The present crisis is different from the 1980 or the 1997/98 crisis because it is a double combination of a breakdown in the financial system and a recession in the real economy. The recession started earlier in the US sometime in middle of 2007 and the financial crisis began in the UK in September 2007 but accelerated in the USA in early 2008 with the failure of Bear Staerns and other banks. The bankruptcy of Lehmann Brothers in September 2008 was a decisive event after which USA and UK decided to recapitalise their banking systems massively and also initiate a fiscal package for reflation. This has been done across the developed countries and in China. The G20 meetings in November 2008 and April 2009 deepened this resolve.
The causes of the financial crisis are still being debated. But the main one is the financial imbalances in the global economy. China accumulated large financial surpluses from its exports . China along with many other countries of Asia over-saved. To make such savings paying someone had to over-consume. USA did this job by running a double deficit on fiscal and external accounts. China lent its surpluses to USA which financed the deficits at low interest rates. Chinese exports also kept inflation in manufacturing products low. Thus the global economy had a virtual boom for fifteen years from 1992 to 2007 but it was the years from 2001 to 2007 which had cheap credit at its centre.
This cheap credit in the USA could not find profitable productive investment channels so it went mostly in real estate investment. Lenders began to extend loans to less and less creditworthy borrowers –sub-prime mortgages. Because these mortgages were packaged together and sold forward as equities, it gave the lenders an impression that they had transferred the risk to other people. The equitisation also saved the original lenders’ own resources so they could lend some more. A huge inverted pyramid of credit was constructed on this basis. When doubts began to appear that the real estate prices may not continue going up and when the speculation in commodity prices stoked inflationary fears and interest rates began going up, the boom collapsed.
The global economy had enjoyed a boom for 15 years. The capital inflows to developing countries had gone up from $ 200 billion in 1992 to $ 900 billion in 2007. It is now down to $ 200 billion. This is the first effect of the crisis. The developing countries –China and India especially benefited form the long boom . African countries began to see some fruits in the first years of the new century. Now there will be a setback. Many banks have lost their capital values and the financial sector will shrink. Countries such Iceland, Hungary, Estonia have bankrupt banking systems. In OECD countries output loss has been massive -15 % in Japan , -7% in Germany etc. Unemployment has gone up very sharply.
It is difficult to say who will emerge as new powers in the future. Innovations will be called for and once again USA is most likely to be the innovative economy. The challenge of global warming requires a reconfiguration of the fuel use technology and most likely electric cars and new carbon efficient technologies will have to replace most of the present energy using machinery.
The global financial architecture needs reform and IMF may need to restructured to achieve this. Then any financial surpluses will be recycled not via the USA but via the IMF. |
