The Global Economic Crisis, For Dummies

You’d have to be hiding under a rock – or a large stack of couch cushions – to not know that the world economy is in some serious strife right now.

Some of the world’s biggest economies are in recession, including the U.S, the U.K Japan, parts of Europe and our own Pacific neighbour, New Zealand.

Australia is not faring much better. While the Federal Government still hopes to stave off a recession, any growth in our Gross Domestic Product (GDP) is predicted to be close to zero.

So what happened? And what can we do as families to make sure we weather the storm OK? This guide will try to help answer those questions.

What caused the Global Economic Crisis?

Following a period of worldwide economic boom, the bubble finally burst.

A big contributor was the collapse of the US sub-prime mortgage crisis. Subprime is the practice of extending credit to people who would otherwise not have access to the credit market. When these people started defaulting on their mortgages in large numbers, the banks and lenders had to file for bankruptcy.

However, the nature of the global economy meant that the debt on these loans was tied up in investment programs and securities around the globe, thanks to tricky hedge funds and other unregulated financial products. So when the subprime mortgages went under, so did the investments.

As a result, ordinary businesses across the world with no direct connection whatsoever to US sub-prime suddenly started facing difficulties or even folding if they couldn’t get a bank loan. The whole system started to fail.

In Australia, higher interest rates, falling consumer confidence, stockmarket turmoil and higher oil prices forced (and are forcing) consumers to cut their spending. Business profits started to slump.

Next thing you know, the big ‘R’ was looming.

Want to know more about sub prime? Watch this stick figure animation.

What is a recession?

Technically, an economy is in recession if it experiences two consecutive quarters of negative growth.

The word also has a wider meaning — it generally refers to a downturn across a broad range of economic indicators like spending and business investment.

A prolonged and worsening period of economic stagnation generally stops being referred to as a recession and becomes a depression.

Some say recessions are an important part of the economic cycle and don’t always have a huge negative effect. Paul Keating famously called the 1991-2 economic downturn “the recession we had to have” following huge inflationary growth during the 1980s.

But a boom doesn’t have to be followed by a bust – the government hopes to have a soft landing this time by providing stimulus to keep people spending and money changing hands.

During a recession unemployment rises dramatically and businesses cut staff to save costs. The Australian unemployment rate is predicted to rise to at least 7% by June 2010 – that’s 800,000 people who could lose their jobs.

What is the Government doing about it?

Last year the Rudd government announced the first of its economic stimulus packages , throwing lump sum payments at pensioners, carers, families and first-home-buyers.

Spending was strong over the Christmas period, but the outlook is still grim. This week, the government announced a new $42 billion stimulus package which is currently under Senate inquiry. In addition to cash handouts, the government will spend big on infrastructure projects like improving schools and insulating homes, which will create job growth.

In addition, the Reserve Bank of Australia (an independent body), has been dropping interest rates to encourage investment and home ownership.

Will it work?

No-one knows. The Federal Opposition is refusing to support Rudd’s plan, concerned the “excessive” spending will plunge Australia into hundreds of billions of dollars debt that will burden future generations.

Other economists believe bold spending is the only way to avoid a deep recession.

How can I recession proof my family?

While we all might have to tighten our belts for a while, no-one is predicting a second Great Depression just yet. There is no need to buy a shotgun and hoard food – for now.

Some things that might help keep the family afloat include:

- Paying off debts. Sure, the government wants us to spend, but you’ll have less to spend if you’re throwing away cash on interest payments each month.

- Buying local. Support your community and keep money in the country by buying Australian goods and services where possible. Now is a good time for that renovation project!

- Having a back up plan. If your family is living on one wage, think about what the stay at home parent can do as a “side hustle” to add to the household income. Consider small business ideas or part time work. Alternatively, if you have been out of the workforce for a while, it might be time to enrol in a course and brush up on skills.

- Insuring your home and lifestyle. If you can afford it, house, medical car and even income insurance will ensure that if the worst happens, you’ll have a safety net.

- Making yourself indespensible. If your workplace is retrenching staff, try to ensure you’re one of the least replaceable. Now is not the time for an experimental career change.

- Becoming thrifty. Sewing, gardening and home crafts are taking off as people rediscover the lost skills of their grandparent’s generation. Start small – learn how to darn a sock or grow your own tomatoes.