The financial crisis Essay
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The financial crisis witnessed in the year 2007 had been preceded by a lot of strong economic developments across the world. The world experienced economic growths free from any crisis as many emerging and developed economies posted good financial results in all spheres with inflation being a record low. These good times were because of a few underpinning factors that the world enjoyed but eventually proved counterproductive and unsustainable. The foremost activity that led to booming in many countries across the global at the time was real estate business.
The value of real estate was on a record high across the globe and especially in the world’s strongest economies like the US. Then it was noted that many nations including America were experiencing high current account deficits. The third factor was to do with much influence that had grown especially among consumers as well as financial institutions across the world (Wolf, p. 50). Indeed it was during this period that the seeds of financial crisis were planted.
It is argued that the housing booms and leverage were much caused by the global financial imbalances among other factors.
The US as one of the world’s strongest economies boasted of the highest private homeownership together with the most dynamic and strongest markets in the world. The deregulation of the US market over the years from 1970 led to a poor and fragmented oversight body that is the government. Probably as the world can testify now, this was a fatally dangerous for the world economy. But still the world grapples with the real connectivity between the global economic crunch and the global imbalances.
As some people arguably put it, the financial crisis in the United States had little to do with the global economic imbalances, but rather the internal failures of economic regulations as well as policy errors (Obstfeld & Rogoff, p. 3). On the other divide, the global imbalances played a major role in the financial meltdown through some systematic processes. This paper is intended to follow the second view that the global imbalances and the financial meltdown experienced in the United States are correlated.
The two phenomena are the manifestations of the deeply rooted financial cultures in various countries and the financial markets distortions that sway those financial policies across the globe. For example, United States was able to fund macroeconomic imbalance by its foreign borrowings. Wolf (2008, p. 76) suggests that this made it delay making some touch decision regarding some of its financial policies. This was indeed the trend in many countries around the globe that had huge deficits. China on the other hand had the luxury to lend which ensured that it could place bigger reserve buying especially in the United States market.
China therefore did not see the need of raising the value of its currency and as a result also delayed rebalancing of its financial policies. In light of these developments therefore, it is clear the economic crunch could have been avoided or nib in the bud had the option of postponing the inevitable been available (Gruber & Steven, p. 67). Some scholars and financial observers have contended that the global financial imbalances were bound to be and are natural since they are the manifestation of backwards financial practices that characterize the emerging economies.
They cite a framework whereby they claim that global imbalances are a win-win situation. From such framework, the developing nations are beneficiaries of savings and liquidity offered by the developed nations like America, which on the other hand profit from easy borrowing conditions. This analysis is wrong because it tend to assume that strong economies like the US are perfect in their capital markets and therefore would not face any risk with the ever exploding leverage (Frankel, p. 65).
Obstfeld and Rogoff (2009) explain the correlation as thus: “external imbalances are often a reflection and even a prediction, of internal imbalances. Economic policies … should not ignore external imbalances and just assume that they will sort themselves out” (p. 5). A brief history of how the global imbalances have reflected and even magnified the financial crunch experienced in the US would suffice. Just to begin with, the global imbalances have opened the underbelly of the US and other developed countries political and financial systems to the world scrutiny.
In fact the outcome of such scrutinizes have found those countries financial and political system to be inherently weak (Clarida, p. 80). The World Reactions to Global Imbalances The discussions on what the growing global imbalances portend for the global economy reached crescendo in 2003 when Japan and China were censored by the group of seven countries to lift their intervention buying of the dollar. According to Dunaway (2009, p. 30), during the G7 convention in that year, which was attended by the IMF in Dubai, the United States agreed to promote its national savings and the EU pledged to have productivity raised.
The following marked new developments – the G7 treasuries together with central bank heads agreed that the answer to the current account disparities was a stronger structural policy that would stimulate growth. The G7 had another gathering in 2004, where the Toshihiko Fukui, the Japan central bank governor noted the potential problems of the global imbalances. He said that the world cannot turn a blind eye to the growing concerns of imbalances. This came from the wake of his country’s refraining from any intervention purchase of the dollars as was requested by the G7 in 2003 (Obstfeld & Rogoff, p.
7). The world began to see the risks thereafter. The European financial institutions saw the potential risks of the America’s ever expanding current account deficits, which they noted could be catastrophic to the stability of the global finances. Their particular concern was with the America’s uncontrolled household mortgage borrowings that they claim could have far reaching consequences on the world economy. Many jobs could be lost as well as increase in the interest rates would hit hard the individual and the financial institutions (Borio, p. 50). One Mr.
Padoa Schioppa noted that the Americas external deficits as well as the ever-increasing prices of oil would prove to be the main risks to the global financial stability. He did not forget to mention the increasing prices of real estate and the practices by European countries in having ratios in loan value. What was most remarkable was probably his general conclusion in the trends that continued unabated. He suggested that the world had forgotten about the resolutions made at the G7 summit in 2003 in just over a year because of the real estate boom (Obstfeld & Rogoff, p.
12). In 2005, the US government reacted to the growing concerns over its financial practices. Alan Greespan said in a statement that the Americas current account deficits would certainly stop at some point and that Americas flexible economy would facilitate any required adjustments without causing many disturbances to the world economy (Obstfeld & Rogoff, p. 14). Other observers have argued that certainly America’s foreign deficits are caused by the external factors which if only recognized and acted upon would cure its financial problems.
While most analysts agreed with Greespan that gradual and clear adjustments do occur, it is paramount that policymakers remain on guard incase of such developments. Despite Greespan’s assurance, the US politicians and financial authorities did nothing to control the risks (Brecher, Childs & Cutler, p. 120). Many did not foresee the dangerous grounds the world economy was getting into in 2004; developments of that year further destabilized the global imbalances. It was indeed this period that seeds of economic crunch was sowed that later erupted in 2007.
European countries and the United States received much blow as well as blames for this mess. Although most of the factors that led to the widening of global imbalances took root from the period preceding 2004, the developments during this year facilitated and amplified some of the hitherto dominant policies (Borio, p. 70). It would therefore be in order to look at the period preceding 2004 in order to fully understand some of the forces responsible for the widening global imbalances. The Global Imbalances Of 1990s