'Hard Times: For these times'Global economy under hostage
Asani Consulting Pvt. Ltd.
The current global financial crisis is worst in the economic history of the international economy. It has surpassed the severity of the impact of the Great Depression that arose out of the US stock market crash in October 1929, lasting till most part of the early 1930s. It is a fairly known fact that the current edition of the financial crisis started off with an "asset-price bubble" in the US real estate market that gradually crept into the financial and other sectors.
Inevitably, the US aggregate demand fell drastically and monetary policy interventions in form of slashing interest rates could not save the day for the US. Import demand fell subsequently and countries exporting to the US saw a decline in their export incomes. The U.S. economy already had the highest trade deficit, implying that the US was importing the most it could.
Speculations in the mortgage loan market fuelled ever larger bubbles in the US economy. A "bubble" is an economic phenomenon of 'unnatural' price-rise, i.e. a price rise that is not due to productivity growth or production specialisation, and, the price rise is very fast. The outcome is a financial crisis; a situation when price falls at a faster rate than the rate at which it increased: Also, there is erosion of the value of 'assets'.
Over the decade of 1990s, most economies across the world adopted open market policies to leverage their 'competitive advantage'. Exports to the advanced countries earned them crucial foreign exchange in massive proportions to boost their domestic investments and increase scale of economies. The Chinese domination of manufactures in the global markets, India's competency in software, South Korea's competitiveness in automobiles testify the fact that countries gained from specialisation in production and exports. In the process, countries actually got interlinked and hence grew economically interdependent.
Any disturbance in the domestic economy has every chance to spill over to the other economies. In addition to this, cross-border investments increased both in equity and debt segments, resulting in faster capital flows especially into the emerging economies like China and India. Financial crisis cause fluctuations in capital flows due to increased risks and consequently securities markets across the global economy were affected by making stock prices volatile. Volatile stock indices not only shake investor's confidence, but induce "herd-instinct" among investors; once foreign investments starts exiting, more and more foreign investments leave the country.
Thus, any instability in a country does not remain within the confines of that economy, raising concerns of the "contagion" effect of international finance in a globalised world. The rate at which the present US financial crisis spread to the advanced economies and now even to the developing world, pose a serious threat of setting a "domino-effect" every time there is a financial crisis in any part of the world.
So much so, the G-20 economies have come together for a Bretton-Woods Conference II round on 15 November in Washington. They decided to take a relook at the existing financial architecture and discuss a remedy to the chronic financial crises since 1971 when US dollar replaced gold as the standard international currency.
Two important issues come to the fore in this context: Financial Regulations and Volatile Currencies. Gaps in the US financial regulation caused rampant speculations in home loan market, and, falling value of US dollar hurting economic interests of countries across the world. The time has come for delinking the world economy from the US economy and very soon dollar might have to be replaced with a truly international currency. This could help controlling the "contagion" effect of financial crisis and prevent the destabilising effect of a crisis erupting in any economy on other economies.
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