We now see the economic crisis entering the vicious cycle of falling demand, falling asset prices, deepening corporate losses and failures. There are more personal credit defaults and bankruptcies. This trend will continue for some time. This vicious cycle can be partially explained if one understands basic economics and the effect of “multiplier effect” by economist Maynard Keynes. I shall attempt to illustrate this using a simple example, hamburger.
If each Singapore family takes 1 hamburger a month, some 500,000 hamburgers will be consumed. We need bakers to produce the buns, farmers to produce the cows, onions, salad and tomatoes. Then you need factories to produce the sauces, carrier bags, straw and condiments. You need truck drivers, store men to support the logistics. Next you need staff to prepare, serve and clean the outlets. So, thousands of jobs are created just for this hamburgers. When these workers are paid, they have money to consume and will create more jobs. That’s how 1 hamburger per family per month can generate so many jobs and trigger off the ‘multiplier effect’.
Conversely, if no one takes hamburgers, then many jobs will be lost. This will create more jobs losses and thus the vicious cycle will continues. When jobs are lost, many will not be able to service the loans and will default. Asset price will fall, consumers sales will drop, factories will shut due to lack of demand. Thus the lack of spending will exacerbate the economic crisis.
With falling demand, from big corporations to small businesses, they have to scale down productions, reduce costs or delay capital expenditures. In many instances, factories are forced to shut down when it is no more viable. All these measures continue to hurt employment and reduce consumption.
The financial market too will be caught in this spiral due to falling profit and even losses from business. This triggers major market selloff which will put the market into a vicious cycle. In many cases, loans are recalled or ‘forced selling’ of collateral to meet loan obligation. This action triggers further fall. Many loans were not renewed and bank stop lending due to fear of default, forcing companies to suffer serious cash crunch. Lacking credit, suppliers will not sell raw material to companies, thus stopping the production cycle. Workers become redundant and retrenchment to follow.
With unemployment spiking up, the service and transport industries too will take a hit. Hotels are facing falling occupancies rate. Food and beverage outlets especially those catering to high end will suffer drop in business. Airlines too are finding it hard to fill up the seats in airplanes. Many container ship, oil tankers and bulk carriers are lying idle. With shipping rates and bulk rates dropping, owners are left with no choice but to decommission some of these ships. Likewise, airlines are parking and mothballing planes in desert. Naturally, this will lead to many job losses and retrenchment.
How to reverse this vicious cycle? Almost all the governments have aggressively addressed this problem of rapid economic contraction. Trillions of dollars has been pumped into the economy for infrastructures spending. This is supposed to increase consumption and create jobs. Some country like Taiwan even gave shopping vouchers. Some just gave money to citizens. All these are meant to boost domestic consumption. In Singapore, the government help employers to pay part of the compulsory contribution to the employees’ fund. This measure is supposed to discourage employers from retrenching workers so as to let people remain in employment.
The US is by far the most aggressive. It has spent billions in bailing out banks, auto industries and now even going to bail out homeowners who have defaulted. It has taken over insurance and mortgage companies.
It has been proven in previous economic downturns that all these measures were effective. It has been the template to boost economy and create jobs. But then again this economic crisis is unprecedented in that, the recession is global in nature. Previous crisis were all localised like the Asian financial crisis that only affect part of Asia and the dot-com crisis mainly affect the US. American economics is highly dependent on domestic consumption while the Asian economic are dependent on export. This situation is extremely disparaging. As such, Asian economy can only recover when the US begins to spend again.
Are the measures put in place enough to solve this measure, I think it falls short......my next blog.
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