WHAT CAUSED THE GLOAL ECONOMIC CRISIS?
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So far there has been no unanimity on the factors responsible for the crisis. There have been two different, but mutually exclusive view points on what is behind the crisis.
According to one view, the financial sector debacle has its origin in the “Global Imbalance” – the phenomenon of large current account surpluses in China and few other countries co-existing with USA with a large deficit. The global imbalance is reflected in the large mismatches in the current account positions of some countries and their mirror image in the form of domestic savings – investment mismatches.
The US has been running huge deficits. Countries such as China and Japan needed an outlet to deploy their surpluses. It was mutual convenience, as it were, for the savings of Asian Countries to find a haven in the U.S which needed money because it saved very little. The money from the Asian surplus countries flooded the US market that kept the interest rates low, inflated the prices of real estates, shares and other assets. When the bubble burst, the financial sector crisis surfaced. Hence, an orderly unwinding of the imbalance alone would help mitigate the crisis. If this is so, macro economic policies of countries need fine tuning.
The US Govt’s unsuccessful effort to persuade China to revalue the yuan to make their exports less competitive points to the belief that the global imbalances to be the primary reason for the global economic crisis.
However as per the totally different view expressed by the IMF in a recent paper, global imbalance is only an indirect cause. The main culprits were the deficient financial regulation and the failure of market discipline resulting in a systematic flouting of rules and regulations by banks.
1. Deficient Financial Regulations.
2. Failure of market discipline leading to systematic flouting of rules and regulation by the banks.
The sub prime crisis showed that almost all the banks used their ingenuity to develop structures and products that were outside the normal regulatory confines of banking in order to satisfy their customers seeking high returns. In the process they created a large number of shadow institutions – Investment Banks, Hedge Funds and the like. These shadow institutions grew over time to be systemically important. Through securitization and other means, the banks convinced themselves that the risks were spread out.
The complex instruments presumed to minimize the risk with the original issuer and guarantee a high return for the investor who bought them. In the end those created them did not comprehend their risks. Hence, IMF prescribes brining shadow banks within the ambit of regulations.
Hence, winding down global imbalance and enhanced regulation will be the key measures that would be agreed upon as a solution to the global economic crisis.
====================================.
So far there has been no unanimity on the factors responsible for the crisis. There have been two different, but mutually exclusive view points on what is behind the crisis.
According to one view, the financial sector debacle has its origin in the “Global Imbalance” – the phenomenon of large current account surpluses in China and few other countries co-existing with USA with a large deficit. The global imbalance is reflected in the large mismatches in the current account positions of some countries and their mirror image in the form of domestic savings – investment mismatches.
The US has been running huge deficits. Countries such as China and Japan needed an outlet to deploy their surpluses. It was mutual convenience, as it were, for the savings of Asian Countries to find a haven in the U.S which needed money because it saved very little. The money from the Asian surplus countries flooded the US market that kept the interest rates low, inflated the prices of real estates, shares and other assets. When the bubble burst, the financial sector crisis surfaced. Hence, an orderly unwinding of the imbalance alone would help mitigate the crisis. If this is so, macro economic policies of countries need fine tuning.
The US Govt’s unsuccessful effort to persuade China to revalue the yuan to make their exports less competitive points to the belief that the global imbalances to be the primary reason for the global economic crisis.
However as per the totally different view expressed by the IMF in a recent paper, global imbalance is only an indirect cause. The main culprits were the deficient financial regulation and the failure of market discipline resulting in a systematic flouting of rules and regulations by banks.
1. Deficient Financial Regulations.
2. Failure of market discipline leading to systematic flouting of rules and regulation by the banks.
The sub prime crisis showed that almost all the banks used their ingenuity to develop structures and products that were outside the normal regulatory confines of banking in order to satisfy their customers seeking high returns. In the process they created a large number of shadow institutions – Investment Banks, Hedge Funds and the like. These shadow institutions grew over time to be systemically important. Through securitization and other means, the banks convinced themselves that the risks were spread out.
The complex instruments presumed to minimize the risk with the original issuer and guarantee a high return for the investor who bought them. In the end those created them did not comprehend their risks. Hence, IMF prescribes brining shadow banks within the ambit of regulations.
Hence, winding down global imbalance and enhanced regulation will be the key measures that would be agreed upon as a solution to the global economic crisis.
Informative article..
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