What Are Global Imbalances and Did They Cause the 2008 Crisis - Essay Example

What Are Global Imbalances? Did They Cause The 2008 Crisis? What are Global Imbalances? Did they cause the 2008 crisis? One of the crucial global economic concerns prior to the 2008 crisis was the existence of large ‘global imbalances’ that relate to the extreme and persistent current account deficits experienced in the American economy. Global imbalances relate to the situations where some nations possess more assets in comparison to other countries in the global context. From a theoretical perspective, inflows and outflows of capital tend to experience cancelation when the current account is in balance, thus the existence of zero value. Numerous researchers tend to focus on the examination or assessment of the relationship between the global imbalances and the 2008 financial crisis. Some researchers note that the global imbalances did play a critical role in the 2008 crisis. On the other hand, other researchers note that the global imbalances had little to do with the 2008 crisis. In essence, the economic research paper seeks to demonstrate that global imbalances did not cause the 2008 crisis. It is noteworthy that there were global imbalances between the U.S economy (deficit nation or country) and the Southeast Asian and oil-exporting, as well as European nations (Superavit nations). In the course of understanding the connection between the global imbalances and the 2008 crisis, it is ideal to note the influence of the other economies on the economy of the U.S. In the first instance, it is critical to note that the current surpluses were available in the U.S. financial markets (Caballero et al., 2009). The outcome of the current surpluses was evident in the pushing down of the long-term interest rates, thus the potentiality and ability to promote, as well as engage a credit boom and the real estate bubble. Moreover, there was substantial or significant increase in the risks of the size of the economy involved in the global imbalances, as a sever correction could have had negative implications for the global economy. In the process of evaluating this relationship between global imbalances and the financial crisis, it is critical to assess the implications of two pre-crisis perspectives (Dooley, Folkerts‐Landau, & Garber, 2009). First, it is ideal to concentrate on the assessment of the new paradigm. According to this perception, global imbalances provide a new type of global equilibrium which could undergo substantive maintenance over time without necessarily ending in crisis. One of the approaches towards maintenance of the global equilibrium was saving glut rather than the implementation of any policy intervention (Nier & Merrouche, 2010). From that perspective, it is crucial to note that the large negative net foreign asset position of the U.S was fully sustainable, thus could not lead to the worldwide financial crisis. On the other hand, the traditional view notes that global imbalances generate a dangerous situation which leads to serious risks to the international economic, as well as financial stability. According to this perspective, the source of the problem concerning global imbalance relates to the decline in the savings rates in the U.S (deficit economy) which had the tendency to generate large, as well as prolonged current account deficits. In addition, overly lax fiscal and monetary policies were essential in the generation of the decline (Bini, 2008). There is substantial need to correct the global imbalances with the intention of eliminating or preventing any loss of confidence. Failure to handle the issues in relation to global imbalances might lead to a sudden stop of the capital flows leading to the depreciation of the dollar (Serven & Nguyen, 2010). It is critical to note that the economic crisis did not materialize in accordance with the expectations of the advocates of the ‘traditional’ view or perspective. For instance, there was no loss of confidence in the economy of the United States. In addition, there was no sudden stop of capital flows into the American economy. Similarly, the break came in the presumably stronger component of the new global equilibrium with reference to America’s financial system. In examining the relationship between global imbalances and financial crisis, it is essential to examine why the U.S financial market was the main recipient of these flows of savings. In addressing this question, it is essential to note that the capital exports from the emerging markets, particularly to the United States’ financial market were perceived as logical consequences of the inter-temporal optimization process (Wade, 2009). Moreover, the selection of the financial market of the U.S as the main recipient of savings from emerging market economies, as well as oil-exporting nations was based on the quality, effectiveness, and efficiency financial system. Foreigners investing in the United States’ equity and bond market earned lower returns in the past five years prior to the crisis in comparison to the amount they would obtain following investments in their own nations (Whelan, 2010). Nevertheless, there were still numerous or diverse reasons why they might choose to engage in the investment in the financial systems, thus financing the large current account deficit in the United States. Similarly, foreign investors focused on purchasing the United States’ portfolio investments with the intention of benefiting from highly developed, liquid, and efficient financial markets. Furthermore, such entities might choose to exploit the strong corporate governance, as well as institutions in the U.S to facilitate diversification of risks (Forbes, 2009). After the crisis, there was a substantial degree of financial connectedness between the developed nations that was not accounted for when formulating the ‘savings glut’ hypothesis. For instance, the European Union nations, without the external current account imbalances as a whole, had the tendency to act as the active agents in the context of American financial markets under the influence of the international banking systems and institutions (Acharya & Schnabl, 2010). In addition, there were diverse compositions of the portfolios in accordance with the origins of the capital flows. Furthermore, the emerging nations or countries accumulated mainly safe, as well as liquid assets in the course of operating in the financial market (Dooley & Peter, 2009). It is essential to note that the European banking systems had substantive and clear preference in relation to the risky assets under the financial assistance through borrowing within the context of the financial markets in the U.S. The situation got worse because of the mismatch between the maturity terms and the structure of the currency in relation to the assets, as well as liabilities under the ownership of the European banking systems and institutions in the case of the U.S (Obstfeld & Rogoff, 2009). Taking this into consideration, the significant role of the European banking systems and institutions in the U.S financial markets undermines the critical notion that the global imbalances were essential in executing causal role in the crisis. It is impossible for the economic practitioners and researchers to explain the fall in the long-term interest rates in the U.S while utilising volumes of the capital flows from the European nations, as well as the emerging and oil-exporting nations. It is only possible to sustain the perception relating to the influence of the external capital flows on the interest rates through incorporation of the flows from the European Union nations or countries (Borio & Disyatat, 2011). According to the empirical evidence, there is a substantive weakness in relation to the relationship between the current account imbalances and the 2008 crisis. This is through turning of the analytical attention towards an examination of the fragility of the financial, as well as the monetary system. These come out as the fundamental causes of the 2008 crisis. In the evaluation of this new perception, it is critical to incorporate the net capital flows as the essential variable with reference to the concept of the ‘savings glut’ advocates. Nevertheless, it is critical to note that net capital flows have lost explanatory relevance; thus, the perfect opportunity for understanding the growing influence of the gross capital flows in the analytical importance (Truman, 2010). In this context, it is essential to note that net capital flows only consider a small part of all capital movements in the global capital flows. Furthermore, it is vital to analyse the capital flows cycle of boom, as well as burst that affected the global financial conditions rather than exclusively in the context of the domestic economies with reference to the destination economies. The United States’ financial market had to address a stressful issue by large inflows in relation to the foreign capital. It was essential for the policymakers to avoid the management of such capital flows through the high-risk financial innovations. This is though subjecting the financial systems and market to the strict controls. In this context, the new research notes the influence of substantive mechanisms to prevent future financial crises through the implementation of the new regulations to limit expansions of credit (Dunaway, 2009). There are diverse perceptions in relation to the need to correct global imbalances with the intention of overcoming the financial crisis. These perceptions remain divergent. For instance, certain economic practitioners believe that the current account imbalances in relation to the 2008 crisis were irrelevant in the economic context (Acharya & Schnabl, 2010). This makes it essential for the policymakers to concentrate on reforming financial systems with the intention of preventing the occurrence of global financial crises in the future. In addition, such global and account imbalances are irrelevant, thus the need to take corrective measures in the medium term. Some of the crucial reasons for correcting of the global imbalances include inter-sectoral changes relating to the existing account imbalances. These imbalances manifest in the excessive growth of the non-tradable goods sectors with costs concerning the reduction in the productivity growth (Whelan, 2010). Deficit financing has the potentiality to create or generate problems with respect to the credibility of the capital markets. According to economic practitioners, European Union, as an institution, had a balanced current account in the critical years leading to the 2008 crisis. Nevertheless, nations within the European Union had widely divergent balance with reference to the payment positions. The ‘savings glut’ hypothesis tends to demonstrate different characteristics to the ones of the European Union. From the EU perspective, relatively less developed nations focused on the presentation of the account deficit. On the other hand, the relatively developed countries focused on the presentation of the account surpluses. It is critical for the imbalances to begin to reverse because of the real convergence between nations. Figure I: Global Imbalances 1996-2015 (Source: Suominen, K 2010, “Did global imbalances cause the crisis?” VOX CEPR’s Policy Portal.) There are diverse causes or issues that tend to determine intra-European imbalances. In that context, the observed imbalances have the tendency of responding to the expansionary policies within the southern economies which do not adhere to the process of convergence. Similarly, these intra-imbalances might emanate from the loss of competitiveness of the economies with reference to the case of Southern Europe. This is because of the significant changes in the real exchange rates, as well as other factors such as the demographic factors. Deficits tend to appear to relate to the expectations of the growth and development in the future context, thus suggesting the influence of the deficits as part of the process relating to the real convergence. Loss of competitiveness comes out as one of the critical determinations of the deficit nations. Loss of competitiveness relates to the growth model like in the case of Germany following the German reunification, thus the reduction of the unit labour costs emanating from the reduced public and private wages. There was also erosion in the union bargaining power leading to loss of competitiveness. It is also critical to note that the differential evolution of inflation rates might have led to the loss of competitiveness in association with the deficit economies. From this perspective, the effects of the diverse trends within the unit labour costs and inflation rates were critical in helping worsen the real exchange rates with reference to the case of the deficit countries. According to the empirical evidence, age structure of the population is vital in influencing the saving rates, thus the eventual implications in the account balances. Prior to the 2008 crisis, there were economic alarmists and optimists. It is essential to note that imbalances grew in the early 200s while peaking at 6.5 percent in relation to the GDP of the U.S in 2006. During this context, the Congress threatened steep tariffs against China, thus the tendency of the Bush administration sought to implement various remedies inclusive of the IMF consultation with the surplus nations. According to the ‘alarmists’, the U.S was in for the sudden stop, as well as hard landing, thus the capital flight prior to the collapse of the dollar, increase in the interest rates, and decline in the output. There were numerous concerns. Some of these concerns include declining in the United States’ private savings, rising energy prices, growing budget deficits, relative exchange rates, and the focus of the tradable by the nations engaging the American economy. On the other hand, ‘optimists’ saw the influence of the imbalances as a symbiotic pattern with the potentiality of the channelling the surplus nation savings with the intention of achieving safe, as well as liquid destinations. The symbiotic pattern enjoyed the greater availability of credit. In addition, the optimists note the need to keep the fiscal deficits in check, thus enabling the United States’ current-account deficit to be near permanent. In the accounts, the landing was neither imminent nor hard with all factors remaining constant. Some economic practitioner focused on the examination of the flexibility of the capital markets, thus facilitating America’s ability to borrow more. Moreover, the world economy would have the perfect platform to absorb any of the United States’ adjustments, effectively and efficiently. Conversely, some economic practitioners hypothesized that the America’s unique aspects were vital in keeping the economy of the U.S safe against any sudden shocks, as well as hard landings. From this perspective, the economy of the U.S was too big to fail. It is critical to note that the U.S capital markets are so large relative to the global market. The departing investors would have the opportunity to undermine the world economy, thus the chance to focus or concentrate on their own fortunes. The tendency of denominating the United States’ debts in dollars would limit the influence of depreciation in the ailing emerging markets in causing the rise of the American liabilities in comparison to the global economy. The discussion justifies that the 2008 crisis had the tendency to vindicate the optimists. The crisis, from the perspective of the alarmists, did not occur, leading to the emergence of the politicized debate to explain the role of imbalances in the crisis, thus incorporating a three-sided argument. In the first aspect, pre-crisis optimists as well as numerous economists focused on regarding the imbalances as a sideshow to the crisis. Instead, these entities and institutions transferred the blame the financial regulations, supervision, and the moral hazard. It is fundamental to conduct a succinct assessment of the influence of the Federal Reserve’s loose or ineffective monetary policy in the cause of the 2008 crisis. Economists also blame the post-9/11 expansionary monetary, as well as the fiscal policies in the course of triggering the global boom. Moreover, global imbalances had the opportunity and tendency to interact with the problems within the financial sector. Other researchers note that the global imbalances were the leading cause of the 2008 crisis because of the generation of the low cost of financing. The third perception of the debate relate to the influence of the global imbalances acting as the ‘handmaiden’ to the 2008 crisis, thus the tendency to act as a more or less central contributor to the crisis. From the standard account perspective, global imbalances had the opportunity to relax the United States’ credit constraint, as well as the perpetuated low American real interest rates with the potentiality of stoking borrowing and the housing bubble with reference to one of the largest economies in the global context. In this context, imbalances tend to operate as the shorthand for the drivers. One of the favoured determinants relate to the low savings in the case of the United States. Others include the export-led growth approach by the Asian continent, the build-up of the reserve, and the existing exchange rate policies. It is essential to note that the U.S became the major deficit country. This is because of the potentiality of the U.S to offer service as the safest global economy, as well as the reserve currency issuer, thus the perfect platform to experience rapid growth and development in the household wealth from the housing appreciation and gains from the stock market. It is essential to note that the wealth effect had the influence on keeping savings low, thus perpetuating the foreign borrowing. Similarly, diverse factors were at play in the different current-account deficit nations with the exception of Germany or Japan. In essence, the flow of money into housing instead of equipment relate to the regulatory, as well as the supervisory gaps within the mortgage underwriting and securitization with reference to the case of the United States’ economy (Tridico, 2012). In this context, it is essential to note that the origin of the European crisis relates to the volatility of financial systems and market. For instance, the capital inflows into the southern European economies paved way for the unprecedented credit expansion which was vital in encouraging and maintaining of the speculative bubbles within the European housing markets. Similarly, banking systems and institutions in the European nations were essential in financing the credit expansion through borrowing within the context of the European capital markets. Moreover, the large-scale borrowing in the European capital markets had diverse positive implications, as well as the significant potential risks. Some of the positive elements or implications of the large-scale borrowing include increased accessibility to the funds necessary to the finance in relation to the facets of the process of real convergence with reference to the case of the southern nations in Europe. On the other hand, the significant potential risks had to emerge from the temporal dimension of most of the credits with reference to the short-term loans. The short-term loans were essential in heightening the vulnerability of the European banking systems and institutions to the capital flow reversals. Nevertheless, the financial crisis in the U.S was essential in the creation and development of the necessary conditions with the intention of ending the indebtedness process (Rose & Spiegel, 2012). The 2008 crisis contributes to the liquidity shortage, thus the perfect opportunity towards hampering the ability of the European banks to continue refinancing the loans within the European capital markets. It is critical to note that the suppliers of the capital within the context of the markets had the opportunity to examine contamination of the balance sheets under the influence of the toxic assets in the case of the United States. In essence, global imbalances relate to the situations where some nations possess more assets in comparison to other nations in the global context. Several researchers tend to focus on the examination or assessment of the relationship between the global imbalances and the 2008 financial crisis. Some researchers note that the global imbalances did play a critical role in the 2008 crisis. Contrary to that viewpoint, other researchers note that the global imbalances had little to do with the 2008 crisis. The paper illustrates and justifies the fact that global imbalances did not play critical causal roles in the 2008 crisis. Bibliography Acharya, V. V., & Schnabl, P 2010, “Do global banks spread global imbalances ? asset-backed commercial paper during the financial crisis of 2007–09,” IMF Economic Review, vol. 58, Iss.1, pp. 37-73. Retrieved May 6, 2015 from http://pages.stern.nyu.edu/~pschnabl/public_html/AcharyaSchnabl2010.pdf Blanchard, O. J., & Milesi-Ferretti, G. 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