Sunday, January 29, 2012

How long will current crisis last?

A good analogy to understand the current financial and economic crisis, that started in 2008, would be to consider a person who falls seriously ill. One option to treat the patient would be to perform an operation, but there are huge risks with this option. The other option would be to gives the patient steroids. This will make the patient will feel better, but only temporarily. Unless the underlying medical issues are corrected, the patient will not recover fully.

The US had these two options in 2008, let the economy fall freely and go into a depression (to correct the underlying structural issues), or to use steroids. The US government took the second option of giving a lot of steroids - rapidly reduced interest rated from 5.25% to almost zero, started income tax rebate program, stimulus package, quantitative easing (QE), etc. Thus the economy got better but did not fully recover. Hence the steroids were required again and again (e.g. QE II and now there is a talk of QE III). While all this is happening the underlying structural issues are slowly being fixed (like the huge debt in the system is getting reduced) which will eventually help the economy recover.

So coming back to the original question - the current process may take another year or two. But after that we should start seeing signs of a sustained recovery... well, at least until the next big crisis!

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