Government & Nonprofit

The Financial Crisis of 2007

This paper examines the global impact of the financial crisis of 2008, and the implications for US power in the long-run.
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  The Financial Crisis of 2007: Implications for the Washington Consensus "There's been a lot of comparison here about Bretton Woods... you know, last time you...  saw the entire international architecture being remade,'' he said. "Well, if, if it's just  Roosevelt and Churchill sitting in a room with a brandy, you know, that's an easier negotiation.” President Barack Obama, G20. The above quote captures the essence of the debate that has been raging over the future shape of the global economy and the extent to which it may be reflective of a more multipolar international system i.e. a system that is no longer monopolized by the great powers, particularly the United States, in terms of the institutions and the norms underlying it For over sixty years now, the structure of the international system has been completely dominated by the United States with the dollar serving as the reference point. With such an important role in the system, the United States along with the other great powers was able to  benefit considerably from such a convenient structural arrangement. Besides, this structural arrangement also allows the institutions underlying the system to be exclusively reflective of the values espoused by the West, more particularly the United States; and to be binding on the nations being subjugated under it (the  poor and middle income countries to be exact). All that aside, the international economy seems to be currently at a juncture where the prevailing norms that have hitherto been so vital to its longevity and functionality no longer seem to apply. In effect, the old structural arrangements have become obsolete as emerging economic powers become more assertive in terms of their national interests, and the West (The United States) becomes relatively weak in terms of their economic standing due in large part to the disproportionate effects of the global financial crisis. In fact, the economic crisis has exerted a cataclysmic impact on the U.S. economy, and may perhaps have created undesired effects which may serve to undermine U.S standing in the world in the long run. In order to expound more perspicaciously on the impact of the global financial crisis on the U.S. model and the institutions that underpin it, this paper will seek to exhaustively: 1. Reexamine the global financial crisis and the extent to which it has undermined the   basic principles and values of American style free market capitalism; 2. Survey the future of the U.S. model in the long run. So often the conventional wisdom as to what contributed to the global financial crisis revolves around these factors: the credit rating agencies, the deregulatory framework which characterized the United States for the past thirty years, the housing bubbles, and the Federal Reserve’s monetary policy for much of these decades. To a large extent, many of these factors help explain one aspect of the crisis, and it is very safe to assert they constitute the symptom of a larger structural problem inherent in the global economy. The essence of this problem centers on blatant imbalances that distort the system. That is, countries are allowed to build massive amount of current account surpluses whether through sound free market policies or mercantilist ones, then, turn back and lend that money to the deficit nations as a means of sustaining the habits of importers in those countries. When taken in the context of the global financial crisis this situation  becomes all the more deleterious. This process accelerates for much of this decade. In effect, the world economy was experiencing what many economists refer to as a global saving glut. That is, as countries were accumulating massive amount of surpluses in their current accounts, they were redirecting those funds to the United States and other industrialized economies by investing in US markets. These funds, in quest of attractive returns, were being diverted in more risky assets. The real estate market in the United States and Europe to a certain extent became the repository for those funds. Since the riskier the assets, the greater the returns, risky borrowers became the typical target of these investments. It is very conclusive to assert that the Federal Reserve’s role was no better in this respect. With all the monetary tools at its disposal,  perhaps one likely policy option should have been to raise interest rates or perhaps decreasing the money supply as a means of cooling down the economy. Instead, as of 2001, in the wake of 911, as a means of stimulating investment and consumption in the economy the federal reserve cut the federal funds rate and this only serves to reinforce the redirection of savings from surplus countries to the United States for investment where they are supposed to accrue in returns from risky but rewarding investment portfolios. As is the case with all asset bubbles, it got to a point where the model becomes unsustainable. With massive  amount of default on the part of borrowers, the banking system in the United States became nearly insolvent leading to a credit freeze with an abrupt collapse in interbank lending. With banks unsure of which of their counterparts had greater exposure to these toxic mortgages, the credit market stop functioning, and the economy came to a standstill. At such a turning point, the need for government intervention became all the more urgent. With the financial system in the United States tethering on the brink of collapse, the government stepped in with an infusion of about 700 billion dollars as means of stabilizing the bank’s balance sheets. Such an infusion as understood at the time was supposed to replace the toxic assets on the banks’ balanc e sheets, and would allow them to make loans again. However, it seems the stabilization process has been a continuous one and at its core are two lingering  problems. First, the real estate market has not stabilized yet. Second, assets would be marked down by  banks in one quarter, only to be further reduced in the next. In a way, this climate of uncertainty only serves to perpetuate the crisis. Considering the foreclosure issues going on around the country currently, it may take years before the real estate market stabilizes. Only then will the financial system returns to its initial state of health and prominence. Many economists argue that this is one of the defining features of financial crises. When contextualized in terms of the international political economy, the financial crisis may have done some irreparable damage to the image of the United States as the central player. Many reasons underlie this observation, and they are: 1. The financial crisis may have simply accelerated some trends that have  persisted for over twenty years; 2. The emergence of a multipolar international system in which agreement about the norms underlying it are increasingly becoming more and more difficult and uncertain; 3. The rise of state capitalism which is distorting the free market system while creating disadvantages for purely private firms. To the extent that they may not affect the United States in the long term, it is quite certain that they  put the United States at a strategic disadvantage in the short run. Besides, considering the length at which the United States had to go to rescue its financial institutions, the United States may have discredited its  brand of free market capitalism, and the institutions which underpin it in the international economy. More  importantly, this may have served to embolden the state capitalists in the international system, and may  push some of the emerging markets in that direction as well. It is not an overstatement to suggest that the global financial crisis may have reinforced trends that have persisted in the past twenty years. In fact, for over twenty years the emergence of certain countries economically within the international system to greater degree of assertiveness in terms of their national interests has accelerated a movement of the world’s center of gravity away from the United States. This has given rise to a more multipolar international system where the status quo in terms of the institutions that are at the heart of the system seems no longer reflective of the world in reality. In fact, many of the emerging economies have yet to be fully integrated into the international system despite the G20 group which has  been created in the wake of the financial crisis. In a way, if the overarching problem were simply the fact that emergence of the rest of the world to greater prominence within the international system to the extent that these economies maintained the same principles of free market capitalism and were committed to allow the ingenuity of the market to allocate resources as efficiently as it possibly can, this would not be an obstacle to the long term hegemonic viability of the United States. However, the problem runs much deeper. First, the externality question is in order here. That is, despite the fact the current system is not quite reflective of the world reality to the extent that these emerging economies currently benefit from it, they do not necessarily have a great incentive to change it. For, altering the current arrangement would mean a greater share of the responsibility and could probably constitute a burden on their economies. Therefore, free-riding is certainly a better arrangement in the short-term; which is very dangerous. Basically, these economies want a global economy more reflective of their interests without the responsibility that may come with it. The second aspect to this deeper problem is that the many countries that are evolving toward greater  prominence in the international economy cultivate a form of capitalism where the state plays a central role in the economic decisions of firms in its economy. Perhaps at the outset a basic definition of States capitalism should provide some clarit y. State capitalism, as defined by Ian Bremmer is the following: “: A  system in which the state functions as the leading economic actor and uses markets primarily for political gain” (Ian Bremmer, Foreign Affairs). China and Russia, according to Bremmer,  are the leading examples of such a brand of capitalism. He argues that they have been very effective at using the political clout of the state to advance the economic goal of their respective societies. This has led to the state owning large industries that it sees as strategic sectors, providing huge subsidies to other industries as a means of making exports competitive, and maintaining large investment portfolios or Sovereign wealth funds as a means of  propping up these industries. Evidently, some of the largest funds in the world are in fact state owned. This is especially true in the natural resource industries such as oil and gas, petrochemical, and so on. To the surprise of many policymakers in the United States, this brand of capitalism is on the rise and may accelerate in the post-crisis phase of the world economy especially considering the weak position the United States is reduced to in the international arena in the short run due in large part to the disproportionate effect of the global financial crisis. The danger to this turn of events is the extent to which this brand of capitalism may lead to a restructuring of the international system and global politics along with it. Many reasons underlie these important observations. State capitalism in its current form politicizes allocative decisions that once were the domain of the market and lead to production inefficiencies as well as hampering effectiveness. Furthermore, states become no longer content with regulating markets and some of their undesired effects; they are actually running those entities, and are using them toward political ends. Not only does this distort the international economy, but it also puts purely private firms at a competitive disadvantage. Ian Bremmer, who writes extensively on the matter, captures the essence of the problem in those terms:  “Thanks to state funding, these national oil corporations have more cash to spend than their private-sector competitors--and they pay above-market rates to suppliers to lock in long-term agreements. If the national oil corporations need additional help, the Chinese leadership is able to step in with promises of development loans for the supplier country” (Ian Bremmer, Foreign Affairs). 
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