Thursday, August 11, 2011

Financial Crises Stage 2

The financial turmoil following S&Ps downgrade of US debt, publicly signals the onset of stage 2 of the US-European financial crisis. It is also a wake up call to these countries' socio-political system, which has failed to fully deal with the policy reform issues thrown up by the financial crisis. One has repeatedly pointed out over the past 18 months (within the international institution with which one is associated) some of the critical issues (e.g. US household mortgage debt problem or the solvency issue in 3-4 euro countries) that were not being addressed and others which were being wrongly addressed (the focus on sharp instant expenditure cuts vs. legally and institutionally sustainable reduction in expenditure). However, it is only over the last few months one had come to the conclusion that given the political gridlock in the USA and political constraints in the Euro area, these two regions are likely to see a lost decade analogous to Japan. In this context, I view the S&P down grade as a 'wake up call' to the political systems of these two economies to resolve the policy stasis if they want their economies to recover at a pace faster than the 7-10 years of previous financial crisis. This requires policy intervention to accelerate household mortgage debt de-leveraging and a solution to the solvency problem through contributions from the debtors and stronger Euro countries.

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