Subprime Mortgage Crisis and East Asia - Research Paper Example

? Introduction The global economy is affected by the world financial and economic crisis that has become harsh since the mid of 2008. This crisis is as a result of the introduction of the subprime mortgage issues in the United States that manifested in the mid of 2007. Europe was the first place to receive the impact of subprime mortgage crisis, but the effect spread in the rest of world afterwards. Justin and Boris (2011) indicate that the East Asia would not resist the impact that was affecting most of a global economy. The subprime mortgage crisis in the United State was more severe than the great depression because several assets and derivatives had been purchased and sold in the unstable market. Moreover, the subprime mortgage crisis had several liquidity risks compared with that of the exchange traded products. According to Justin and Boris (2011), commercial banks finance in the East Asia asks for the mortgages without considering the credit evaluation of the borrowers. Thus, the paper will evaluate the financial crisis issues that were triggered from the U.S sub-prime mortgage crisis, and affected the East Asian economy. The sub-prime mortgage crisis The sub-prime mortgage crisis was a result of the speculative issues in the housing market that commenced in the United State in 2006. It has caused severe impact across the East Asia countries in the form of financial crisis and the country’s credit crisis. Justin and Boris (2011) indicate that the forces caused by the sub-prime mortgage crisis will probably run out of control for years, causing the collateral damage. The disruption in the East Asia countries credit market is of historic proportions and will have significant economic impacts. Moreover, the crisis has caused essential societal changes that affect the consumer habits and the values. Justin and Boris (2011) indicate that the East Asia economy was affected where the GDP was recorded 4.2, 4.8, 5.7 and 1.9 per cent from 2005 to 2008. This led to the ever recorded a decrease in GDP in 2009 that amounted to -4.0 since 1980. Therefore, this crisis has significantly affected the Europe and Asian countries, and most of the Asian countries have rearranged their financial and banking industry. Delgado and Burge (2009) claim that the proximate cause of the sub-prime mortgage crisis was the busting of the housing issues in the East Asia during the summer of 2007 when subprime defaults commenced to rise and foreclosures increased. It then spread to prime loans and other types of consumer credit, and the financial institutions with the subprime related products were severely affected. The Asian countries were severely affected by the sub-prime mortgage crisis during the early stage of the crisis because the banks were not exposed to the dangerous assets that were engineered and crafted in the United State. According to Delgado and Burge (2009), the data gathered in the Economist and Financial Times, the $500 billion was written off by banks globally in the 2008. The financial institutions in Japan accounted for only five percent, and its sectors were relatively resilient. The global financial crisis has affected the China and Japan very strongly as they stand among the most opens in the world. Foreign capital inflows declined significantly as commercial banks and foreign institutional investors withdrew funds to meet redemptions in their countries. According to Delgado and Burge (2009), private capital flows in China slowed from $516.7 billion to 2007 to an estimated $134.4 billion in 2008. Table of the GDP of the East Asia countries 2007 2008 2009 China 11.9 9.7 8.5 Japan 2.1 0.5 -0.2 Korea 5.6 3 3.9 2.1 Modified from: IMF (2008a) According to Ghon (2008), the Banking leading declined that was as a result of the direct and indirect equities. During 2009, the capital flows were estimated to be only $44.1 billion, and in the beginning of 2008, stock markets declined by about 62 percent in China (Ghon, 2008). Thus, the Chinese stocks markets had been the worst performer in the region decreasing over 65 percent. The capital inflow has demanded decrease in China’s exports dramatically because of the global economy slowdown (Ghon, 2008). Meanwhile, the growth forecasts for Japan and China both private and public sources like IMF and the World Bank have been slowed down greatly. The IMF issued a worrying forecast for Korea predicting that the economy could contract by four percent in the 2011 (Ghon, 2008). The forecast for the Chinese economy also has marked down and the social impacts of the financial crisis including unrests are causing unemployment. The increasing financial crisis has caused several central banks in china and Korea to lower interest rates to low levels. Their governments have been pressured to make a purchase of nonperforming loans from significant banks to assist them maintain liquidity in their lending tasks. Moreover, they have been forced to recapitalize significant institutions, and using expansionally fiscal policies. These expansionally fiscal policies involve the cutting down of taxes and increasing expenditure in order to promote the aggregate demands. According to Lee (2008), the financial crisis has affected the Japanese yen and Chinese Yuan that has reduced their values against other currencies. Banks and financial institutions in China and Korea have suffered large losses that have impaired their own capital (Lee, 2008). The gradual decline of their creditworthiness led to a sharp decrease in transactions in the interbank markets. The decline in their stock prices caused degradation of their financial stability in the global economy. This continued until the money, debt securities and stock market deeply declined causing difficult situations for the financial and non financial firms to receive funds. Currently, the United State is facing budget deficit and it is asking support from china to support its debt issuance (Lee, 2008). China is being pressed to revalue its currency upward in order to open its financial market to allow free capital flow with flexible currency exchange rate. Impact of Revaluation of china’s currency According to Frankel and Rose (2000), the revaluation of china’s currency will cause vast capital inflows into Yuan, but Chinese government intervention can expand the Chinese reverses and raise its purchases of treasures. It is believed that the increased purchase of the United State treasury bonds will at least solve its financial problems. However, its will create problems to china because the savings of the hardworking people will disappear overnight via inflation and hyper inflation like the case of the financial crisis in the East Asia. Lee (2008) indicate that the hyperinflation in America would affect the China economy because it has tried had to integrate with the United State via trade dependency and holds dollar asset to match trillion dollars. China will lose all her foreign currency reserves and her exporters will lose tens of billions in bad debts via trade credits and other financial arrangements (Teranishi, 2005). This will affect the china’s economy that will result in the high unemployment, reduced wages and hyperinflation in the country. In order to rescue the United State from the financial crisis, President Obama has created a relationship with China, the significant supplier of cheap credit. Teranishi (2005) indicate that the main strategy of United State is to maintain dollar hegemony with China that will the economic surplus accumulated by china to remain a part of United State financial system. However, this relationship will create severe conditions for the Chinese people, as they will be submitted to a perpetual low standard of living. Meanwhile, this has led to decreased in the technology development, environmental deprivation and resources exhaustion in the region. Meanwhile, the relationship has secured the conditions of the Chinese economy crises that are inevitable in the capitalist economy like United State (Teranishi, 2005). This has led to current economic crisis, exports to America from China has declined drastically by the last half of 2008. Several as 67,000 factories have closed in china that led tens of millions of employees being laid off in order to improve the situations (Teranishi, 2005). Moreover, this has resulted into labor disputes and protests over the loss of back pay that has become common incidents in the China. According Frankel and Rose (2000), this situation has contributed to instability in Chinese community and has caused critical condition. In order for China to avoid this revaluation impacts, it should change its strategy by avoiding trade dependency and break away from the America trade orbit (Teranishi, 2005). As a result china would be capable to concentrate her efforts on improving domestic economy, protecting national industries and securing the welfare of its people. With the current account surplus up to 8 percent of GDP and increasing, China is now viewed as a country with significant misalignment in its exchange rate. According to Teranishi (2005), the china’s domestic structural problems have been contributing to the global imbalance in the economy. The most significant impact of revaluation of currency is actually its domestic saving and consumption imbalance, and not the exchange rate disequilibrium. No matter how fast currency revaluation is, if the system constantly generates a saving rate up to 50 percent of GDP, the surplus will not be successfully be decreased (Shah, 2009). The Chinese currency should be revalued because it is increasing the Chinese productivity. The country should promote its domestic economic structure in order to decrease the saving and current accounts surplus. For China to improve the situation, it should reform its fiscal, financial and the social system that will lead to economic expansion and employment production. In 2003, the United State administration and the IMF commended china for holding on to the fixed regime against market speculation for renminbi devaluation. Bankruptcy due to huge deficits in Japan Before, the financial crisis in the 2007, Japan was supplying about 60percent of the funds of global total credit markets and utilizing capital inflows from abroad (Shah, 2009). In order to react to the crisis, Japan had to think about the United State and Europe banks that were providing funds to Japan. During the financial crisis, Japan had neither capital flight nor sharp depreciation on the Yen currency. This led to large budget deficits, but it was financed by domestic sources of Japan’s status as the biggest creditor in the world. Japan incurred large deficits in international trade, current accounts and accumulated large reserves of foreign exchange by running a surplus in those accounts (Shah, 2009). Decrease in stock market values reflected huge changes in expectations in Japan, and flight of capital from asset led to increases in risk. Japan banks lending was directed to commercial activities, the difficulties faced by the trading companies spilled over to banks. Thus, the bankruptcies of the medium city bank during the financial crisis were caused by non performing loans to trading companies (Shah, 2009). The failure of trading companies and decline in exports of indigenous and light industry products in Japan spilled into the rest of the economy. Unemployment crisis Japanese banks fully integrated Basel two starting in March 2007 before the European and United State. East Asia accounts are estimated to be one eighth of the global GDP, but it contains one third of the global population (Shah, 2009). The export sector and related service institution are the source of labor of many people in Asia. During the crisis, these sectors were severely affected, and forced to lay off employees rather than absorbing unemployed labor. Shah (2009) approximated the average global unemployment rate in 2009 to be 6.1 percent, while that of Asia was estimated to amount 34 million. In the 2009, the Chinese announced that about 10 million migrant employees had lost their jobs in China as the world economic crisis deepened. Meanwhile, Japanese administration reported that in April 2009, they had to change unemployment rate in Japan to five percent. Korea recognized that its unemployment rate increased for the first time in the past five years to 3.6 percent in January 2009 (Shah, 2009). These countries have not established a stable social security system because they lacked the effective buffer methods. That means the mainstream of lay off employees do not get adequate social support that would enable them to make a living losing their jobs. Barro (2000) indicate that the social instability in these countries as a result of financial crisis is connected with the increase of unemployment. Maintaining economic growth to offer new job opportunities has been the effective mechanism in the East Asia to reduce the unemployment rate. However, the financial crisis has declined the pace of economic expansion in East Asia and decreased the market’s ability to offer jobs opportunities. Deshpande (2011) indicate that the financial crisis further motivated the conflict that existed in the labor market as millions of new unemployed workers flowed into the market when industries were forced to lay off workers due to market tightening. According to Barro (2000), globalization offered an opportunity for East Asia countries to recognize the rapid economic growth after the mortgage crisis. Several rising economies in East Asia followed Japan’s strategy and commenced industrialization process guided by a trade led growth strategy. According to Deshpande (2011), the financial crisis exposed the weakness of the regional economy, mainly in the financial sector. The strategy the East Asian countries like China suffered severe impact from the financial crisis because they had liberalized their economies too quick and ignored that the domestic financial markets and institutions were still immature. The financial crisis affected the Korea mainly as a currency crisis, leading to a sharp depreciation of the Korean that drained off its foreign exchange reserves. Unemployment table of the East Asia Three countries Unemployment rate period source China 4.3% March 2009 National Bureau of Statistic, China Japan 5% April 2009 Ministry of internal affairs, Japan Korea 3.9% May 2009 National Bureau of office, Korea Managing financial or economic crisis in East Asia The countries have managed to improve the regulatory surrounding the operations of the financial markets that have assisted in preventing a stock market crash. According to Saw (2010), capital controls have prevented large scale speculative capital movements that were the underlying cause for the 2007 Asian financial crisis. As a security, china’s policies towards promoting the financial system have been strategized along the supportive fiscal and trade policies. According to Saw (2010), East Asia countries like china should promote its domestic economic structure in order to decrease the saving and current accounts surplus. For China to improve the situation, it should reform its fiscal, financial and the social system that will lead to economic improvement and employment creation. China administrative adopted various solution measure, including diversifying its foreign reserve assets in order to encourage people who owned enterprises to invest more internationally. This would help the country to improve the value of Yuan that will speed up its domestic devolution. According to Saw (2010) the East Asia should focus on the domestic structural adjustment to decline macroeconomic imbalances by promoting greater domestic consumption. This can be done via increasing household income, offering more public social products, opening up more services activities and liberalizing products prices. Saw (2010) indicate that the East Asia growth model should shift from being export and investment to the one that is motivated by the domestic consumption. This would not only stabilize the East Asia foreign exchange reserves, but also render East Asia economic growth more sustainable in the long run. East Asia should think critically about taking bolder steps towards deeper and inclusive economic cooperation. Saw (2010) indicate that the greater regional integration could become a new source of East Asia trade growth that would operate as a buffer against future external demand shocks arising from outside the region. Meanwhile, in order for the Korea to prevent the effect of the financial crisis, it should avoid the myth of having strong economic fundamentals and work towards reducing the discrepancy in the market foreign exchange. Learning from the financial crisis and Japan’s prolonged economic crisis, the Chinese administration has made a huge effort to reduce non-performing loans. These improve corporate governance and manage a controlled floating exchange rate for the country. Conclusion The worldwide financial crisis that was triggered by the subprime mortgage crisis of 2007 brought a sharp decline in East Asia export that led to rising concerns over unemployment and social instability. Meanwhile, the Asian countries out looked export that created an adverse chain reaction in the trade development of East Asia economies due to their expanding trade interdependent. Maintaining economic growth to offer new job opportunities has been the effective mechanism in the East Asia to reduce the unemployment rate. The sub-prime mortgage crisis was a result of the speculative issues in the housing market that commenced in the United State in 2006. It has caused severe impact across the East Asia countries in the form of financial crisis and the countries credit crisis. East Asia countries like china have spent a vast amount of fiscal funds on encouraging industrialization. However, this strategy has suffered moral hazard and corruption problems that make hard for countries to curtail the severe impacts of financial and economic crisis. References Barro, R., (2000) “Inequality and Growth in a Panel of Countries." Journal of Economic Growth, vol. 5, no.1, PP. 5-32. 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