Discuss the possible causes of the financial crisis. Do you think GFC could be repeated again? Discuss. Explain the scale and impact of financial crisis in economies of different countries including your own country, identify some of proposed reforms.
We have witnessed in the 20th century and before problem related to credit risk, financial crisis, fiscal deficit crisis, banking fund crisis, economic crisis, the great depression, oil price increase/decrease, currency crisis, housing bubble crashes and more all if the above crisis are to some extent interrelated with each other as a part or whole.
Financial crisis can be termed as a situation where financial assets starts losing their value suddenly e.g. stock markets downfalls, burst or crash of financial bubbles, currency crises, negative GDP and sovereign defaults, etc (Viney, 2009). The main reasons for the financial crisis can be global as well as domestic but as the world economy is mostly governed by the American and the European economy the situation of financial crisis on any of this zone can bring a huge financial crisis in a developing country as there economy are very much dependent on them. In the very basis context we can understand that the main crisis in an economy starts when a country is unable to break even and this scenario when takes place in the industry, country or globally then the crisis begins in manufacturing/service sectors or when a financial bubble bursts in the economy as a whole.
Crashes: This is an unpredictable loop hole where the investor expects that a price of asset will increase day by day and there are potential buyers readily available at the higher prices but when this scenario reverses investors want to sell the asset at any ready price given which has cumulative effect of a crash. Some of the examples of crashes are Wall Street Crash of 1929, Japanese property bubble, etc
Balance of payment crisis: Where the country is unable to maintain a current account deficit they are forced to devalue their currency to sustain this deficit and so the buying capacity of the consumer reduces to a great extent (Wood, 2005).
Banking crisis: Bank run is one of the major reasons of banking crisis. This situation is seen when there is a sudden rush of withdrawal by the depositors from banking system and banks are unable to payback this sudden demand and the bank tend to become insolvent as a result depositor loses its money. Countries like Argentina, Uruguay and Myanmar have faced bank runs in the 20th century (Copelovitch & David, 2008).
Currency crisis: This type of crisis occurs when central bank of a country is unable to maintain a fixed exchange rate of currency due to decrease in foreign exchange reserves. This type of crisis is the main reason for the failure of economy of any nation as it increases the probability of banking crisis and default crisis. This type of crisis is mainly witnessed in the developing economies and not to that extent in stable economies of the world (Copelovitch & David, 2008). The countries that witnessed this type of crisis are Mexico, Asian region countries, Argentina, etc.
Recession: One of the foremost reasons for a financial crisis is recession in a country. It is said to be a recession in country when the growth index of a country i.e. GDP is negative for a period of six months or more. Recession results in unemployment, winding up of businesses, decreasing living standards of people resulting in a more decrease in demand. This situation has been witnessed by countries once in a century by seeing the historical trends.
Hyper Inflationary recession: The price of goods are increased to such a extent due to inflation that people experience difficulty in doing day to day transactions as the value of currency has a reduced to a great extent. The best example of such recession is Kenya.
Speculative overpricing: This type of crisis occurs when certain types of assets value are increased to a great extent and these prices sustains at that level for a long period of time. People want to have a capital gain instead of regular income flow and as a result when the prices of assets decreases in an economy people are willing to sell them even at a capital loss ( Mishkin & Eakins, 2009).
A Mismatch in assets and liability of an economy: Where the apex authority of a economy is running down a large amount of funds in the country against a small amount of asset present with it e.g. where banks gives long term debt to companies against deposits of general public this situation leads into a crash when depositors demands there funds immediately in large numbers (Mathai, 2012).
Real Estate Bubble: A situation where a sudden rises in the prices of real estate is witnessed by a steep down fall in the prices of real estate.
Failure of regulatory framework: Excessive and ineffective regulatory systems both are dangerous for an economy. Excessive regulations invite trouble like when there is shortage of capital in economy the regulator demands from banks to maintain more amount of reserves with it which brings huge capital shortages (Mathai, 2012). Ineffective regulatory looses the confidence of its investors and have to face a shortage of fund in the economy as an unconfident investor withdraws money.
Financial Frauds: One remembers the name of the famous Lehman brothers as soon as we hear financial frauds in the context of global economy. These types of frauds occurs when the directors fails to exercise their fiduciary duties towards the company. Some financial frauds occur when companies attract investors on large scale in the fraud schemes/ plans and go bankrupt.
Bankruptcy: This situations also known as leverage of funds can be explained as companies borrows more to invest more so as to earn a large amount of money from its investments but when this plan fails it arises a situation where companies are unable to pay the borrowed amount by it and thus leads to bankruptcy (Bottomley, 2007).
Dependence on Foreign direct investments: The amount of dependence on the funds from a foreign economy brings a lot of trouble when the domestic scenario seems unstable as investors are always concerned about their money as their main motive is wealth creation at minimum risk. So when these investors withdraw money it causes capital shortages in economy (Bottomley, 2007).
High oil prices: Increase in oil reserves and the petro credits forced the improper lending of economy and foreign reserve outflow (Maxfield, 1997).
Ineffective monetary and trade policies: Ineffective trade policies of countries kept the value of their currencies depreciated against the globally accepted currencies like US Dollar, Euro, etc. that depressed the banking system to a large extent (Austin & Bilski, 2008).
Ignorance of historical trends: History always repeats itself sooner or later as people sometimes don’t learn from their mistakes and makes decisions which hurt them sooner or later (Singer, 2007).
Many of the above mentioned factors contribute to the global financial crisis. In a recent report International Monetary Fund (IMF) has warned against the financial crisis arising in near term due the troubles being faced by the euro zone. It has also forecasted a cut of 4% over the next five years in global output which is clear evidence of the world economy being moved towards the recession it witnessed in 2008-09 (Mankiw & Taylor, 2011).
The decreasing oil prices either due to competition or due to terrorism activities is resulting in the crisis in the oil producing nations at some points of time the prices are falling to such an extent that it seems to be even less than the production costs to those companies this type of event occurs due to negative competition produced by terrorism activities (Cahill & Stilwell, 2008).
The failure of Greek economy in the end of 2015 is going to have an effect on World Bank as the country is unable to pay heavy debts on it. The currency is regulated so much that there is even restriction on withdrawals of your own funds.
Chinese economy infusing funds and a reduction in its growth rate due to less demand of the goods produced by them is a big economic event as funds are largely blocked in the developing countries by various fund managers and developed countries.
All the above mentioned events when examined can cause a global financial crisis if persist on a longer period of time. So there is very much chance of crisis being repeated if the scenario don’t improve. Therefore, it is important that the regulatory must come to the forefront and brings a balance in the economy (Mankiw & Taylor, 2011).
United States of America:
The purchasing power of the consumers came down considerably which made a huge gap in the demand supply chain, there was a cut of millions of jobs due to which unemployment increased, banks failed considerably which resulted in a large amount of funds infusion by the government so long time frame of recession caused depression. Reforms were made in the form of making some acts like Dodd-Frank Act, Systematic risk regulation, formation of financial stability oversight council, etc.
European Countries:
The major trend of recession was seen when the industrial production fell nearly 2% in a single month in 2008 recession which resulted in lower circulation of money and reduction in exports. The tourist cantered countries in the zone noticed a sharp fall in the number of tourists attended there was a sharp fall in the currency rates as compared to other countries.
The European Commission has come up with the European economic recovery plan which focused on reforms in taxation, incentives and social impacts.
Pakistan:
First and foremost effect of financial crisis on a developing nation is reduction in growth rates. The target in the year 2009 for growth was 3.3% which actually was possible only up to 2% this was due to a heaving cut in exports due to great recession in developed nations and an increase in an import bill of country in the same year. The privatisation program also slowed down as foreign companies which made it successful before are trapped in the slow down. Foreign direct investment was reduced to half due to financial crisis.
The reforms implemented by the State Bank of Pakistan helped it emerge very strongly and nearly unscathed, no major collapses and no governmental write offs were witnessed.
China:
China economy is investment and export led economy so any financial crisis in the developed economies gives a big blow on the current level of export as purchasing power reduces outside and rotation cycle of money increases within the economy. This type of system forces government to infuse funds in economy on timely basis.
Russia:
The stock markets witness a major blow initially but later on it emerged very sharply as best performer due to its short term fundaments in 2008. Country highly depends on crude oil exports which faced a steep fall of 70% in 2008 making it a trouble for economy to sustain. The major reform taken was to devalue the currency which resulted in a short term reserve fall but a long term strong recovery.
Conclusion
The global financial crisis has no link with any person or mistakes by a state. However, it can be defined as the collective failure and matter of weak policies. One thing that needs to be noted in this regard is that the happening of GFC cannot be attributed to a single day but happens due to wrong policies over a period of time. Moreover, the financial crisis stressed on the negligent nature of the regulatory system and also the deficiency when it comes to the part of supervision. The influence was seen in both the developed and developing countries but the strong policies in the developed counties like Australia ensured that the harm was extent and that the economy was restructured in a short span of time. To make sure that any further crisis is averted, the financial structure of the economy should be balanced in a manner that will negate any adverse situation.
References
Austin, R. P. and Bilski, A. Y 2008, An Introduction to the Conference Themes in The Credit Crunch and the Law, London Press
Bottomley, S 2007, Australian Share Ownership Study, viewed 19 May 2016, https://www.asx.com.
Cahill, D and Stilwell, F 2008, The Sub-prime Credit Crisis Could It Happen Here? viewed 19 May 2016, https://www.ampcapital.com.au.
Copelovitch, M.S and David, A.S 2008, ‘Financial Regulation, Monetary Policy and Inflation in the Industrialized World’, Journal of Politics. pp.680
Mishkin, F.S and Eakins, S.G 2009, Financial markets and institutions, Australia
Mathai, K 2012, Monetary policy: stabilizing prices and output, International Monetary Fund.
Mankiw, N.G.; Taylor, M.P 2011, Economics, Andover: Cengage Learning
Maxfield, S 1997, Gatekeepers of Growth: The International Political Economy of Central Banking in Developing Countries, Princeton: Princeton University Press
Singer, D.A 2007, Regulating Capital: Setting Standards for the International Financial System, Ithaca: Cornell University Press
Viney, C 2009, McGrath’s Financial Institutions, Instruments and Markets, Sydney
Wood, D 2005, Governing Global Banking: The Basel Committee and the Politics of Financial Globalization, Aldershot: Ashgate.
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