Abstract
The 2007-2008 financial disaster was a blow to many global economies, including the US money market. This paper presents some of the proceedings that are thought to have led to the catastrophe. It shows how the US played a key role in fueling the crisis. It also provides some of the key lessons that countries have obtained from previous experiences. The lessons are meant to make them establish proper mechanisms for preventing the possibility of occurrence of any such crises. Hence, the paper presents a section on the strategies that countries have put in place to prevent the recurrence of another financial disaster. Lastly, it also seeks to answer the question of whether globalization and the established international markets have outgrown the US monetary structures.
The Cause of the Recent Global Financial Crisis
The 2007-2008 international financial disaster was a defining moment to the US economic business cycle. The monetary catastrophe began in 2007 following the explosion of the housing sector bubble. Later, it grew into a terrible calamity that affected global economies, especially during the late 2007. Nations such as the UK experienced a credit crunch through the financial crisis that resulted in the collapsing of businesses and the erosion of consumer confidence. In Jordan, although the banking sector was not affected, commodity prices went up due to the high dependence on oil in production processes (Mohammed & Ayuba, 2012). From a global scale, the damage on economies and their prospects was irreversible.
Although many economic scholars noted losses in mortgages as the main cause of the crisis, different theories have been advanced to explain the major cause of the international economic catastrophe. For example, Adelson (2013) regards losses in mortgages as too minute to provide sufficient explanation for the crisis. Depending on the measurement methodology, the total losses due to the crisis ranged between $5trillion and $15trillion (Adelson, 2013). This observation suggests that mortgage losses only triggered the financial crisis.
After the disaster activation phase, several other economic issues amplified the effects of the losses. Liang (2012) attributes the cause of the global financial crisis to financial globalization, which created real exchange imbalances. The US has the responsibility for supervising monetary risks and international liquidity. However, its failure to offer the crucial banking services heralded the 2007-2008 financial crisis (Liang, 2012). As Adelson (2013) adds, “Excessive securitization, the 30-year deregulation trend, the quant movement, the spread of risk-taking culture throughout the financial industry, and globalization” (p.16) are the major causes of the financial predicament. Therefore, failure to effectively manage financial risks, including liquidity, securitization, and deleveraging issues potentially can be considered the cause of the 2007-2008 worldwide financial calamity.
Historical Economic Lessons
Experiences from the 2007-2008 global financial crisis are important in forming benchmarks for preventing future crises. What could have been learned from the 1974-1982 intercontinental loan pour, the 1982 debt catastrophe, the 1990s renaissance of capital pour, the 1994-1995 Mexican disaster, the Asian catastrophe of 1997, and the 1998 Russian calamity?
The 1974-1982 pour in intercontinental loans occurred due to excessive lending by the Japanese, the American, and the European banks to LDCs, including Mexico and Brazil, with the hope of making large future financial gains. Amid the efforts of the IMF to advance more loans to the struggling debtors to increase their future financial ability to repay the loans, the LDCs were unable to do so. An important lesson here is that excessive giving of loans without considering potential risks such as bankruptcy of the lender in the event the debtors fail to pay is crucial in ensuring long-term sustainability of the financial system. Expecting high future gains is inappropriate, especially when excessive risks are involved (Eken, Selimler & Kale, 2012). The financial system operators seemed not to have obtained any message from these experiences. Hence, the elevated credit availability to boost mortgages because of the expected high future gains contributed to the 2007-2008 international financial calamity. Similar to the interventions of the IMF during the international lending surge in 1974-1982, the US attempted to resolve the challenge through excessive deleveraging, which only worsened the situation. The experiences of the 1982 debt catastrophe and the 1990s renaissance of capital pour among others indicate the importance of effective risk management in financial systems.
How all Countries Protect Themselves from any Future Global Crisis?
Considering the negative implications of the global financial crisis for different nations, many countries have developed strategies for protecting themselves against such crises in the future. One of such strategies is putting in place mechanisms for managing credit risks. Financial organizations provide liquidity to creditors and/or depositors by putting in place programs for giving money on demand. A liquidity risk arises if the outflow of deposits is accompanied by poor financial arrangements (Barajas, Chami, Cosimano, & Hakura, 2010). Such arrangements include commitments that involve abandoned loans and the requirements to purchase securitized assets.
Banks lend money by developing credit lines and other credit commitments. When borrowers take advantage of the available credit commitments, banks are exposed to higher financial risks. In fact, a drop in liquidity supplies compels interested people to draw money in the form of loans from accessible credit lines (Eken et al., 2012). During the 2007 to 2008 economic predicament, non-financial sector organizations had no access to short-term loans upon the drying up of commercial paper markets. People who utilized the commercial paper resorted to prearranged credit lines from the banks to help them in funding their paper whenever necessary. Since banks had the obligation to fund the loans, the available lending resources became incredibly limited. Countries are now adopting strategies for preventing these risks from occurring by developing and adopting concepts of risk management in financial institutions.
Countries are also protecting themselves from global financial crises by looking for less risky ways of funding budgets. The most important mechanisms include equity assets and deposits. Other alternatives include an extensive trading of unguaranteed savings, reacquisition of bonds, and the use of unguaranteed apparatus. However, countries engage in the analysis of potential risks that these alternatives can present.
Without risk analysis as evidenced by the 2007 to 2008 worldwide financial disaster, these interventions can be limited. For instance, repos are used in financing highly risky resources such as “private-label mortgage-backed securities” (Eken et al., 2012, p.25). By mid-2007, Gorton and Mentrick (2011) inform that all these securities were possible to fund through short-term loans that could be acquired from repos. Following the global financial crisis, the above approach changed so that only about 55 percent of all such securities were possible to fund from repos by the end of 2008 (Eken et al., 2012). Hence, financial bodies suffered huge losses, as the only available option was to sell securities in a collapsing financial market. This observation underlines the necessity for developing sound and effective macroeconomic policies and financial systems.
Developing nations are pushing developed nations to provide a room for them to participate in the global financial system and the international monetary agenda. Ozkan (2012) asserts that developing nations are calling industrialized nations (the G-7 nations) to “put obstacles to the restructuring of international financial systems” (p.202). Indeed, China now calls for fair power distribution among nations to permit its involvement in the development and implementation of international monetary policies in a bid to ensure that it also participates in self-protection against future global financial crises.
Has Globalization and the Integrated Global Economies Outgrown the US Financial System?
Globalization is defined as the process of massive transfer of values, ideas, and meanings across territorial boundaries. It is initiated by the spread of ideologies together with commodities across national boundaries. Globalization results in an increased integration of different products, capital, and labor markets through territorial boundaries. Although it may attract the transmission of negative economic shocks across the porous boundaries for different nations, it is crucial since it leads to the integration of global economies. Integration means combining different small economies to form one superior economy. As such, globalization and the integrated economies have outgrown the US financial system.
Future projections indicate that the integration of a few emerging economies can surpass the US financial system. For example, Ozkan (2012) says that the global financial crisis may translate into hegemonic transition in which the US will share its superpower position with two emerging economies, namely India and China. Indeed, China presents immense challenges to the continued capacity of the US financial system to remain as the dominant system that regulates the international financial exchange system. Even without the integration of other economies, the Chinese economy continued to grow during the global financial crisis. This situation presented possibilities for it to form the epicenter for global economic hegemony by replacing the US coinage (Ozkan, 2012). Even if the 2008 global financial crisis did not occur, the Chinese economy was still projected to outgrow the US economy without its integration with other economies. Quoting the work of Goldman Sachs, published in 2003, Ozkan (2012) says that the Chinese economy was projected to outgrow that of the US by 2041. However, the global economic crisis pushed down this date to 2019 (James, 2011).
The increasing business between China and developing nations suggests an integrated economic system that is enhanced by globalization in which the Chinese Yuan is now becoming a dominant foreign exchange currency. However, developed nations, especially the G-7 nations, are pushing for an evolved financial system that can operate in their favor. On the other hand, nations such as China push for financial systems and policies that meet their new economic status.
The immense growth of the Chinese economy together with the control of the global business arena, especially in infrastructural development in other nations and the preference of China as the center for most of manufacturing outsourcing processes, has now shifted the debate on whether its currency needs to replace the dollar in balancing the international trade. All economic indications are that this plan might come to pass (Ozkan, 2012). However, the integrated economic force, which has now outgrown the US financial systems, raises the question of whether China, which cannot control all the entire world economy alone, should have its currency used in balancing international trade. Should the IMF introduce a more international mechanism such as Special Drawings Rights (SDRs)?
Reference
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