During 2007 the world economy grew at 5.2 percent which was mainly powered by the rapid economic growth in the emerging economies of China, India, and Russia at 11%, 9% and 8% respectively. Hence, during the year 2007, the economic condition of the world appeared to be very bright and these emerging markets played a vital role in bringing about booms in stock and property markets in most countries of the world. There was consistent growth in Europe and North America and large-scale investments brought rapid economic development in the markets of Africa and the Middle East. Japan too had started to show positive signs in recovering from the deflationary pattern that characterized its economy during the last few years. Essentially it was the economic conditions in the emerging economies that played major roles in influencing the economic atmosphere in countries that are not very well off. Most developing and underdeveloped economies depend heavily on such developed economies regarding their economic welfare.
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With large-scale economic prosperity being experienced during 2007, most experts had started to believe that the rapid economic growth in the developing countries is going to set the stage for consistent and unfettered growth for years to come. It came to be widely believed that Asia had now disengaged from the USA in being able to take off on its strengths with the immense surging power of the two giants that China and India had become. However, recent trends have clearly proved that the world economy has been hard hit in several ways that threaten to lead to a 1970s style stagflation with constraints in capital and resources that may be much tighter than experienced during those years.
The present crisis has its root in the subprime crisis in the USA which was caused by large-scale disbursement of risky mortgages without conducting the required due diligence on the part of financial institutions. Most people and companies that were given mortgages did not have the required creditworthiness to the extent that they were given loans and financial limits. As long as the prices of houses were rising as a result of the boom in the real estate sector, there were no problems, but soon the housing prices began to crash and the number of defaulters in regard to the mortgages began to increase at a very fast pace. In adding fuel to the fire, such sub-prime loans were included in forming collateral security for Collateralized Debt Obligations (CDO) that were essentially financial instruments being transacted and sold amongst financial institutions. Consequently, with the collapse of the housing prices, a large number of such CDOs had to be written off and there was reduced confidence amongst banks in further investment in infrastructure and other developmental activities in the absence of any concrete underlying security. This resulted in a serious credit crunch and banks had to be saved from total collapse by way of government interventions and regulations in the USA, UK, and other countries. The world economies are now plagued by a serious shortage of liquidity because of which it has become extremely difficult to fund economic development.
Another cause of worry is the spiraling cost of commodity prices which is evident from the steep rise in oil prices which has had adverse repercussions on the prices of most other commodities. As compared to early 2007, the price of oil had increased by over three times, the prices of rice and food grains have more than doubled resulting in a spate of literal food riots in a number of countries. Prices of all commodities including those used in consumption, construction and energy have been constantly rising. Such rise in prices is the result of increasing demand for all commodities in the emerging economies of China, India, Russia, and Brazil which account for over three billion of the world’s population. These countries are experiencing rapid economic development and the purchasing power of the people is increasing by the days. Since a large number of people in these countries were initially falling below the poverty line and have now started to enjoy the fruits of prosperity and economic development, there has been a massive increase in demand for most commodities. These countries have witnessed a spate of economic activities that have enabled the people, primarily those in the middle-income category to improve their income levels and living standards leading to further demand for goods and services. In this context, there is an added worry in the context of whether adequate natural resources exist to meet the burgeoning levels of demand in these countries.
The economies of the world had faced a similar crisis during the 1970s when the average annual economic growth rate of the world was 5%, but with constraints being faced in food and oil supplies, the growth came down to 3.2% annually. Growth opportunities had become very limited and prices continued to spiral due to lack of adequate supplies. This came to be known as the era of stagflation and during those times also there were heated debates where economists argued in driving home the point that the economies of the world faced a great threat and may ultimately collapse. But that was not to be and beginning with the 1980s, most economies started to recover towards growth and prosperity. The present time is indeed critical for most economies and a strategy that brings about proactive economic reforms will surely enable us to get over the present crisis.