Usa Economy

US economy

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TOPICS FOR TODAY….

About USA

• Current account deficit • Various currency standards • Twin deficit • Various recessions • Sub prime crisis • Some current issues • • 11/29/09

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The current account Current account of a country records current or short term flows of fund into and out of a country. 

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 The current account of US includes: – – Net Export – Net income on investments – Net transfers

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Current account deficit • • • • •

1997 - $140.4 billion 2001 – $384.7 billion 2005 - $729.0 billion 2006 - $788.1 billion 2007 - $731.2 billion

Historical perspective on U.S. external balances

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Global gold standard (1870-1914) •

The gold standard fixed major currencies against one another, which encouraged high level of capital mobility.

• • British investment in US flowed into bonds of canal, turnpike and railroad companies or state govt. 

• United state joined Gold Standard in 1879. • • In 1897 global holding of the foreign assets were estimated 7% of the world GDP. • • In 1914 this rose close to 20% 11/29/09

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Global gold standard (1870-1914) • • Due to adherence to the gold std., during 1891 and 1897 the US Treasury increased interest rates in order to avoid dollar sales and maintain fixed exchange rate. • • This resulted into harsh recession .

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The interwar period (1914- 1939) • During World War 1 in 1914, monetary policy around the world became directed towards domestic goals such as financing war . • • This led to decrease in worldwide holding of the foreign assets. • • In 1925, a new gold standard initiated under which countries held reserves in dollar, sterling or gold. • 11/29/09 AMRITA SCHOOL OF BUSINESS •

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• Since UK has set the value of sterling against dollar at prewar exchange rate, pound was overvalued due to inflation after the war.

• • This encouraged investors to sell pound in exchange for gold.

• • To avoid outflow of the gold in UK, the US increased money supply in order to decrease interest rate to the level as in UK.

• • With this excess supply and low interest rate there came a major stock market boom. 11/29/09

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• To protect its gold reserve the US increased interest rates, after the UK abolished the Gold standard in 1931 • • Tighter money supply caused by this hike in interest rates caused great depression • • US withdrew from gold standard in 1933. • • Critics believe that gold standard was the main reason for the Great Depression of 1930s. 11/29/09

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Bretton woods system (1950-1971)

• Under this fixed exchange rate system the dollar was pegged to gold while other currencies of the world were pegged to dollar. • • The dollar was convertible with gold at the rate of $35 per ounce. 

• In the initial years of bretton wood arrangement current account transactions had to be regulated. 11/29/09

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• European policymakers chose to prevent open purchase and sales of foreign exchange. • • The US officially allowed them to build dollar exchange reserves by expanding Export and restricting Import. • • In 1958 US authorities started concerning about balance of payment. • • By the 1964, the official liability exceeded the US monetary gold stock. • 11/29/09

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• In 1971 the US trade balance turned negative first time after since 1893. • • When other countries along with the Britain showed intention to convert to gold, president Nixon introduced floating exchange rate system. • • A world wide recession followed as inflationary pressure took hold, exacerbated by the oil crisis.

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Twin deficit of the 1980s q Ronald Reagan became President in 1981 

v

Policies undertaken

v v Taxes were cut v Defense spending increased v Expansionary fiscal policy 

v Results

v

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v High inflation v High interest rates v Dollar appreciated v Export < AMRITA Import SCHOOL OF BUSINESS

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CURRENT ACCOUNT DEFICIT 

• It increased from  0.1% of GDP in 1980 to a deficit of 3.3% in 1986 

• Which later improved to a deficit of 1.8% of GDP   11/29/09

• •

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Current Account Deficit

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Budget deficit The government budget deficit increased from 2.8% of GDP in1980 to 4.8% in1986. 6 5 4 3

Budget Deficit

2 1 0 1980 11/29/09

1986 AMRITA SCHOOL OF BUSINESS

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New Economy of Late 1990s

• Twin deficit separated • • Productivity increased through use of IT • • Consumer spending increased and lower household saving rates • • Budget deficit of 5% in1992 decreased to 2% in2000 • • Huge foreign capital investment 11/29/09 AMRITA SCHOOL OF BUSINESS •

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Escalating Current Account Deficits (2000–2005) • 2001-2002 – – – –

mild recession oil price soared fiscal stimulus – tax cut monetary stimulus – low interest rate

• • Budget surplus of 2.4% in 2000 to budget deficit of 3.4% in 2003.

• • Current account deficit continued and it was $ -4,242 billion between 2001 and 2007 11/29/09

•

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GREAT DEPRESSION(1929-1940)    

The White Angel , Bread Line Massive unemployment, factory and mill closings, and mortgage foreclosures characterized the Great Depression in the United States in the 1930s. This photograph was taken by Dorothea Lange in 1933. Culver Pictures 

The Great Depression in the United States began on "Black Tuesday" with the Wall Street crash of October, 1929.

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Microsoft ® Encarta ® 2007 . © 1993-2006 Microsoft Corporation. All rights reserved. 

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 

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Effects: – High unemployment – Poverty – Low profits – Deflation – Plunging farm incomes – Lost opportunities for economic growth and personal advancement. 11/29/09

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Banking Crisis, 1930’s By 1933 the banking system in the United States was near collapse. Some banks had made speculative investments in the stock market and were hurt by the crash of 1929. Others failed when depositors, fearing that their bank would go bankrupt, rushed to withdraw their savings. Here, depositors besiege Merchants Bank in Passaic, New Jersey. Microsoft ® Encarta ® 2007. © 1993-2006 Microsoft Corporation. All rights reserved.

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Causes of Great Depression • Stock market crash in 1929 • • High consumer debt • • Ill-regulated markets that permitted malfeasance by banks and investors • • Cutbacks in foreign trade 11/29/09

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Cont.. • Lack of high-growth new industries • • Growing wealth inequality • • Interaction to create a downward economic spiral of reduced spending • • Also falling confidence, and lowered production. • 11/29/09

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THE BETTMANN ARCHIVE

Microsoft ® Encarta ® 2007 . © 1993-2006 Microsoft Corporation. All rights reserved.

WPA Workers To ease unemployment during the Great Depression, President Franklin D. Roosevelt created the Works Progress Administration (WPA) in 1935. Called the Work Projects Administration after 1939, the WPA employed 9 million people in various public works projects between 1935 and 1943. 11/29/09

Franklin Delano Roosevelt Franklin Delano Roosevelt took office as president of the United States in the depths of the Great Depression. His optimism and confidence helped reassure Americans, while he initiated programs known as the New Deal to aid Depression victims and try to revive the economy. Microsoft ® Encarta ® 2007. © 1993-2006 Microsoft Corporation. All rights reserved.

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OIL SHOCK(1973) 

The 1973 oil crisis started on October 15, 1973, when the members of Organization of Arab Petroleum Exporting Countries or the OAPEC (consisting of the Arab members of OPEC plus Egypt and Syria) proclaimed an oil embargo "in response to the U.S. decision to resupply the Israeli military during the “Yom Kippur war”

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 11/29/09

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CAUSES OF OIL SHOCK(1973)  

1- After the Bretton Woods Accord, there was a depreciation of the value of the US dollar, as well as the other currencies of the world and OPEC country charged higher per barrel.

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2- America’s support to Israel in Yom Kippur War.

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3-Charging of high price of refined petrochemical and food items in OPEC countries. • 

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IMPACT OF OIL SHOCK • OPEC forced the oil companies to increase payments drastically. The price of oil quadrupled by 1974 to nearly US$12 per barrel (75 US$/m3). • • The traditional flow of capital reversed as the oil exporting nations accumulated vast wealth and Much was absorbed in massive arms purchases that exacerbated political tensions, particularly in the Middle East. 11/29/09

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Impact of Oil Shock… Cont… • “Oil price shocks”, referring to disruptions in the production and distribution of oil, that result in the increase of oil prices “have been held responsible for recessions, periods of excessive inflation, reduced productivity, and lower economic growth” • • In the United States, the retail price of a gallon of gasoline rose from a national average of 38.5 cents in May 1973 to 55.1 cents in June 1974. Meanwhile, New York Stock Exchange shares lost $97 billion in value in six weeks • 11/29/09

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Dotcom Bubble

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Was a speculative bubble covering roughly1995–2001

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Stock markets in Western nations saw their value increase rapidly from growth in the new Internet sector and related fields

• • •

The technology-heavy NASDAQ Composite index peaked at 5,048 in March 2000, reflecting the high point of the dot-com bubble

•

11/29/09 • Over

AMRITA SCHOOL OFReserve BUSINESShad 1999 and early 2000, the Federal increased interest rates six times and the runaway

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NASDAQ Movement

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Cont.. 

A combination of :

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ü rapidly increasing stock prices ü ü individual speculation in stocks ü ü widely available venture capital created an exuberant environment ü ü many of these businesses dismissed standard business models ü ü focused on increasing market share at the expense of the bottom line • 11/29/09 AMRITA SCHOOL OF BUSINESS

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Reason for collapse • Massive, multi-billion dollar sell orders for major bellwether high tech stocks (Cisco, IBM, Dell, etc.) • • This selling resulted in the NASDAQ opening roughly four percentage points lower on Monday March 13, 2000 from 5,038 to 4,879 • • The massive initial batch of sell orders processed on Monday, March 13 triggered a chain reaction of selling that fed on itself as investors, funds, and institutions liquidated positions

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Cont.. • Accelerated business spending in preparation for the Y2K switchover • • Poor results of Internet retailers following the 1999 Christmas season • • Several communication companies, burdened with unredeemable debts from their expansion projects, sold their assets for cash or filed for bankruptcy • • Many DOT-COMS ran out of capital and were acquired or liquidated 11/29/09

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Subprime crisis •Credibility criteria

• •A credit score above 620 (credit scores are between 350 and 850 with a median in the U.S. of 678 and a mean of 723)

•

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•A debt-to-income ratio no greater than 45% (meaning that no more than 45% of gross income pays for housing and other debt)

•

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Causes: 

– Boom and bust in the housing market –

– Speculation – – High-risk mortgage loans and lending/borrowing practices – – Securitization practices – – Inaccurate credit ratings – 

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CURRENT RECESSION(2007………

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Many crisis interlinked to form a giant recession. – – Fuel crisis  where oil prices soared to over $150 a barrel – – Food crisis  where wheat/rice prices tripled and was followed by riots and export controls – – Housing bubble  where in the asset values had a sharp fall AMRITA SCHOOL OF BUSINESS –

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Cont.. – Subprime mortgage crisis  raised alarming doubts about solvency of major banks – – Credit crisis  where the banks almost stopped lending – – Securitization Liquidity crunch spreads the crisis like a wildfire. 11/29/09 

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Obama’s stimulus package • Middle-Class Assistance: • – Congress to direct 40 percent of the stimulus bill toward tax breaks aimed at businesses and middleclass workers – – Most workers would receive a $500 payroll credit, and some businesses would "receive incentives to create job – – Making equipment purchases more affordable 11/29/09

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Cont.. • Considering unemployment benefits and health coverage to assist jobless workers  Infrastructure Development 

• Important part of Obama's job creation plan is infrastructure investment • • Support new federal spending of as much as $700 billion on construction projects and other programs to try to stimulate the economy 11/29/09

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Cont.. • Direct Aid to States: – – Federal government to find $700 billion to bail out Wall Street and bank executives – Health care, in particular, is one of the top costs plaguing the states – Currently, at least 27 states are facing budget gaps and some have already slashed safety-net programs 11/29/09

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Obama’s policy “OUTSOURCING” 

Obama Govt. is strictly avoiding outsourcing.

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• Unemployment rate at 7.6 per cent, there is no need for companies to hire foreign guest workers through the H1-B programme.

• • Elimination of Incentives and tax break for companies that ship jobs overseas," 

• US President Barack Obama opposed the idea of inviting overseas nurses, including from India. 11/29/09

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OBAMA’S POLICY “EDUCATION” "The future belongs to the nation that best educates its citizens," Obama said. "My fellow Americans, we have everything we need to be that nation." •

Obama focused for more funding for early childhood education programs that have shown results.

• • Obama focused for performance based pay to the teachers 

•

Increase in grants for poor students and new tax credits for families paying tuition.

• • Increasing the hours of instruction, possibly by expanding the academic year, which currently runs from late August or early September until early June at most schools. 

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OBAMA’S POLICY “TEXTILE” • Initiatives to curtail the currency manipulation by the Chinese to increase exports and daunt the imports.

• • Impose a program to monitor the textile, and apparel imports from China, once the safeguards are removed, and increase the funds and enforcements of policies regarding unfair trade practices.

•

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OBAMA’S “ANTI-TERROR POLICY” • Obama has announced plans to close the detention facility at Guantanamo Bay in Cuba that was opened by the Bush administration to hold terrorism suspects • • He has announced to take the US Troops from IRAQ. 

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OBAMA’S “TAX POLICY” • To get people spending again, 95% of working families will receive a $1,000 tax cut 

– first stage of a middle-class tax cut. 

• Tax cut for company who do not employ foreign workers.

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American Recovery and Reinvestment Plan • Doubling the production of alternative energy in the next three years. • • Modernizing more than 75% of federal buildings and improve the energy efficiency of two million American homes, saving consumers and taxpayers billions on our energy bills. • • Making the immediate investments necessary to ensure that within five years, all of America’s medical records are computerized. •  11/29/09

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Cont.. • Equipping tens of thousands of schools, community colleges, and public universities with 21st century classrooms, labs, and libraries. • • Expanding broadband across America, so that a small business in a rural town can connect and compete with their counterparts anywhere in the world. • • Investing in the science, research, and technology that will lead to new medical breakthroughs, new discoveries, and entire new industries. 11/29/2009

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Outcome of London G 20 summit 

Leaders of the world’s largest economies have agreed a $1.1 trillion package of measures to restore growth and jobs and rebuild confidence and trust in the financial system

 

To restore growth in jobs, that we will take essential action to rebuild confidence and trust in our financial system

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Cont.. • Principles to reform the global banking system • • Bringing the shadow banking system including hedge funds, within the global regulatory net • • New international accounting standards, resist protectionism • • Regulation of credit rating agencies • • An end to tax havens that do not transfer information on request. 

11/29/2009 • New financial 

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Cont.. • Equipping tens of thousands of schools, community colleges, and public universities with 21st century classrooms, labs, and libraries. • • Expanding broadband across America, so that a small business in a rural town can connect and compete with their counterparts anywhere in the world. • • Investing in the science, research, and technology that will lead to new medical breakthroughs, new discoveries, and entire new industries. • 11/29/09 AMRITA SCHOOL OF BUSINESS

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s dollar efficient to serve as a reserve currency? • • •

With the Fed creating billions of new currency, there is widespread fear that it may lose its value against other currency The situation may go worse if emerging economies lose their faith in the dollar and start selling US treasuries to support their local economy

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• • •

RBI has warning this issue for nearly two years. The imbalances which have arisen because of US spending for beyond its means, continues to exist

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Solution for the problem • According to economist like Roast, the American households need to deleverage and start saving

• • This may be bad news for china and other Asian economies which are looking for revival of American demand to boost their industrial demand 

• Revival of demand from emerging markets such as China and India.

• • Investment in the infrastructures.

• 11/29/09 •

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RECOMMENDATIONS 

We think the economy will start to recover if

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1. The conflict in Iraq continues to wind down with no threat of moving into Pakistan or Iran. 2. 3. Gasoline prices stay where they are now WITHOUT anymore drastic decline. 4. 5. Detroit gets a bailout with extremely heavy oversight written into the package 6.

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RECOMMENDATIONS 

3.

1. 4. 1. 5.

Reasonable tariffs are placed on nonnecessary imports such as Flat panel TVs, Foreign cars with US retail values of over 30,000 dollars, High-priced clothing, clothing whose companies cannot prove human rights standards are being met etc... Obama's administration starts to lean on the banks part of the 700 Billion Bailout for documentation and receipts The government starts loaning money and giving tremendous tax breaks to business that produce material goods and imports in order to raise the value of the dollar

• 11/29/09

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THANK YOU PRESENTED BY: Neeleema Nikhil Nivedita Preetam Pranav Prabhas Parashar Rahul 11/29/09

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