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The New Normal

Raj Nallari's picture

The Western world is likely to have a low output performance in the next 2-3 years because the financial systems in US and European countries has broken down, while the fiscal burden and public debt arising from the economic and financial crisis is quickly mounting, and these would contribute to credit restraint and private sector being crowded out. Very little has changed in terms of regulating the US and European financial system. If anything, the US financial system has become even more concentrated around Goldman Sachs, JP Morgan, AIG, Citibank and a few others, transparency in transactions has not much improved, and financial firms are continuing their merry ways of the past. Many of these larger financial firms have received large bail-outs and could still go under. Unemployment rates are likely to be higher for the next few years. The result is that governments of major countries will be expanding their roles further in protecting too big to fail financial firms, including re-regulating the financial sector, protecting the politically connected industrial companies in the name of protecting jobs, and will spending more money on social protection. All this means that higher taxes may be warranted. More government and less financial leverage will be the new norm and characterized by de-leveraging, deficits and debt, and re-regulation.

In emerging and developing economies, whose financial systems are intact, are expected to grow at about 6 percent during 2010-12, on average, and it is China, India and other Asian countries that are pulling the world wagon with continued adoption of technology and institutions. China and other East Asian countries need to cooperate in increasing their domestic spending particularly on consumption so as to maintain, world output and export growth of the early 2000s.

Under these economic conditions, will US dollar and Euro be strong enough to continue to be major currencies in the world? More recently, China, Russia and a few others have been pushing for an international reserve currency such as the already existing SDR (special drawing rights). Geo-politics will play a major role in whether or not the world will have a new reserve currency.


“More government and less financial leverage will be the new norm and characterized by de-leveraging, deficits and debt, and re-regulation” This is sad because what we should be doing now is to allow the private banks to help the economy more by lowering their capital requirements now, even at the risk of more bailouts tomorrow, instead of having government bureaucrats do the lending or decide on fiscal spending. Bank capital is scarce and expensive as a result of it having been lost financing AAA rated operations with extremely low capital requirements of 1.6 percent... and so what could be wrong temporarily reducing the 8 percent capital requirement, to 5 percent for instance, when lending to those small businesses we need urgently need to prosper and create employment. A dollar spent by a bureaucrat is a tax dollar spent but a dollar lent by a banker does not necessarily mean a future tax dollar spent.

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