The skyrocketing commodity prices, climbing raw material cost, reeling worldwide stock and dropping oil prices, result from inflation and recession occurring at the same time leading to a bizarre phenomenon of stagflation. It is often remarked that the economic situation of the world is best reflected by the state of the United States economic potential. United States continued four quarters of contracting output would make European recession inevitable. If at times undue attention seems to be given to America, it is because the American economy occupies such a dominant position, accounting as it does for about one-fifth of the world output and over one third of the output of the industrialized countries. Bankers, financiers and politicians worldwide depend on economic events in America. For example, apart from the direct effects on the major financial markets, a change in the dollar's exchange rate affects the prices of many internationally traded commodities such as oil, and influences trade balances worldwide, especially those of the 25 or so countries with currencies directly pegged to the dollar. “If America sneezes world gets cold.” A barrage of poor earnings from major US corporations revived worries of global recession and showed the depth of the financial crisis the Bush administration trying to handle. Bush skill in handling international crises is showing a drop in confidence. While the Bush administration says things are going well “we are responding to the unprecedented challenges with unprecedented actions,” the news from America is looking like a catalog of easily predictable, and widely predicted, pitfalls. The US government is now paying the price for its hasty decision to attack Iraq without the UN consent. Though some of them would say that there are net benefits in small acts of destruction, Bush administration saw almost endless benefits in enormous acts of destruction. They tell us how much better off economically we all are in war than in peace. They see miracles of production, which it requires a war to achieve. And they see a post war world made certainly prosperous by an enormous accumulated or backed up demand. In Iraq and Afghanistan they joyously count the houses, the whole cities that have been leveled to the ground and that will have to be replaced. In America they count the houses that could not be built during the war the jeans that could not be supplied, the worn out automobiles and tires, the obsolescent televisions and refrigerators. Together they bring formidable totals. The more war destroys, the more it impoverishes, the greater is the post war need. But need is not demand. Effective economic demand requires not merely need but corresponding purchasing power. To most this will seem like an increase in total demand, but what really takes place is a diversion of demand to these particular products from others. The people of Iraq will build more new houses than otherwise because they must. But when they will build more new houses they will have just that much less manpower and productive capacity left over for everything else. Whenever business is increased in one direction it must be correspondingly reduced in another. Mere inflation-that is mere issuance of more money with the consequences of higher wages and prices-may look like a creation of more demand but in terms of the actual production and exchange of real things it is not. Post war demand in most countries will shrink in absolute amount as compared with pre war demand because post war supply will have shrunk. By free international trade if Bush administration means the freedom of ordinary people to buy and sell, lend and borrow, at whatever prices or rates they like and wherever they find it most profitable to do so. If they mean the freedom of the plain citizen to raise as much of a given crop as he wishes, to take his capital and settle where he pleases I would not mind but I suspect what the planners mean by free trade, they mean that if people docilely obeys they will be rewarded by a rise in their living standards. If America succeed in tying up the idea of international cooperation with the idea of increased US domination and control over economic life, the international controls of the future seems only too likely to follow the pattern of the past, in which case the plain man's living standards will decline with his liberties In an attempt to keep up the price of an agricultural commodity foodstuffs price have gone up 41 percent since October 2007, pushing many people over the line from poverty into privation or even hunger. World Food Program, another UN agency, estimates that it will need $500 million on top of what donor nations have already pledged to fill what the WFP calls a global “food gap.” But increasing current spending is only a short-term solution. Higher food prices appear to be here to stay, if and attempt is made to keep up the prices of an agricultural commodity and no artificial restriction of output is imposed unsold surpluses of the overpriced commodity continue to pile up until the market for that product finally collapses. This is what happened to the British rubber restriction and the American cotton restriction programs. U.S. policy must adjust accordingly. There is no point in arguing that as a result of the restriction scheme the price of farm products has been raised and the farmers have more purchasing power. Over the past three decades oil prices have jumped sharply on five occasions: in 1973 after an OPEC embargo, in 1979 after the Iranian revolution, in 1990 after Iraq's invasion of Kuwait in 1999-2000 as the world economy boomed and OPEC cut its production and in 2007 after Iraq's occupation. Compared with previous oil crises, the recent jump in the oil price has been the maximum and is not necessarily representative of market fundamentals. Conventionally a rise in oil price is thought to be inflationary. The impacts of higher oil prices effect economies in two ways real incomes and spending are reduced among the oil consumers' examples are Europe and Japan. If the economy is already overheating with tight labor markets a rise in oil prices is more likely to push up core inflation examples are India and China The impact on oil exporters depends on whether the oil exporters save their windfalls or spend it on imports from oil consuming countries. Fundamentally the gulf economies are largely insulated from the global situation but for the high domestic inflation imported through high prices of global commodities, which were the derivatives of high oil price. Since oil producers can be divided into three groups:OPEC, the former communist bloc, and the free world and oil output in the free world is price responsive that is it is profitable to extract oil from marginal fields only when prices are high. America guzzles more oil, but it is also a producer so its net oil imports are smaller. However, whereas nearly all oil was sold to US on long-term contracts at fixed prices in the past and its oil import bill was unaffected that is why Fed Reserves said America is less likely to worry about the threat to inflation from higher oil prices than about risk of slower growth. Will the American economy start to recover or is it stuck in recession is a tough question. How could a rise in oil prices be both inflationary (raising prices) and deflationary (reducing demand)? Today, they understand better the various channels through which oil prices affect the economy. Economists are perplexed by the whole notion of stagflation (stagnation along with inflation) as a result of the high prices of oil. There is an important role being played by the international financial market on the world oil market. This mainly takes place through the investment funds and speculators in the future oil market, which contributes to the rise or decline of prices as per their view of the oil market on one hand and the investment opportunities in the different financial channels on the other hand. The decline of interest rates on many of the main currencies, fluctuations in the stock market together with a decline in dollar value and increase in the demand for raw materials pushed some investors in the future market to sign contracts for the purchase of raw materials, particularly oil contracts, a matter which has remarkably contributed to the rise in oil prices. For the moment, however, the fall in the price of oil and commodities and the pulling of hedge funds are putting bearish pressure on the economies. The current financial turmoil is rooted to the sub prime crisis. During boom years mortgage brokers enticed by the lure of big commissions took buyers with poor credit into accepting housing mortgages with little or no down payment and without credit checks. Banks and financial institutions often repackaged these debts with other high debts and sold them to world wide investors creating financial instruments called collateralized debt obligations (CDOs). The serious sub prime mortgages crisis began in June 2007 when two Bear Stearns hedge fund collapsed. Federal Reserve and European Central bank dumped $100 billion in liquidity into the system that calmed the market down for a short period. However the sub prime continued to be solid as long as the housing market continued to escalate and interest rates didn't go up. Lehman Brothers slow collapse began as the mortgage market crisis unfolded during the summer of 2007. Its stock began a steady fall from a peak of $82 a share. The fears were based on the fact that the firm was a major player in the market for sub prime and prime mortgages. Shortly after Lehman Brothers filed for bankruptcy, Merrill Lynch complained of suffering from the same disease, and before the effects could become devastating, it cut a deal with the bank of America for $50 billion far below its value. Any country integrated into the global economy through trade as well as capital flow cannot remain completely immune to the current global credit crisis, in spite of strong economic fundamentals and largely insulated macroeconomic situation. This is the underbelly of globalization. Globalization has ensured that even Indian economy and its financial markets cannot stay protected from the current financial wreckage. The meltdown is also expected to hit other banks except Islamic banks. While there is a general atmosphere of gloom and doom after the great fall, most experts believe that the future of Islamic Investment banking is more tenable because they are free from the most destabilizing factor of interest and have better robust credit rating mechanism although they are in the nascent stage. * The writer is a Researcher of Comparative Economics in Jeddah. Comments:[email protected]” [email protected] __
