US Exorbitant Privilege and Sub-Prime Crisis - Example

US Exorbitant Privilege and Sub-prime Crisis By Lecturer’s and For the past several years, there has been a expeditious increment in the international flows of capital mainly due to the increasing globalization of equity markets (EICHENGREEN, 2011). According to analysts, the foreign earnings position of a state is nothing but the leveraged portfolio whereby a state is richer in international assets but short in local assets. In this regard, exchange rate increment and decline and variations in asset prices lead to the slackening of the US exterior control (EICHENGREEN, 14, 2011). For example, all things remaining constant, a decrease in the price of a dollar creates a gain in capital on the US international asset investment, which in turn creates a rise in the return on its net foreign portfolio (MARK KRAMER, 65, 2008). For example, in December 2004 reports show that the US profitable international asset position was 2.5 trillion dollars, which represents approximately 22 percent of the GDP, while assets were 10 trillion dollars, which is 85 percent of the GDP, while the liabilities were $12.5 trillion which accounts for 107% of the GDP. In the report, almost all values of the international financial obligations are in dollars, whereas an aggregate of 70 percent of the United States international assets are in international denominations (GOURINCHAS & REY, 42, 2005). All things held constant, a 10 percent decrease in value of a dollar represents a shift of approximately 5.9 percent of the US GDP to the US from other countries globally. In the same year, 2004, in terms of differentiation, the shortfall on services and goods was 5.3 percent of the GDP. For this reason, capital gains can be very huge (MARK KRAMER, 16, 2008). The US payment system is among the largest in the world. On a daily basis, about a million transactions, valued in the trillions, go through these banks as sellers and purchasers conduct their transactions on goods, services or financial assets. Such transactions go through the depository establishments that retain their accounts with the Reserve Bank. In this regard, the Reserve Banks play an important role in acting as a go-between in clearing and settling of interbank payments (EICHENGREEN, 28, 2011). The Federal Reserve plays a critical role in both the nation’s wholesale and retail payment systems, providing a wide range of fiscal services to depository organizations. Retail transaction is usually for miniature dollar amounts and often involves clients of a depository institution (MARK KRAMER, 46, 2008). The principal function of the Federal Reserve is making sure that there is enough cash in terms of coin in movement and currency to meet stipulations from the populace. The Federal Reserve creation is a result of the variations in the populace stipulations as there is a seasonal rise and fall of demand, and this goes hand in hand with the level of economic changes (LUCARELLI, 22, 2008). A good example is, during the holiday season whereby an institution increases their orders of coins and currency from Reserve Banks so as to fulfill client needs. Reserve Banks, in 2003, conveyed to depository organisations about 36.6 billion notes having a value of 633.4 billion dollars and received from depository institutions about 35.7 billion notes having a value of 596.9 billion dollars. To understand the US external asset position measurement, I will use the United States total international asset position of 1952-2004 by the use of the official series despite its drawback of not measuring the investment at the current prices but at historical cost. Due to this, there is a need to reconstruct the estimates of the market values of each liability and asset dating back to 1952 through the combination of BEA’s international investment positions data and the international transaction data from both the flow of funds and BEA (LUCARELLI, 38, 2008). The computation of the dollar is in terms of capital gains or losses for each asset class and this is used to determine the international investment position. Surveys of the treasury benchmark on exterior liabilities and assets are used to make nation weights and currency approximates in the United States financial portfolio (LUCARELLI, 21, 2008). The developed series gives an account of US exterior fortunes dynamics at market prices in quarterly basis from 1952 differentiated by asset form. Fig; 2 Fig; 2 above gives the report of three discrete determinants of the total US foreign asset ranking (SEABROOKE, 89, 2001). This is obtained by taking the ordinary estimate reached to by accumulating current accounts, additionally the BEA’s estimates of the US International Investment Position at market value from the 1982. From this, it depicts that US went from substantial creditor position in 1952 which had 15 percent of the GDP to a considerate debtor position depicted by -26% of the GDP towards the period end. Fig; 2 depicts the same general tendencies depicting that component of valuation have vital weight on both medium and short run changes of the United States exterior ranking. Therefore, component of valuation is the difference between my measure (N F A) and the piled up series of current accounts (SEABROOKE, 11, 2001). This shows the exact accumulated exchange rate adjustments and capital gains value omitted from the measure of the current account. Fig; 3 Fig; 3 depicts net valuation components as a share of GDP. In the 1970s the cumulated current account measure tended to overrate the NFA ranking of the US such as 4% of GDP. From this time assessment effects worked in favour of the US, reaching up to the ultimate position of 9.4 percent of the Gross Domestic Product in 1994:3 (SEABROOKE, 62, 2001). From this, there is a depiction that over the whole period, except a few years, the component of valuation worked to offset movement of the current account and stabilize the net international asset position of the United States. Next is that the evolution of the measurement of the component is regular with most of the evolutions of the US dollar. The depreciation of the dollar in the 80s and currently can clearly be seen in the figure in relation to increase in valuation component (RAJAN, 66, 2010). This valuation component however disappeared between 1995 and 2003 while at the same time dollar appreciated. Next is that there are very limited exceptions in the sample. In the figure, the turnaround is seen in the component of valuation in 1977 to1980. Around 1976:4 and 1980:2 the valuation component is seen to move from -3.6 percent to 5.9 percent of the GDP, which is regarded as a total shift accounting to about 10 percent of the GDP. At this time, the United States returns in terms of gross liabilities were lower than the returns on United States gross foreign assets (RAJAN, 68, 2010). The reason behind this is due to the low US equity returns. During this time the performance of the United States stock Markets in the international stock markets was poor. Therefore, as banks do, the United States can take an intermediation margin, provided by the unequivocal return differentials between liabilities and external assets. Over a long period of time United States assets have moved progressively out of bank loans which are long term towards FDI, and also towards equity. This happened since 1990 (ALLEN, BOFFEY & POWELL, 108, 2011). On the other hand liabilities have taken over by bank loans, trade credit and debt. In this regard, United State has become like that of venture capitalist with high gain insecure investments on the resources side. In addition, its leverage has been on an upward trend with time (RAJAN, 110, 2010). The securitys currency value is fixed as well. The body responsible for issuing the international cash is capable to designate its whole stock of liabilities in dollars, thus modifying the switch rate exposure to other nations globally (HELLSTEN, 74, 2008). A decline of the US dollar has two advantageous effects on the exterior spot. It aids in giving rise to net exports, and it also raises the United States assets dollar value (HELLSTEN, 81, 2008). The huge positive surplus of gross asset’s real return over gross liabilities can be divided up into a return effect and a composition effect. Low yield safe securities dominate the US liabilities on the other hand US assets contain a large share of FDI and equity which increased dramatically over time. The US can be therefore be characterized to be a stock market investor (DARGIN, 37, 2013). The above explanation can be referred as the composition effect. On the other hand, return effect is whereby each class of assets showing decreased returns earned by the United State on its liabilities than on its assets. This price effect constitutes the other aspect of the exorbitant privilege, and could occur in particular as a result the issuer of the international currency having liquidity discount (DARGIN, 42, 2013). It is evident that current external imbalances can be paid back either by future trade excesses or by potential constructive returns on the net foreign asset situation of the United State. Historically, the channel of valuation has put up around 30 percent of the international adjustment process (SEABROOKE, 58, 2001). From the above examination of the exorbitant privilege that can be enjoyed by a country to be precise United State it is evident that such opportunity can arise on three occasions (SEABROOKE, 60, 2001). The first is the conventional belief of bond seignior age; the second is sovereignty in policy making in terms of macroeconomic; and the third flows structure the key currency imbalances in a randomly determined economy. Factors may have contributed to the economic crisis of 1997-98 include the credit bubble. In the 1990s, China among other developing nations and the largest oil-producing states came up with enormous capital superfluous (RAJAN, 114, 2010). As a way of discharging these monies they loaned them to the United States and Europe, which dramatically affected the interest rates making them to fall. Due to this, credit spread narrowed implying that there was a decline in expenditure borrowed to finance risky investments. In this sense, a credit crisis developed in Europe and United States, the most outstanding manifestation of which was a growing trend in high risk mortgage investments (LONG & SIEVERS, 96, 2011).This therefore leads to a conclusion that US monetary policy could have contributed to some extent to this crisis. Next is the housing problem. Starting in 1990s and rejuvenating in 2000s, there was constant and enormous housing burble in the US, which was influenced by house prices increasing far much beyond the trends in history and by rapid regional boom and bust series in Arizona, California, Florida, and Nevada,. These bubbles brought in a lot of losses for homeowners and more so investors (LONG & SIEVERS, 115, 2011). Next is non-traditional mortgage. Lessening credit spreads overly hopeful ideas about U.S. housing prices, and flaws in secondary and primary mortgage markets brought about poor inauguration performances and combined to increase the credit flow to U.S. housing finance (ARBOGAST, 44, 2013). At the same time, many homeowners and homebuyers did not live up to their responsibilities to recognize the terms of their mortgages and to make careful financial decisions. These factors further amplified the housing problem (ARBOGAST, 47, 2013). The major cause of the crisis revolves around the extraordinary NTMs numbers that were let into the US fiscal markets by government housing policy (DAVIES, 153, 2010). These high risk and weak loans aided in the development of the bubble, and they did not take any action to curb the epoch-making numbers when the bubble depressed. This endangered losses in the PMBS that were in custody by financial institutions around the world and in the US, weakening both their apparent stability and their liquidity. The build-up of 27 million Alt-A mortgages was not a accidental event, or even the result of main forces such as imbalances in global finance (DAVIES, 159, 2010) As an alternative, these bubbles and the loans to which they contributed were the express effect of a far more ordinary occurrence: U.S. government housing policy, which led by HUD over two administrations intentionally, reduced principles in mortgage underwriting so that the higher number of persons could buy homes. While this procedure was going on almost all the people involved or not involved were satisfied (MARK KRAMER, 121, 2008). Homeownership in the U.S. truly increased to the highest level ever recorded. But the consequence was a financial disaster from which the U.S. has still not improved. United States, being the main contributor of reserve assets to the system, has been in the position to sponsor current account deficits for long periods. Following 2001, increasing U.S. current account deficits largely reflected expansionary fiscal policy in the United States and thriving expenditure growth (RAJAN, 118, 2010). Sponsoring was in largely given by foreign governments. The major individual advantage the United States has is the in large amount and liquidity of its government securities markets (CRUM, 26, 2013). This is a mainly important consideration for investments by nations in official reserve assets. The definition of a reserve asset gives emphasis that such an asset should be extremely liquid and that the instability of its value should be low down (DAVIES, 139, 2010). Nevertheless, in due course there is a boundary to the willingness of other countries to hold U.S. assets. This limit depends on how close other possible reserve assets are to being alternates for U.S. dollar assets. However until the boundary is achieved, the accessibility of cheap foreign financing permits the United States to put off unfavourable procedures to boost national savings. Between 1990 and the onset of the financial crisis in 2007, the United States was able to increase its national debt in dollar terms twice without being punished by a decreasing appetite for the debt (MARK KRAMER, 57, 2008). On the contrary, shareholders accepted lower yields on U.S. government securities. Emerging economies in East Asia, such as China most exploited flaw in the global financial system during the 2000s (TARAPORE, 66, 2010). To uphold more and more undervalued exchange rate, due to the fact that productivity growth in China exceeded that in the rest of the world, China had to build up a dramatic amount of official reserves; with nearly $1.5 trillion of these reserves mounted up in the three and a half years following the country’s exchange rate rule was changed in July 2005 (CRUM, 49, 2013). China’s exchange rate policy had an impact on those of other East Asian countries in that they wanted to maximize appreciation of their currencies in reaction to competitive pressure from China, and these countries probably built official reserves to levels higher than they ever wished-for. Liberalization of trade during the 1990s and the rise of recently industrializing countries, particularly China, was a main competitive surprise to superior economies (CRUM, 49, 2013). It had especially physically powerful effects on European economies, with their rigid creation and labour markets, still Japan was also affected. Depreciating currencies in the late 1990s took the demands of Europe and Japan to press on structural reforms (CRUM, 52, 2013). In Europe, labour market changes were urgently needed but politically hard to employ. However, due to delay on changes, European countries situated themselves up for a swift delay in growth when there was upward Euro trends in the 2000s. The impact of that appreciation was first offset due to strong demand from China and Middle East who increased exports of the major European economies, especially France and Germany, but this demand came to an end when the Middle East and China slowed (RAJAN, 164, 2010). European countries, who are currently facing recessions, are suffering the results of their earlier decision for needed reform delays. Economic revival is at a slow pace in the Euro area (RAJAN, 2010). Reference List EICHENGREEN, B. J. (2011).Exorbitant privilege: the rise and fall of the dollar and the future of the international monetary system. Oxford, Oxford University Press. CRUM, B. (2013). Saving the Euro at the Cost of Democracy? JCMS: Journal of Common Market Studies. 51, 614-630. RAJAN, R. (2010). Fault lines: how hidden fractures still threaten the world economy. Princeton, Princeton University Press. MARK KRAMER. (2008). Russian Policy toward the Commonwealth of Independent States: Recent Trends and Future Prospects. Problems of Post-Communism. 55, 3-19. LUCARELLI, BILL. (2008). The united states empire of debt: the roots of the current financial crisis. ePublications@bond. http://epublications.bond.edu.au/gdc/25. (SEABROOKE, 2001). US power in international finance: the victory of dividends. Hound mills, Basingstoke, Hampshire, and Palgrave. GOURINCHAS, P.-O., & REY, H. (2005). From world banker to world venture capitalist US external adjustment and the exorbitant privilege. Cambridge, MA, National Bureau of Economic Research. http://papers.nber.org/papers/w11563. DAVIES, H. (2010). The financial crisis: who is to blame? Cambridge, Polity Press. ARBOGAST, S. V. (2013). Resisting corporate corruption: Cases in practical ethics from Enron through the financial crisis. ALLEN, D. E., BOFFEY, R. R., & POWELL, R. J. (2011).Peas in a pod Canadian and Australian banks before and during a Global Financial Crisis. Joondalup, W.A., School of Accounting, Economics and Finance, Edith Cowan University. http://www.business.ecu.edu.au/schools/afe/wps/index.htm. DARGIN, J. (2013). The rise of the Global South philosophical, geopolitical and economic trends of the 21st century. Singapore, World Scientific Pub. Co. TARAPORE, S. S. (2010). Financial policies and everyday life: the Indian context. New Delhi, Academic Foundation.Top of Form LONG, S., & SIEVERS, B. (2011). Towards a Socio-analysis of Money, Finance and Capitalism beneath the Surface of the Financial Industry. Hoboken, Taylor & Francis. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=957670. HELLSTEN, S. K. (2008). From Information Society to Global Village of Wisdom? The Role of ICT in Realizing Social Justice in the Developing World. Bottom of Form Read More