From the year 2007 to 2011, the global economic system as a whole learned some of its toughest lessons and faced the hardest of times since the great depression of the 1930s. All of this started with irregularities in the US housing market and following credit crunch; then came the demise of Lehman and the chaos in the financial markets which triggered the global downfall in the growth rate, literally acting as fuel for a global recession.

This crisis was transported through various channels across the globe, creating a situation very close to the great depression where the pace of growth actually faded dramatically, where trade stumbled, financial markets dried out, and of course global unemployment bloomed.

A conceptual analysis of the empirical evidence from the period between 2007 to 2011 presents two broad cases of distinction. In the first case we were struggling to put the US economy back on track with the help of financial bailouts to corporations and financial institutions. In the second case we found that international institutions are providing a series of bailouts, creating a firewall against default by some countries in the Eurozone.

Death by Debt

Rapid, large scale accumulation of public debt poses a repugnant and most grievous threat to a national economy because it paralyses the eligibility of a country to secure any assistance in the future by the international community. It is nothing but financial death for a nation because it kills the natural basis of the financial system. The banking industry may collapse, lowering the value of domestic currency, causing irreparable damage to banks invested in the sovereign debt of the defaulting nation and worsening the potential global credit crunch.

Today economies, markets, and institutions are so interconnected and interwoven that any event or activity that can trigger a potential negative extreme, will have a direct and strong impact on other economies. For example, a drastic increase in public spending in China will probably increase demand for natural resources in Australia — and many more sophisticated illustrations can be easily found.

Bailouts and Future

How far can we really rely on bailouts? It all depends on how much we are prepared to mend the gaps between revenues and expenditure in government finances. In simple words, bailouts provided to any country does not mean that fiscal disparities are eliminated. In fact, bailouts often only act as the respirator of an ailing economy at its death bed.

In the case of the Eurozone debt, with the complications and assistance extended by the International Monetary Fund (IMF), it is a matter of diplomatic dynamics and not a real resolution that can be relied upon in the future.

IMF and other global economic and financial intuitions should draft a policy recommendation that virtually limits any reliance or mere assurance of a bailout by other nations in the future.

Image Courtesy of    DoraBakoyannis

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About the author

Muhammed Faraaz
Post-graduate in Economics from India, unfolding complexities and policies. Proponent of Classical Economics.

1 Comment for Sovereign Debt, Bailouts and the Future

Asif Iqbal

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