Assets prices bubble bursts: causes of recessions

Although historical economic trends indicate that, recessions tend to follow normal economic cycles, which are characterized by troughs and peaks in any economy, and at every economic peak points, there is in most cases, a bubble burst.

Although historical economic trends indicate that, recessions tend to follow normal economic cycles, which are characterized by troughs and peaks in any economy, and at every economic peak points, there is in most cases, a bubble burst.

Such bubble bursts have taken such forms as stock markets crashes, and housing price bubble burst (two of the most important medium of assets to store value).

Bubble bursts occur where the market prices of underlying assets exceeds its intrinsic/perceived market value and if such information is rallied to financial markets buyers shy away from such assets leading to a free fall of their prices.

This fall comes with heavy losses in not only incomes of holders of such assets, but also wipes out large portions of balance sheet asset values of corporations affected by such bursts.

This phenomena which tends to be cyclic, has led many economists to argue that, even if the sub-prime mortgage in USA was not to arise, a major bubble burst in any major world economy would have pushed world economies into such crisis as the one we are experiencing.

This argument is premised on the view that, the extent to which world economic and especially financial markets integration reaches order one level, we should expect such recessions to hit the entire world economies through contagion. Others however, point out that, recent securities and housing bubble bursts in Japan and earlier in 1997 – the Asian financial crisis- were not felt the world over like current crisis mainly because the ‘epicenter’ of such bubble bursts were in economies insignificant relative to the world economy, and whose integration is of an order less than one (in relation to other major economies).

If this theory holds true, one would only expect American (USA) bubble bursts to have such global impact like we witness today.

This is not surprising given that, USA’s economy as measured by GDP is around 60% of world’s total GDP, and that a shock in such a huge economy will certainly be felt by other economies regardless of the level of integration to USA economy.

This therefore means that, we can only expect a global contagious crisis if it originates from USA, at least for the foreseeable future until USA’s share in the global economy is eroded to the extent that it is below 50% of the world economy, a situation that is likely, given the emergence of such economic giants as China, India and Brazil.

This is also the time, that the debate over relevance of dollar as a unit of international reserve and settlement will gain currency.

Economic historians have pointed that, China has studied every economic policy path USA has used to attain its current world economic (and military) supper power, and is blending this with its own home grown innovations, so much so that, it may not take a decade before it catches up with USA.

Chinese culture of savings (which has in part financed USA spending to the tune of around 800 billion dollars), innovativeness, hard work, undefined competitive edge is bound to push this third largest world economy to a level that is at par or even exceed American  than earlier predictions.

If this is so, and there are no reasons to doubt this theory (at least going by growth rates Chinese economy has posted for sometime now), then economic as well as political alliances will assume another form.

The only question one may pose is: are African economies well positioned to take advantage of this emerging order?

If so, what measures/strategies have been designed by our economies to ensure that, such a relationship takes the form of partnership rather than patronage?

Are Economists as fault?

With regard to faults of economists whether macro or financial in predicting the current financial crisis (as pointed in last article) and inability to prescribe mitigation measures, one has to draw a line.

These professionals use numerous assumptions to predict reality given the behaviour of a given people or economies.

Such assumptions among others view reactions of individuals/people as rational and that they act in their best interests.

But at the back of such assumptions is the convictions that, rationality is relative, and that it is in most cases in conflict with the self interest (a value behind people’s enterprise) of the same individuals and people supposedly benefiting from it.

It even becomes a more delicate balance where this involves policy makers whose ‘rationality and self interest’ is skewed to themselves rather than to the led, a phenomena common among developing economies and especially in Africa.

This rationality (or irrationality) and self interest transcends economic values and takes on political as well as a social face which then exposes many people in such economies to the highest level of marginalization and consequently, endemic poverty.

Over all therefore, economists work in a highly uncertain environment due to the nature of man (read woman) as predicting their behaviuor has been, and will remain the main challenges of this profession.

This explains many failures of this dismal science for centuries, despite a host of tools at their disposal to manage various economies and economic shock and crisis, ie,  their assumptious models in some cases, fails to capture reality which is value loaded.

The Credit Card Factor

Nevertheless, the current crisis has been felt much more in western economies than in developing economies owing mainly to the differences in the levels of monetization (the ratio of money supply – currency and demand deposits- to GDP).

The credit card culture in western economies has meant that, virtually every consumers is facilitated to consumer his/her future earnings, and in most cases beyond the earning power of such a consumer (s).

This led to consumers in a number of western economies living on foreign savings mainly from such countries as China and Japan. In the case of developing countries in Africa, credit card culture is yet to be entrenched.

It is even worse in Rwanda where there are yet to develop. But this has meant that, while others have had their credit card credit lines limited or even suspended, our consumers are leavings on their current incomes, and if these are insufficient, subsistence farming has smoothened their consumption, thereby limiting the impact of credit crunch to such consumers. Whereas this explains financial lapses in our economy that will have to be addressed, it has nevertheless mitigated the extent of the impact the current crisis had on our consumers, at least for now.

That our economy has by and large, been resilient to this crisis therefore, can be explained by a combination of defaults (missing financial instruments) and prudent, and excellent economic governance strategies in place.

The latter provides more explanation. 


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