supply curve became very irregular and the model for housing industry becomes inaccurate, causing predictions to be far from reality.

Dr. Paul Yip further expands on the stages of an assets bubble in the housing industry. It can be separated into 3 stages: Seeding Stage, Development Stage, and Final Stage. In seeding stage, the economy just rebounds from trough, there is an upward inertia of asset price and is said to be the best stage to curb an asset bubble. Countries often fail to do so, not because of failure to spot the trend, but because of time lag or overly strong expansionary policies implemented. In the development stage, exceeding expectations cause a change in the economic behaviours, increase housing demands. The upward spiral of housing prices increases cost of living, followed by CPI and wages, which in turn, increases house prices even further. With this endless upward and vicious cycle, it fuels the rise in asset price to the critical point of a bubble burst. Once in the development stage, it is very difficult to stop and require extra curbing. Unfortunately, Singa8

pore and many East Asian property markets have already passed the seeding stage, and are at the early part of the development stage.

Given that the biggest assets for most consumers are housing assets, any effects on housing prices will have a big or averse impact upon the economy. The ripple effect of any bearish impact on the housing market will jolt a wide-spread and contagious effect on the whole economy.

Dr. Paul Yip believes that control on market sentiment is the key factor in curbing, or rather, slowing down a housing bubble expansion from bursting so suddenly. In a housing boom, demand will be much greater than the increase in land supply. If the economy were to satisfy all these demands, there will be excess supply in the long run. If the economy does not satisfy all these demands, housing prices will keep rising. Hence, what most Asian governments are implementing by increasing supply of housing development is not solving the root problem for the bubble in the making, according to Dr. Yip. Dr. Yip said that Singapore is among the safest in Asia, but could still be hurt by the contagion effect when there is a bubble bursting in the region or elsewhere, while Hong Kong is stated to be the most risky place.

By the end of the seminar, not only did I learn more about the important causes of housing bubbles, I had a more accurate evaluation of Singapore’s challenges with the rise in housing prices. We must commend the government for its handling price stabilization, as we are among the more stable countries in Asia, however, there may be further challenges the economy faces with its focus on increasing supply of properties in the long run.

9

Keynes vs Hayek: Who can save us?

By Lenard Ong

John

Maynard Keynes and Friedrich August Hayek were two prominent economists of the Great Depression era with sharply contrasting views. The arguments they had in the 1930s have been revived in the wake of the latest global financial crisis.

Friedrich August Hayek began his career in economics after serving in World War I, claiming the experience inspired him to help society avoid mistakes that led to the war. The Great Depression of the early 1930s helped Hayek formulate many of his theories. Hayek was popular for his free-market capitalist preaching .

After the British depression of the 1920s, he promoted the idea that private investment, rather than government spending, would promote sustainable growth. Hayek did not believe it was possible to spend your way out of an economic crash. Notably, he did not assert that there should be no government spending, but rather that there should be adequate government spending in a post-boom crash . But instead of distorting the economy with easy money by regulators, there should be more of a focus on sustainable production levels. Another key argument of Hayek’s was to let the troubled bigger institutions fall in order to weed out the internally weaker players for long-term sustainability.

Hayek was dismissed by many as one who wanted to liquidate everything without reason – however, behind what seems an extraneous solution, is a reasonable verdict for long-term efficiency in the economy. In the USA, the Federal Reserve, the nation’s central bank, availed risky banks with cheap money with nearzero interest rates. However banks are now absorbing piles of cash and reluctant to lend, while consumer businesses are starving for credit.

Unlike Keynes, Hayek believed that genuine recovery from a post-boom crash called not just for adequate spending, but for a return to sustainable production But this production is purged by distortions of easy money from the Federal Reserve Bank’s zero interest loans. According to Professor George Selgin of the University of Gerogia, a key supporter of Hayek’s views, “the (current) economy is like a drunk throwing up the morning after” – it is trying to rid itself of bad investments it was initially tempted to take because of easy money. In effect, rescuing big institutions with bail-outs will only add fuel to the fire, and fail to prevent the 10

inevitable suffering. It might mask or delay it somewhat, but only at the cost of more suffering later.

What many staunch Hayekians are saying is that there is no easy fix to the current crisis in the US—“no painless recovery from an unsustainable boom”. In their opinion, liquidating the whole sub-prime crisis is needed in order to revive healthy investments back into the economy. That would have meant letting insolvent banks that lent or invested unwisely go bust, though the ramifications are huge, but Hayek believed that that is the only way the economy can begin anew.

Keeping the respirator on bad banks will block quantitative easing, or any monetary easing from working effectively. The issue is not so much on reviving spending in the economy, but on using the new money in productive investments, rather than keeping them stagnant in the balance sheets of irresponsible bankers.

John Maynard Keynes, also an economist that emerged during the First World War, was more of an interventionist. He believed that governments could control their business cycles with careful fiscal and monetary control. Keynes led the British delegation of the Bretton Woods conference of 1944, to play a significant role in formation of the World Bank and International Monetary Fund.

Keynes wrote the General Theory in 1936 to explain why the post-war recovery was so feeble. His revolutionary proposition was that following a big shock usually due to a collapse in investment - there were no automatic recovery forces in a market economy. The economy would go on shrinking until it reached some sort of stability at a low level, which Keynes called “under-employment equilibrium”.

The level of output and employment in an economy depended on level of aggregate demand or spending. Consequently, if spending shrank, output would shrink. In this situation, Keynes said it was the government's job to increase its own spending to offset the decline in public spending – despite its effect of running a deficit.

Hence, the austerity measures of the US economy with budget cuts, is not the solution during a recession. As Lord Skidelsky, a Keynsian, pointed out, Keynes's message was “you cannot cut your way out of a slump; you have to grow your way out.

Three years after the collapse of 2008, our economy is flat—there are no signs of growth, and spending cuts will not produce any”.

Keynes rejected Hayek’s views to the core, as did Hayek on Keynes’ illusions of government control through the business cycle. Hayekians believe the 2008 property bubble was in fact excessive credit creation with overspending by banks.

Keynesians would argue on the other hand that the US government is not intervening enough to keep the economy going. Siding with one end of the spectrum may be too extreme, but could that be what the US economy needs right now?

11

The Eurozone Dilemma— To be or not to be The Eurozone is experiencing its tumultuous journey through the crisis.

Stronger nations are blaming weaker ones for their economic mismanagement, while everybody is rummaging for solutions for their own stability.

In reflection, the debt crisis brings to question whether the formation of the Eurozone was a good idea in the first place...

12

The existence of the Eurozone—that is the question.

By Jeslyn Lye “

Greece

may default!”, “Eurozone debt

crisis threatens banks, rest of world: IMF” are just some of the headlines about the Eurozone that filled the news in the past two years. Will the Greek economy really become bankrupt? What will be the fate of the remaining three peripheral economies - Ireland, Portugal, Spain? With at least five of the 17 members plagued by sovereign debt and uncertainty of the fate of Eurozone in this time of economic turbulence, one cannot help but wonder -- was Eurozone doomed to failure since its inception?

How it all started?

Anyone who had a brief glimpse at the history textbooks would know that the previous few centuries were a golden era for major European powers – trade boosted by technologies in naval power, industrialization, and colonization. However the two World Wars in 1914 and 1939, collectively devastated European industrial infrastructures and brought the collapse of the European economy. Determined not to let history repeat itself European nations were determined to strengthen their trade ties with one another, to insulate themselves from another war.

Eurozone Countries: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Spain, Slovakia, Slovenia

13

Foes to friends, was it possible? What were the chances of Germany, France and Great Britain not going to war ever again after 1945? After World War II, Europe nations turned their attention to rebuilding their economies and to containing the communism threat in Europe. Moves were made towards European economic integration.

Union. EU members had to meet the five main Maastricht criteria in order to adopt the Euro as their official currency:

European Coal and Steel Community (ECSC) were formed, pooling the heavy industries of European economies. From the ECSC evolved the European Union (EU) in 1958 initially with six members. In 1992, the Maastricht Treaty (Treaty on European Union) was signed, establishing the Maastricht criteria (convergence criteria) and the EU single market for EU member states to enter into the final stage of the European Economic and Monetary

3) Ratio of gross government debt to GDP must not exceed 60%.

1) Low inflation rate of not more than 1.5% points higher than the average of the best performing member states.

2) Ratio of the annual government deficit to GDP must not exceed 3%.

4) Countries wishing to adopt Euro must join the exchange-rate mechanism (ERM II) under then European Monetary System (EMS) for two consecutive years prior to entry.

5) Nominal long-term interest rate must not be more than 2% points higher than those in the three lowest inflation member states in the previous year.

States of e.g. United America States of

Stages of Economic Integration

zone e.g. Eurozone (EU) e.g. European Union

e.g. ASEAN Free Trade

Reduced tar-

iffs

Zero tariffs & reduced nontariffs barriers

FTA + common external tariff

Customs Union + free movement of goods & service

14

Common market + central monetary authority + same currency

Full monetary union +complete fiscal policy harmonization

In 1999, the Eurozone was formed, with the central monetary authority being the European Central Bank (ECB). According to the Maastricht Treaty, all EU members must ultimately join the European Economic and Monetary Union (EMU), Eurozone, with the exception of United Kingdom and Denmark who are legally exempted. However out of the current 27 EU members only 17 are part of the Eurozone (also referred to as EMU).

European Union (EU) and Eurozone: Are they not the same?

Some of the factors EU member states perceived as advantages of the formation of the Eurozone included: 1) Reduce transaction cost Consumers and firms will no longer need to change currencies between the member states. Red tape when transferring large amount of money across borders would be eliminated. Hence, internal investment could grow as companies in the member states could take advantage of the lower transaction costs.

The European Union members have a common market where there is a free movement of people goods, services and capital and common trade policies, while the Eurozone is a higher level of economic integration with a common monetary policy. In Eurozone, members are still responsible for their own fiscal policies and for bank regulation and rescue, while their monetary policy is governed by the Euro- Source: European Commission pean Central Bank (ECB).

2) Less volatility in currency With a single currency, member states would not be as open to speculative attacks as when they were using their respective individual currencies. With the same currency internally and a reduction of external currency instability, exporters can predict profitability of their exports with greater certainty. Investors are also more confident to invest in the member states leading to possible greater trade and growth.

15

3) Controls high inflation After breakdown of the Bretton Woods system and the oil and energy crises in the 1970s, several European countries like Germany had struggled to control high inflation rates in the 1970s and 80s. But with the Maasticht criteria on joining the Eurozone, countries are forced to keep their prices stable more prudently. Beside the low inflation requirement to join Eurozone, the European Central Bank (ECB), also ensured a decade of low and stable inflation for Eurozone with the help of controlled monetary policy.

4) Price harmonization It will be easier for consumers and firms to compare prices in different member countries when they are all in Euros. This will especially enable both consumers and businesses to source for cheaper raw material or goods, hence increasing competition and with it, productivity growth.

However, the formation of the Eurozone, wasn’t without its fair share of skeptics. It is the first economic and monetary union where monetary policy is decided at the central level while fiscal policies are carried out in the local level. It is also first iin amalgamating diverse economies, n terms of the size, and economic performance of the member states.

tailers will have to incur cost in changing labels, changing system software and the cash registers, educating staff and reminding customers.

2) Loss of National Sovereignty With ECB at the helm of Eurozone’s monetary policy, it is impossible to carry out monetary policies at national level. Countries lost the ability to adjust their interest rates and exchange rate as they do not have an independent currency and they issued government bonds in euros. Although fiscal policies and banking policies are left to the individual nations, it doesn’t help that members are vastly different in their economic performances – the union’s monetary policy will not always be optimal for each and every one of the members. In this European sovereign debt crisis, peripheral members like Ireland and Spain were unable to lower the interest rates and depreciate their currencies to alleviate their plight.

3) Loss of some independence over fiscal policy Although fiscal policies are left at the national level, members inevitably lose some control over their fiscal decisions as no country is allowed to borrow more than 3% of its GDP.

Key disadvantages noted were: 1) Cost required to replace currency Members must replace their national currency with Euro and the one-off cost of this adjustment could be rather significant. Re16

The European sovereign debt crisis In late 2009, fears of European sovereign debt crisis emerged among the Eurozone.

A sovereign debt crisis arises when the government becomes insolvent, unable to pay for the interest and capital for the bonds it has issued. Along with the fallback of European banks in effect of leveraging on America’s sub-prime mortgages, significant Eurozone member states were reckless in their spending and risk controls, leading to a domino effect on all other Eurozone members.

Weaker countries in Eurozone, namely Greece, Ireland, Portugal, Spain (commonly known as PIGS in this financial catastrophe), were pretty much singled out in the wake of this crisis. Their government had bore the brunt of the blame for the sovereign debt crisis that threatened all the Eurozone members – they were being blamed for spending too much too recklessly, causing a crisis of confidence among the public on the euro. Wolfgang Schaeuble, Germany’s finance minister wrote “It is an indisputable fact, that excessive state spending has lead to unsustainable levels of debt and deficits that now

threaten our economic welfare.” They were hence slapped with austerity measures – policies that revolve around deficit-cutting, lower spending, and reduction of the welfare provided, when they sought help from fellow Eurozone members and IMF. However, is profligacy really the crux of this debt crisis?

No doubt Greece indeed had been rather irresponsible with its fiscal decisions – it had been borrowing heavily since its initiation into the Eurozone, taking opportunity of the falling bond yields while tax revenues were low, thus running high accounts deficit. Together with the trade deficits, corruption and high government spending everything went downhill when investors started to realize that Greece was on the brink of bankruptcy.

Portugal, Spain and Ireland, on the other hand, suffered from a banking and property crisis that escalated market fears of a faltering Euro. As a result, governments’ deficits ballooned, with need of bailout schemes for banks, with higher unemployment benefits and lesser tax revenue in the time of recession.

17

This European debt crisis brings out questions about the benefits of such economic and monetary union – where is the financial stability that it was supposed to bring?

Euro-area sovereign bonds were not immune to its local economic factors. Peripheral economies were unable to devaluate exchanged rate to overcome balance of payments problem. Stronger economies do not wish to assist the weaker ones when they were so reckless with borrowing. All the EU countries were actually at different stages of their cycle, but were forced to adhere to one common monetary policy that may not have suited the situation of every party involved. To make it worse, slapping austerity measures in the times of recession, will impend the growth that they badly need. These policies could lead to social disruption that could have a significantly negative impact on investment and growth in long term.

Conclusion In my opinion, Eurozone is like a bad marriage from the start – they were incompatible in terms of economic strengths, languages and cultures, but inevitably got together in the end because of the benefits that such union offered. This crisis exposes a fundamental question with the Eurozone – exactly how unified can they be with their deferring economic views? Yes, a single currency resulted in lower inflation and currency stability for the Eurozone members, but at a time of crisis, how do we use one weapon of monetary policy to ward off a variety of battles? Independent fiscal policies are imperative, but how are they supposed to complement, or off-set a monetary policy that may not be in everybody’s favour? The Eurozone is now like the ships that were chained together in the Battle of the Red Cliff from the Romance of Three Kingdoms – it is either they undo their links fast or they put out the fire from the affected vessels fast before the fire catches up with the entire fleet and burns all of them down. And this time round, if Eurozone goes down, it will not be the only region affected – in this time of market volatility, the whole of financial world would be thrown into frenzy.

References:

Banner reads “Enough is enough!”.

18

Charlemagne: In the Brussels bunker, The Economist, 17 Sep‐ tember 2011.

EMU Special Report: Pros and cons, BBC News, 21 November 199.

Europe's currency crisis: How to save the euro, The Econo‐ mist, 17 September 2011.

Eurozone, Wikipedia, h p://en.wikipedia.org/wiki/Eurozone, Last assessed: 26 Sep 2011.

Michael Holden, Stages of Economic Integra on: From Autar‐ ky to Economic Union, Parliamentary Research Branch, 13 February 2003.

Neil Fligstein, Euro‐clash: The EU, European Iden ty and the future of Europe, Oxford University Press, May 2008.

Professor Wendy Carlin, 10 Ques ons about the eurozone crisis and whether it can be solved, UCL European Ins tute, 8 September 2011.

US DEBT CRISIS: A Bumpy Road Ahead...

By Sruti Pegatraju Though the current economic recession is being coined as a financial Armageddon, the fact of the matter is recessions come and go. To experienced economists, such scenarios are all in a day’s work. However in the current economic turmoil, the state of future economic stability still remains an ambiguity. US has been attracting everyone’s attention, since the beginning of its tumultuous handling of the mortgage crisis, to its banking crisis and its current overbearing issue on debt. Getting beaten black and blue, the economy is sputtering through a recovery, but is still not free of troubles with its looming debt situation.

els even before the crisis. US debt is currently at 90% of GDP at a whopping USD 14.3 trn. Though debt has been long standing at such levels for America, it is the recent crisis in 2008 and the excessive government spending on bailouts, along with consistently low GDP growth levels, that brought to light the looming debt level as a serious concern for the sustenance of the world’s number 1 economy. US deficit has hit a record of USD 1.5 trn this year, which accounts for more than 10% of GDP. This is a worrying figure, for the vast size of the country’s economy, where a deficit any higher than 7% of GDP is considered dangerous. The relationship beThe current debt situation: tween deficit and debt is that, when a High deficit is old news to the US econo- country is in deficit (i.e. the country is my, which has been sporting high debt lev- spending more than it can afford), they will

19

need to cover these deficits by borrowing from others, be that from American or foreign investors. Hence, the larger the deficit, the more the country has to borrow, which increases its debt level. A 2010 study by economists from the University of Maryland and Harvard University suggests that high debt levels lead to slower economic growth. When the nation’s debt exceeds 60% of GDP, there is slower growth, and when it exceeds 90% of GDP, it may even contract. In America’s current fragile economic state, with high unemployment of close to 9%, and already anaemic growth, further pressure on growth with debt fears is the last thing the economy needs at this point.

Nonetheless, fixing this engraved issue is more of a challenge than one would imagine, as the current government budget is geared towards long-term projects that cannot really afford the cut. The largest component of US budget, almost 25%, goes into defense. Total defense spending for the wars in Afghanistan and Iraq and military equipment and training reached USD 881 bn in 2011. Another significant contributor is the government spending on entitlements, such as pensions, medical insurance for the poor (Medicare), which accounts for 57% of spending. Following Obama’s rise to presidency, a historic achievement for his party was the provision of affordable medical insurance for lower middle-income families, through state and Federal services. Apart from funding for medical insurance, there is also an increase in government spending on pensions for the elderly. Mandatory spending for Social Security is budgeted for USD

761 bn for FY 2012, making it the highest component within government’s entitlement program. In lieu of the financial crisis making the middle income bracket more helpless than most, government has seen it as imperative to protect their basic needs through increased spending in these programs. Spending on unemployment benefits had also increased as a result of growing population of unemployed workers with cost-cutting in American businesses. Federal spending on unemployment benefits had reached a record-high of USD 65 bn in November 2010.

The debt deal: With the escalating fears of the US debt, the Federal Reserve, the country’s central bank, imposed a deadline to the government, on reaching a deal on curtailing spending. The deadline confirmed was August 2nd 2011, the date after which the Fed believed US would be in serious threat of running into default. Though both Republicans and Democrats appreciated the severity of their debt situation, the political efficiency at which the bill was conducted was very poor indeed.

20

After months of bickering, and going around in circles, Congress approved the Budget Control Act before the August deadline to raise the debt ceiling by USD 2.1 trn and cut the federal deficit by USD 2.5 trn over the next decade. The debt limit will be raised initially by USD 900bn over two periods, and move up to USD 2.1 trn, which will be enough to cater to society’s needs into 2013. Along with the USD 2.5trn in spending cuts, a special committee is also formed to find further reductions of USD 917 bn in spending over the decade. Furthermore, Congress has to approve additional spending cuts of USD 1.5 trn by a self-imposed deadline of December 23rd 2011. If an agreement is not passed by this deadline, a further USD 1.2 trn cut is needed in domestic and defence spending.

Despite the relief on Congress officials and the President’s faces when the deal was passed, the real work on the debt restructuring is yet to begin. The debt deal,

Discretionary spending includes everything that is not in the mandatory budget, to be discussed by President and Congress. This component constitutes 38% of government budget.

per se, has only brought about modest measures of spending cuts in the shortterm. The USD 917 bn in spending cuts are only on discretionary spending that were bound to decrease in any case (refer to chart). The real issues that heated up discussions amongst Republicans and Democrats have been ‘compromised’, but still remain the crux of real changes in US deficit. Republicans won their end of the argument with no tax increases of the rich, while Democrats managed to keep cuts in their entitlement programs off the table.

But the fact of the matter is, Medicaid, Medicare and Social Security remains more than half of government spending, and tax increases for those who can afford it is necessary to increase the governments revenues. It is not clear what the current budget deal will lead to - but that is exactly the problem! Its minimal impact did not tell markets or businesses the direction the economy was heading towards in the long term, and this uncertainty is stalling business activity. Furthermore, with the help of Republicans, market confidence in the short-term has been stumped even further with no short-term spending, nor an extension on tax cuts, that were originally aimed at stimulating the economy.

21

parties with firmly opposing views on how to handle the economy, are too distinct for There are many factors to take into acany middle ground, implying that this debt count, when considering possibilities of conflict may aggravate in coming years. another full-blown recession for the US economy, but the spending cuts being pro- References: posed with the debt deal do exacerbate http://www.businessinsider.com/who-owns-the-usthe pessimism of this notion much more. national-debt-2011-1 http://www.usgovernmentspending.com/ Austerity, at a time of economic fragility http://useconomy.about.com/od/usfederalbudget/p/ will aggravate the sluggish growth in the military_budget.htmhttp://useconomy.about.com/od/ usfederalbudget/p/military_budget.htm| economy. Although a pull-back and budget http://www.washingtonpost.com/wp-dyn/content/ stability is needed, the lack of activity will graphic/2011/01/27/GR2011012701570.htmlz Economist-2/8/11-The debt ceiling deal-No thanks to anydampen market sentiment – JP Morgan one Chase believes the federal fiscal policy will http://www.tradingeconomics.com/united-states/gdpgrowth add 0.3% of a contraction to GDP in 2012. http://useconomy.about.com/od/fiscalpolicy/p/ Mandatory.htm The stoppage of pay-roll tax and unem- http://www.economist.com/node/21525446 ployment benefits in December will lead to a 1.4% fiscal contraction in the coming year. GDP for the US economy is already teetering at barely 1.3% with grim external economic factors (such as oil prices, supply-chain issues with Japan) as well as dwindling sentiment in their own shores, and stalling the economy now can be a dangerous situation. Handling debt, for a country that has both national and international responsibilities is no easy feat. Two Double dip on the horizon?

22

SAMBA BOOM An Economic Profile on Brazil

By Ruenn Sheng Ng Brazil is one out of the 4 newly developing countries, known as ‘BRICS’ (Brazil, Russia, India and China). Brazil is currently the 8th largest economy, as ranked by nominal gross domestic product (GDP). It is predicted that at current growth rates, Brazil is on its way to becoming the 4th largest economy in the world.

From the latest IMF data, Brazil has USD336 billion in foreign reserves as at June 2011, which can fund her imports for almost 2 years.

Brazil has enough cash to last through shocks in world trade.

Strengths of Brazil’s economy Brazil’s inherent strength can be reflected in its increasing wealth, better economic partnerships with other emerging markets, and its increasing international awareness. The export dominance of Brazil is attributed to its richness in natural resources, at a time when a large proportion of the emerging world is trying to industrialize itself. Brazil shares with Australia the title of the world’s largest exporter of iron ore, which is in huge demand especially in China. Apart from its perfect lands for agriculture, Brazil’s ‘sub-salt’ reservoirs bring at least 13 billion barrels of oil. This has been a great advantage for the country due to the current commodities boom.

economic growth. China, for example, has been Brazil’s largest trading partner since 2009, and constituted 15% of total Brazilian trade. Also, Brazil-India trade increased sixfold in 7 years, from $1.2 billion in 2004 to $6 billion currently. They ensure a diversified trade pattern in Brazil, and adept survival from the economic troubles of the developed West.

Brazil’s greatest economic strength currently is its growing middle class. GDP per capita in Brazil is USD12,423 currently in nominal terms. This signifies that Brazil is an upper income country, as classified by the World Bank.

The increase in average income created a healthy level of an emerging consumer economy, spearheaded by a lower middle class.

Around 95 million people earn between USD600 and USD2,600 a month in Brazil. In comparison to the number 1 economy of the world, Brazil’s GDP per capita is now 20% above that of America.

Brazil’s current strong relationships with the other similar emerging economies also boosted her economy. They ensure that Brazil is able to capitalize on its resources and consumer-led 23

nonetheless affecting Brazil’s growth engine.

Trade with EU and Japan constitute about 37% of its exports, while trade with South America and China make up 41%. With dampened demand from Europe and US, Brazil’s economic activity shrank in June 2011, for the first time since December 2008. Industrial production fell 1.6% in June being the second-biggest To proclaim its emergence to the world, Brazil drop in output since 2008, and business confihas been investing heavily into its tourism secdence in the second quarter fell to its lowest tor, staging many international events from level since 2009. beauty pageants, to the upcoming FIFA World Cup in 2014 and Summer Olympics in 2016. The commodities boom has certainly helped Currently with 5 million tourists every year the Brazilian economy, and complemented by spending USD6 billion annually, through its its high interest rates of 12%, has attracted a tourism programme ‘Aquarela Plan 2020’, as great deal of foreign funds. Nonetheless, the well as increasing the exposure and promi- economy may run into difficulties with the strengthening of its currency, which may tamnence of Brazil throughout the world. per with its export competitiveness. Hence, the These strengths act to enhance Brazil to be close inter-connectivity of GDP and export able to attain strong economic growth. For activity may become a concern if Brazil does now, Brazil grows at around 5% year-on-year not expand on other internal avenues of average. Despite its consistent growth, there growth. are certain long-term structural challenges Brazil has to tackle to maintain its competitive Even though high interest rates is an attractive edge in the world. feature for foreign investors, this lax monetary policy may be dangerous for the lack of savWeaknesses of Brazil’s economy ings it is promoting to Brazilian consumers.

Although Brazil’s trade is relatively more de- Interest rates at 12% are well above their target pendent on emerging market customer base, rate of 4.5% and have been high in aims of the economic woes of US and Europe are curbing inflation. Brazil has an inconsistent With the emerging affluence of Brazilian people, consumer spending has become a key growth driver, accounting for 61% of GDP in 2010. The lower middle class is Brazil’s largest consumer group and have uplifted the demand for many consumer products, from cell phones, cars and TV sets.

24

monetary policy. It seems to give mixed signals to the market. Brazil raised reserve and capital requirements on some loans in December 2010, before doubling the tax on consumer credit to 3% in April 2011. This seems to suggest that the government is preparing to stop inflation. However, in September 2011, after nine months of trying to tighten the economy, Brazil decided to cut interest rates by 0.5%, to 12%. Although this decision is popular with Brazilian small businesses, given that Brazil also had the highest inflation she ever had, Brazil’s Central Bank’s moves are now seen as less credible. Future investments in the Brazilian economy will be uncertain, given expected increasing volatile interest rates changes in Brazil. This could limit Brazil’s future potential economic growth.

through BRIC and its trading relations, the country is growing at a constant and steady pace, in comparison to faltering developed economies. She is able to grow better than the average economy. If the government controls its monetary policy and taps into its emerging middle class consumer base effectively, Brazil will play a huge role in the global economic playing-field. President Rousseff’s predecessor President Luiz Inácio Lula da Silva noted, ‘Brazil has rediscovered itself, and this rediscovery is being expressed in its people's enthusiasm and their desire to mobilize to face the huge problems that lie ahead of us.’ It is hoped that Brazil will focus their issues, continue thrive and prosper in the global economy, with zest and vigour.

Brazil is also relatively weak in infrastructure.

Economic development is concentrated in a few select regions, with better infrastructural access. Brazil’s rail network lags behind the other BRIC countries (Russia, India and China), similar countries with huge land areas and population. Lagging infrastructure and an unfriendly regulatory system has dampened Brazil’s attractiveness of business development. According to a recent World Bank rank- Reference: ing on the best places to do business, Brazil http://www2.goldmansachs.com/our-thinking/brics/brics-and-beyondonly ranks at 127th out of 183 countries. Ineffi- book-pdfs/brics-full-book.pdf http://in.reuters.com/article/2011/09/02/idINIndia-59115520110902 cient hiring and firing practices along with a http://news.xinhuanet.com/english2010/business/2011-09/07/ complicated tax system attribute to this lack- c_131109952.htm http://en.mercopress.com/2011/08/27/unemployment-in-brazil-falls-toits-lowest-level-this-year-6 luster business environment of the country.

Brazil’s Economic Future In the next few years, Brazil’s economic outlook seems bright, despite the slight blip due to current global economic trends. It remains a good economy to invest in, in global terms.

With its close association to emerging markets,

http://www.economist.com/node/8952466?story_id=E1_RJVNQGG http://www.gfmag.com/gdp-data-country-reports/311-brazil-gdpcountry-report.html#axzz1XjqJcfNc http://blogs.worldwatch.org/transformingcultures/brazilian-consumers/ http://online.wsj.com/article/ SB10001424052748703580004576180771501773358.html http://www.isuppli.com/Display-Materials-and-Systems/ MarketWatch/Pages/Brazil-and-ChinaJ-ump-on-Board-the-LED-TVBandwagon.aspx http://uk.news.yahoo.com/brazil-external-gap-commodity-boomfizzles-183634505.html http://www.southafrica.info/news/international/brazil-090909.htm

25

26