What Lessons Can Policymakers Draw from Economic Past - Essay Example

Section/# Economic Lessons from the Past: A Discussion of the Great Depression, the Oil Crisis of 1979, and the Subprime Crisis of 2007/2008 Introduction: The economic crises of the past century have had a drastic and measurable impact with regard to the quality of life for millions of individuals around the globe. Ultimately, the struggle for resources, so endemic to the study of economics, helps to explain why many of the conflicts of the past century have been fought. If it were not for the hardship of the First World War or the impacts of the Great Depression, it is unlikely that the character of Adolph Hitler could have arisen within Germany. Moreover, had it not been for the impacts of the Iranian Revolution in the late 1970’s, the fiscal crisis that was precipitated as a result of drastically decreased fuel supplies, would likely not have occurred either. Further, the most recent financial collapse of 2007/2008 could have at least partially been prevented was largely the result of incorrect levels of regulations employed to ensure correct levels of debt to equity within the banking systems existed around the globe. As a function of analyzing these three crises and drawing useful inference with respect to how experts and policymakers can engage these lessons to ameliorate such threats, it is the hope of this student that this discussion will be useful with regard to providing useful inference and applicable best practices that can facilitate future decisions. The Great Depression: Reasons for the Crisis without question, one of the most impactful economic disasters that has taken place during the course of human history is that of the Great Depression. At the conclusion of the First World War, individuals around the globe began to see a glimmer of hope (Mitchner & Mason, 2013). Seeking to rebuild their lives, engaged in commerce and business, and establish something of a new world order, business rapidly expanded and a renewed level of optimism helped to create and overinflated stock market. Although many individuals, wrongly symptoms that the stock market crash of 1929, also referred to as Black Friday, was responsible for ushering in the Great Depression, it was only one aspect of the that contribute to economic hardships and difficulties that were exhibited over the next decade (Alumnia et al., 2010). Shortly after the stock market collapse, individuals began to realize that the sheer magnitude of money that was lost equated to nearly $40 billion in 1929 money. As a result of this, a desire to lay hands on material resources and resist any further drops in value or loss to financial instruments created a run on the banks (Andrews, 2013). Due to the fact that banks did not have a requirement to keep a certain level of reserves on hand at any one point in time, the reserves quickly dried up and the banks merely closed. As individuals saw their entire life’s savings evaporate, the crisis worsened significantly (Matthews, 2012). With billions of dollars being lost, jobs became more scarce and unemployment meant that fewer and fewer individuals were able to afford the same quality of life that they had experienced prior to the collapse. This situation soon worsened as unemployment was estimated to have reached 25% during the height of the Great Depression (Chiodo, 2011). However, another catalyst to the long time frame that was experienced during the Great Depression has to do with the fact that the governmental response to it was so abysmally uninformed. As a result of the fact that so many individuals had lost their jobs, savings had all but evaporated for countless thousands, and the overall state of the economy was in shambles, one of the worst responses possible would have been to restrict trade; however, this was precisely what was engaged in terms of the Smoot-Hawley Tariff Act. Thinking that raising tariffs on foreign goods would spur US production, the actual result was that even more individuals lost jobs as FDI fled the United States and thousands more were laid off. Instead of actually helping the situation, economists widely agree that the Smooth-Hawley Tariff was one of the most shortsighted and ineffective government responses to financial crisis that has ever been exhibited. Lessons and Response: although there are a few mechanisms through which experts or government officials can leverage as a means of dampening investor optimism, it has been widely are that financial policy could have been used as a means of increasing interest rates and waiting the widely overinflated that of stock market during the 1920s. As such, some visible policy within nations around the globe asking situations through which the regulators have imposed higher interest rates as a means of taming an otherwise out of control stock market. Furthermore, and other applicable and unique lesson that was engaged as a result of the Great Depression has to do with the fact that banks were subsequently required keep a certain percentage of deposits on hand at any one given time. Although this does not necessarily preclude the eventuality of a bank run or a financial panic, it does drastically decrease the likelihood that some changes in investor behavior contributed by much wider crisis. Furthermore, a greater and more nuanced understanding of the impact of tariffs on trade has promoted nearly an entire century which has been focused upon the need, desire, and benefits of free trade throughout the globe (Matthews, 2013). Last of all of the realize nations that the Great Depression was able to engender, this particular aspect has had been long these impact and greatest benefit to society and economics the whole. The 1979 Energy Crisis: Reasons for the Crisis as a direct result of the Islamic revolution in Iran, beginning in 1979, and already fragile world oil market was rocked by the threat of disrupted supplies long Iran’s fields. Recognizing that this fuel shortage could drastically impact upon oil markets, similar to prior crises in 1970s, oil-producing nations around the world rapidly increase their oil output. This was performed in the hope that equalizing the supply and demand would diminish the likelihood of further comprises being exhibited throughout financial markets of the world. One of the primary reasons for this particular case being chosen has to do with the fact that the responses to the oil crisis 1979 more predicated based upon the lesson that were American flyer crises during the 1970s. However, even as the oil supply was increased, and Iran began exporting oil once again under a new government, a four percentage differential existed between the overall level of output prior to the crisis taking place and the overall level of wealth output in response. As can be noted by the analyst, a 4% differential and while output could not have resulted in the overall financial panic that were markets. Figure 1.0 accurately summarizes the overall levels of oil production and how they peaked prior to 1979; illustrating a global supply glut. Lessons and Response: Instead, trading behavior and the knee-jerk reactions of investors will ultimately blame for the situation that rapidly transpired. Assuming that could shortage will ultimately be getting the dollar, this created something of a self fulfilling prophecy that investors were able to effect. Whereas there were many steps that regulators, government officials, legislators, and economists have taken with respect to state regarding the global economy against the impact and likelihood of the Great Depression, there are relatively fewer prescriptions for change that could be drawn from the oil crisis of 1979 ((Verlerger, 1979). Ultimately, around the world, as well as their respective economies, sought to place pressure on oil producing nations around the globe as a means of maintaining global supply; seeking to avert the risk of economic stagnation or contraction. However, even though these efforts were largely successful in returning supply to prior levels, the panic that set in within the markets soon began to dictate that way in which investment behavior and futures would behave (Weyant, 1983). Sadly, a level of international or regional intervention was not practiced in terms of calming these markets. Just as with the Great Depression, fear and stakeholder anxiety was what drove the crisis will beyond what reality and true supply and demand could have (Zhao, 2013). The lesson that can most effectively be learned from this is that government regulations and actions alone cannot be seen as sufficient to still a traumatized market; especially one that has recently witnessed the hardships of resource scarcity or one that engages panicked behavior over rational understanding of supply and demand determinants. 2007/2008 Glob al Financial Crisis: Reasons for the Crisis The financial crisis of 2007/2008 was predicated by the banks which had leveraged bad debt in order to create more debt for their clients. Ultimately, this can understood as a situation in which certain types of outstanding credits that eh bank had in the form of loans to various entities or stock market derivatives were falsely identified as suitable contingents upon which further money could be “created” and/or loaned within the financial system. By constraining the amount of capital that could be raised/borrowed from investors and by striking at the underlying stock values of these financial institutions, the means whereby the banks could continue to loan and borrow were fundamentally reduced (Reinhart & Rogoff, 2011). By attacking the very mechanism whereby a bank can operate and hope to engage with consumers and turn a profit, the financial crisis was able to disable a number of banks and financial institutions; both large and small. However, as the crisis bore down on these banks and other entities within the economy, it was soon understood that the levels of debt and exposure to bad debt that the banks had on their books were ultimately untenable (Bernanke, 2007). Firstly, with regards to the banking and economic meltdown that occurred between 2007/2008, this must be understood as a global crisis. Although it began in the United States as a result of the subprime mortgage crisis, it rapidly spread globally and has affected every extant economy in the world; slowing growth, diminishing export strength, and devaluing a litany of world currencies in the process (Fahr et al., 2013). Figure 2.0 denotes the issue of debt to GDP within major world economies. Figure 2.0 In much the very same way, it is necessary to know, understand, and discuss the forces which could have prevented or at least greatly assuaged the crisis as it has been presented to the financial markets and subsequent global economies over the period of the past 5 years time (Mauro & Villafuerte, 2013). In this way, such an exploratory look into the realm of the financial crisis and its subsequent aftermath can allow for a more informed understanding of how the crisis itself could have been prevented as well as the formulation and creation of new and insightful ideas within the reader with regards to how such a situation might be stopped in the future. The first aspect of anticipation and reduction to the crisis came as early as the mid to late 1990s when a number of lawmakers and political analysts began to make a series of warnings concerning the untenable nature of the ways in which the financial sector was being deregulated. Although this deregulation has been attributed to both sides of the political spectrum, in all fairness it can be assumed from a moderate interpretation that both sides were complicit in the wholesale deregulation of the financial sector which ultimately caused the collapse of the real estate bubble (The Banking Crisis 9). Moreover, the first real and measurable signs of impending difficulties on the horizon were first demonstrated around the year 2006 when the Department of Commerce noted that new home permits had dropped an astounding 28%. Normally incremental increases and/or decrease in the reduction or expansion of new home permits are little cause for alarm; however, when something as earth shattering and innately odd as nearly a 1/3 reduction in the demand for housing should have been a major red flag to the Federal Reserve as well as the entire regulatory system. However, rather than heed such a statistic, the Federal Reserve remained unrealistically optimistic regarding how the economy would likely behave over the next several months and years (Horner 33). This allowed for the current situation to continue to extend itself for approximately another 2 years time before the final result of such a failure in oversight and monetary policy was noted by the stock market in the painful round of shocks that exhibited themselves throughout the stock market and economy during 2008 and 2009. Ultimately, the Federal Reserve felt that even though the drop in applications was something of an “anomaly”, the strong employment figures that the economy was continuing to generate were indicative of the fact that increased consumer spending, and low inflation would help to cover and shortfalls that such an externality may have on the economic system as a whole. Unfortunately, this was not the only sign of distress that the economy exhibited prior to 2008. Economists today point to what is collectively known as an inverted yield curve; utilized to predict the recessions of 1981, 1991, as well as 2000. This inverted yield curve is ultimately something that can be understood from the way that Treasury notes are higher than their long term yields. In a typical situation, long term yields are higher as a result of the fact that investors demand and expect a higher return for investing money for such a long period of time within a certain economic mechanism (Childs, 2008). Yet, as individuals believe the economy is cooling, the rate at which they will seek to invest in long-term investments as a means of hedging bets with regards to the rigidity of the system exponentially increases. Again, the Federal Reserve ignored this implication and assumed that due to the fact that interest rates were low that there was a very large amount of liquidity left to continue to provide for high levels of growth. However, as would soon be seen, liquidity exhibited itself to be the fundamental shortcoming of the entire system. As a direct result of the fact that more and more money was being tied up in long-term investments that were hedging themselves against a very difficult path ahead for the economy, the overall level of liquidity that economists and the Federal Reserve expected was not there to back up anticipation. Another fundamental oversight involved the fact that the Federal Reserve and shareholders within the banks and financial institutions had an over-reliance on the rapid change that a change in the Federal funds rate could achieve. Whereas many times previously slight manipulations in the Federal funds rate had effected an overnight change in the way that the economy operated and integrated with the news, there remained a diminishing return and an eventual point at which further reduction of the Federal funds rate could affect little if anything to stem to overall loss of confidence and lack of liquidity that was extant within the system. Preventative Steps: As a function of the breakdown in regulatory mechanisms capable of dealing with the size of the crash of 2007-2008, many of the largest and most effective regulations have been international in scope. But a few of these global regulations include the Basel III International Framework as well as further EU regulations concerning Markets in Financial Instruments Directives (MiFID). Ultimately, these further regulations, in tandem with existing regulations on the banking sector seek to integrate a set baseline of rules with regards to the standards underlying capital liquidity within the market (Biggs & Meyers, 2012). Due to the fact that the ultimate issue that the banking system was faced with during the crash was concentric around liquidity, most of the further regulations that have been passed with regards to seeking to provide a remedy to any further exhibitions of the same problem have been concentric upon speaking to the underlying weakness of the liquidity requirements that existed prior to the crash of 2007/2008. In seeking to identify the overall effectiveness of the current regulations, it can be said that they have kept the world from experiencing any further shocks similar to the ones that precipitated the events of 2007/2008; however, very little more can be said (Serven & Nguyen, 2010). Moreover, lending back to the prior discussion that was had with regards to whether action or inaction would have provided the best utility to the system, much the same can be said with regards to the current level of regulation the defines the financial/banking system. Although the current system has not experienced any other massive shocks, this in and of itself is not sufficient to validate the current level of regulatory constraints. Future regulation for the banks Although the level to which future regulation may take place is merely guesswork, it is the belief of this student that the extent to which banks will be allowed to make speculative entries into other markets will be constrained to certain levels. Naturally, it only exhibits good business practices for a bank not to leverage any particular investment to an imbalanced degree (Adelson & Jacob, 2008). Likewise, the level and extent to which large multinational banks will be able to engage in business as usual without further levels of government meddling will more than likely soon be reduced (Reinhart & Rogoff, 2009). Due to the precedent that has been set, the governments of the world have now taken responsibility for many of the missteps and poor management/planning that large financial institutions and banks have made. As a function of this, the governments have become deeply involved in this process and will seek to have a more active voice in dictating further financial policy and actions of such large players within the future (Taylor, 2013). This only stands to reason as it is the governments that will ultimately be responsible for any further missteps that the banking industry makes. Conclusion: As a function of the preceding research on how the entire economic system has evolved, it is the belief of this author that any further bailouts or interference on the part of the government within the banking system may be foolish. Although the ramifications of inaction are strong, the fact of the matter is that a dangerous precedent has now been set whereby the banking system can behave in as reckless a manner as it wishes, knowing that as long as their bank is large enough to be considered “too large to fail” they can always count on being backed by the government, and ultimately the citizen taxpayers within whatever nation they operate. Sadly, even though the information that has thus far been presented represents a very close estimation of what can be done to mitigate the risk of another financial collapse, the greatest threat that continues to exist is with regards to the economic threat of unsustainable debt; a risk that has only grown in the years since the economic collapse. 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