1. Introduction
Presently, the world is experiencing a financial crisis and an economic one, with a rising unemployment and lower industrial output due to business failures and low consumer spending. The term Financial Crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value (Allen&Douglas:2000).There is not a precise definition of economic crisis ,but according to the Business Dictionary (2010) a common one is that Economic crisis is a situation in which the economy of a country experiences a downturn brought on by a financial crisis.
The financial crisis,that started to show its effects in the middle of 2007 , is triggered by a liquidity crisis in the US banking system and caused by the overvaluation of assets (Krugman:2009). It is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s.It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, substantial financial commitments incurred by govermments,and a significant decline in economic activity.
In this paper,in the first section,we are gong to explain the factors that led the US Economy to the Financial Crisis and also trying to undestand why we had such crises as a reactiong of the above mentioned factors..The second section, explains how the US Financial Crisis,became a Global one. The Consequences of the crisis are described in third section. In this section we will have a look on the channels stroked to the financial crises In last section,we will present some policy reactions.
2. Factors that led the US Economy to the Financial Crisis
It is a very hard work to determine the main cause of the financial crisis. However, according to Dixon, Hugo (2009) is indicated that a combined effect of many factors has led to the explosion in the credit market in the United States and later to the rest of the world. Some of the main factors are:
2.1 War in Iraq
This chapter is mainly as a reference of the RIDA Ibrahim (2008). The suicide attacks by Al-Qaeda to the United States in September 11,2001, aggravated the economic situation in the World Trade Center in New York City.The Al-Qaeda attack,contributet to the loss of business on Wall Street [1] , by destroing ang closing down several points.
About 18 months later,on March 20,2003,began the Iraq War.Economists predicted that the Iraq War would cause a financial crisis for the United States, even before it began. The war in Iraq costed the United States hundreds of billions of dollars, and entered the world into recession because of the adverse effect on oil prices, inflation and interest rates. According to the Nobel Prize-winning economist,Joseph Stiglitz,the war costed 50-60 times more than the Bush administration had predicted,and was a central couse of the sub-prime banking crisis threating the US and the world economy.
2.2 Housing buble
A bubble is a temporary condition caused by unjustified speculation in the price of a stock or commodity to a level that bears no relation to its real worth or potential. Bubbles inevitably fail (burst), wiping out the savings of unsophisticated or unsuspecting investors.(Business Dictionary)
There is general agreement that the US housing bubble was the proximate cause for the most severe financial crisis (in the US) since the Great Depression and lastly,for the current crisis. This crisis has spread to other parts of the world, if for no other reason than the huge size of the American economy.
Figure 1: United States House Prices.
Jan. 1975 - Feb. 2007, Source: Standard and Poor.
As we see in graph nr.1 affected by many factors, Housing Bubble started to show its effects since in 2006.This happened for some reasons:Firstly,grouth in the supply for houses tracked price rises.Secondly,the increase of the interest rate to 5.25%,removed many non- prime prespective buyers from the market.Thirdly,since the house prices fell,home owners were unable to take monthly payments and so they lost their houses ,while banks and ther mortgage lendes were unable to recover amounts loanded and losted hundreds of billions.
2.3 Imbalance in world trade
According to RAMADHAN , M., NASEEB, A.(2009)": The Global Financial Crisis: Causes and Solutions". Url: http://www.wbiconpro.com/323-Adeel-new.pdf
China has benefited a lot from joining the World Trade Organization (WTO) [2] in 2001. It has utilized the advantages of the new global trade system and flooded the world with cheap exports. By keeping the exchange rate of the Yuan very low, Chinese exports were very competitive in the global market. This allowed China to accumulate huge trade surpluses while the rest of the world particularly the US increased their trade deficit. For example the deficit in the United
States Trade Balance has tripled from 69 Bill US$ in 1999 to more than 256 Bill US$ in 2007. Hence, production of industrial and consumer goods has declined sharply in the USA and the American economy has shifted to a service economy.
This caused a big shock and demoralization of the US economy.
2.4 The dominant role of the US$
After World War II, according to KHATIVADA ,S.,Mcgirr,E.(2009) the US economy was the strongest and the most stable. The BRETTON Woods agreement in 1944 enabled the US to pig its currency to the gold and dominate global currencies. The growth in demand for US$ and the fear of losing its stock of gold allowed the United States to adopt the system of Floating Exchange Rate in 1971. To meet the global demand for US$, the US kept printing the dollar without any effective regulation or criteria. This process allowed the inflow of global goods and capital to the United States for exchange of the US$. More importantly, it kept the United States consuming beyond its capabilities leading to a constant deficit in the Trade Balance. Over the last few decades, high import consumption lowered industrial output and shifted the traditional economy toward services. The influx of money to USA created the concept of "Cheap Money" and led to the abundance of credit that was used in unproductive activities that led to the financial crisis.
3. From the US Financial Crisis to a Global one
Because of the Housing Bubble,millions of home-owners in the USA,lost their houses. According to Shah,Anup(2009) after that,banks became owner of these houses.Anyway,the bank reserves level was minimal.In order to profit from the ownership of the houses,banks tried to sell them,but everything derived to an unpredicted result:people weren't interested in the houses,they didn't want them because they were unable to pay.All this coused a devaluation of the house prices.In 2009,houses prices continued decreasing to 32% compared to the 2006's prices.But still,their prices were 50% higher than in 1998.Banks couldn't get enought money to cover the current situation.In this way,crisis spreded quickly and affected the general economy.Less money in americans pockets!
The crisis spreaded to other parts of the world, because of the huge size of the American economy and the huge number of people.So,big companies in the world limited their sales and created an unwanted stock in their magazines.In this way,the companies income decreased dramaticly,and reached the point that companies were unable to pay their employers.The only way was to reduce the workforce!But,by reducing the workforce, these companies has indirectly decreased the demand of goods and services in the countres of their actions.Besides of that, hundreds and thousands of families remained with less income.
4. Consequences of the Global Crisis
Behind of this Global Crisis is a large number of concequences.According to Sasi,K.(2009),"The consequences of the global financiar crisis": http://www.wbiconpro.com/323-Adeel-new.pdf
Some of them are liste here: unemployment, slower global growth, financing challenges for governments, reduced world trade volume.
4.1 Unemployment
The global economic crisis was expected to lead to a dramatic increase in the number of people joining the ranks of the unemployed, working poor and those in vulnerable employment.And the forecast was right... We are now facing a global jobs crisis. The number of working poor - people who are unable to earn enough to lift themselves and their families above the US$2 per person, per day, poverty line, is rised up to 1.4 billion, or 45 per cent of all the world's employed. Rich countries from Europe are also sinking into recession with looming unemployment problem.
Figure 2: United States unemployment rate (%)
Jan. 1999 - Feb 2009, Source: Bureau of Economic Analysis,US Economic.
For Example, Spain's unemployment rate increased by nearly 14 % in 2009. In the US, more than 2.6 million Americans have lost their jobs last year, the highest incidence of unemployment rate since the period of "Great Depression". According to Organization for Economic Cooperation and Development (OECD), by the end of 2009, 210 million people were jobless.
4.2 Slower global growth
Europe's economic situation is shaking global market confidence.Global economic growth could slow to 2 per cent this year and 0.7 per cent next year if Europe's debt crisis worsens, according to the World Bank.Global growth stood at 5 percent in 2007, but in 2009 world growth was approximately 3 %, 0.9 percentage points lower than forecasted in July 2008.This Global Crisis is unpredicted !
Figure 3: United States GDP Growth Rate
Source: NACIONAL Statistics (2009)
4.3 Financing challenges for governments
If the crisis lingers on, state and local governments may begin to feel the pinch as they try to shore up new financing arrangements for their operations (recently the state of Massachusetts failed to raise the full amount of its tender offer and California is in a similarly difficult situation). There is some risk that governments may not be able to guarantee the stability of the financial system, as it has become clear in the case of Iceland, where the banking sector has assets of around 300% of GDP [3] , something no government could ever guarantee, at least not on a short-term basis.
4.4 Reduced world trade volume
According to the IMF [4] , the forecast for world trade volume growth (in terms of goods and services) has been revised downwards by 1.9 percentage points to reach 4.1% in 2009, with a likely impact on labor markets in developing and emerging economies. A drop in exports, as well as capital inflow, may trigger a falloff in investments. Deceleration of growth and deteriorating financing conditions may trigger further business failures and possibly more banking emergencies - the result being that some countries may slip toward a balance of payment crisis.
5. Policy reactions
In response to the global financial crisis, according to RIDA Ibrahim (2008) ,governments and central banks took different measures to rectify the problems and put the financial markets and the economies back in the right path. Governments and central banks have increased their level of intervention as the situation deteriorated. They have rescued systemically important financial institutions in order to avoid a total meltdown of financial markets.
Throughout 2007 and 2008, the United States Federal Reserve Board responded to the
growing crisis with several reductions in interest rates and major injections of capital into the ailing financial system, including banks and non-bank financial institutions. The OBAMA's Administration planed a major economic recovery package, a sort of fiscal new deal combining government spending and tax cuts.
In Europe, the European Central Bank (ECB) and other central banks have lent massively to banks faced with the evaporation of inter-bank lending in order to provide them with necessary liquidity. The global scale of the financial crisis underlines the necessity for international co-operation to avoid measures that distort competition or effectively shift the problem to other countries.
The policy requirement is neither complete financial deregulation nor overly stringent regulations it is instead a "middle-of-the-road" approach.
6 Conclusions
The present global recession is the outcome of the financial crisis that has originated in the United States mortgages market and extended to the rest of the world. But this alone would not have been enough to prompt the crisis: the real problem was that the risks involved in these mortgages were temporarily hidden as they were on-sold through complicated financial instruments. Economists lists many factors for crisis, maybe because they are too many factors or maybe because neither them are clear about the causes. War in Iraq, Subprime Mortgage ,Imbalance on the World Trade, The dominant role of US $ etc, where some other of the main causes listened that led the World in the crisis. From the Housing Bubble the American company passed to the devaluation of the house prices and the so called "Crisis of Confidence". The financial crisis has forced the insolvency of many banks and financial institutions in the U.S. and the world. With the ongoing economic recession, millions of workers worldwide have already lost their jobs, and as experts believe that this crisis will be protracted and deep, more people are also facing lay offers. Governments adopted different policies such as; financial saving plans, spending stimulus packages, and aggressive monetary policies to contain the crisis. However, the negative spread affect of the crisis has extended to other sectors and industries.
It is important to remember however, that this crisis was not a natural, inevitable catastrophe. The current depressed state of consumer and business sentiment can be attributed to specific failures on the part of policymakers, regulators and bankers. Firstly, governments and central banks failed to constrain an expansion of credit that drove an unsustainable boom in asset prices. Secondly, regulators failed to perceive the risks inherent in the financial system, and bankers exploited the latitude they were granted. Banks created marketable securities out of mortgage debt without a reliable assessment of the credit quality of that debt.
"The crisis solution depends upon its causes"
Barry Eichengreen
