Our world is not only linked by politics and culture, but also by economics. One downside to a growing capitalist world is that when financial crises occur, they are often global. Think of it as a chain—even the smallest link can make a huge difference along the line, and if major links are weakened or disrupted, more countries are likely to be affected. Let's explore the causes of financial crises and their effects on our globalized world.
Global Financial Crises Summary
Due to globalization, most, if not all, economies in the world are interlinked. This means a financial crisis or recession in one country can trigger a global crisis, with effects and repercussions that can last years or decades.
But what is a financial crisis? Essentially, it occurs when an asset, a resource of value that allows a business to run, loses value, preventing businesses and people from paying their debts to banks and lenders. When banks aren't repaid, financial institutions run out of liquidity (i.e., cash). As a result, investors and people may begin selling off assets or taking money out of the banking system out of fear of further drops in value.
Governments then have the power to try to resolve the issues through fiscal policies. Governments are typically the final authority in preventing a financial issue from getting completely out of hand. If a government fails to resolve these issues, an inevitable financial crisis becomes significantly more likely. Therefore, global financial crises are often the result of a combination of failures in banking institutions, fiscal government policy, and consumer decision-making being driven by fear and anxiety.
Global Financial Crises Causes
Global financial crises are dependent on several factors. Generally, there can be a failure or mistake in the financial system. For instance, assets may be overvalued, meaning the stock price is higher than its earnings. Assets that are overvalued eventually experience a price drop. In that case, if it's a major asset such as housing or cars, this can cause issues for consumers who either paid more or less than what the product was actually worth.
Financial crises are often caused by a failure in the financial sector
Failed government policies are another cause of financial crises. Governments have the power to regulate financial institutions and when they fail to do so, financial issues can occur. For instance, poor reporting or regulation can allow for financial mistakes that compound over time.
Finally, consumer and investor decision-making can also lead to or exacerbate a financial crisis. By reducing consumption or selling off stocks, the issue can be further compounded.
Global Financial Crises Timeline
There are several stages in global financial crisis timelines. Generally, it begins with the start of the crisis itself due to the failure of financial systems. The failure of these systems is usually attributed to some or all of the causes mentioned in the previous section. The next stage involves the breakdown of financial systems when people or businesses can't pay back their debts to financial institutions. In the last stage, debt increases and assets devalue, often followed by a recession.
For the APHG Exam, remember that these stages can occur differently in each country. Sometimes there's a delay; not everyone is affected at once!
Global Financial Crises Examples
Several notable global financial crises have occurred in the last 30 years. Three major crises, the Asian Financial Crisis of 1997, the Global Financial Crisis of 2008, and the European Sovereign Debt Crisis of 2009 highlight just how integrated the globalized economy is.
Asian Financial Crisis of 1997
Several Southeast Asian countries, particularly Thailand, the Philippines, Indonesia, South Korea, and Malaysia, experienced rapid economic growth in the 1980s and 1990s. This growth was attributed to increased exporting and foreign investment, made attractive by high-interest rates and fixed currency exchange rates with the US dollar. To combat inflation in the 1990s, the US Federal Reserve Board raised interest rates. As a result, the value of the US dollar appreciated—along with all of the currencies that were tied to it. Although it was a positive thing for the US, there was a shock to exports and foreign investment. Thailand disassociated its baht from the US dollar, and as a result, the currency declined quickly, leading neighboring currencies to also plummet.
The Asian Financial Crisis of 1997 was caused primarily by complexities in global exchange rates. As a result, there were major government turnovers in these countries. Meanwhile, economies in other parts of the developed and developing world slowed. The International Monetary Fund (IMF), an international financial organization that assists countries with trade and financial stability, provided bailout packages tied to reform. Most of the affected Southeast Asian countries had to thoroughly change their economies through less government spending and higher interest rates. In some cases, these requirements may have further worsened the problem, leading to major anti-Western protests and backlash in response.
Global Financial Crisis of 2008 and European Sovereign Debt Crisis of 2009
The Global Financial Crisis of 2008 was a period of major global economic stress brought on by the downturn of the US housing market. The main causes of the housing market crash were attributed to a decline in housing prices and defaults in loan repayments.
The high availability of poor loan packages, which included a mix of mortgage loans, were widely sold to investors. With lower housing prices, many people were unable to pay back loan companies. As loan companies began repossessing homes, they acquired major losses because homes could only be resold at the new lower prices.
With major losses, investors, including major foreign banks, didn't want to purchase these loan packages, lowering their value even further. This was an issue as many banks' assets were tied to the value of these loan packages. With a reduction in the value of these assets, major banks, notably Lehman Brothers, filed bankruptcy, leading to subsequent collapses of major banks in the US. As a result, a Wall Street "bailout package" was passed by Congress in order to purchase assets and make investments to stabilize the stock market.
Fig. 1 - Loop diagram of causes behind the mortgage crisis
Although triggered by problems in the US housing and financial market, the global economy experienced a major shock and recession as well. When Iceland's banking system collapsed due to the Global Financial Crisis, Eurozone member countries, namely Portugal, Greece, Spain, Ireland, and Italy, were unable to repay their government debt. As a result, a sovereign debt crisis ensued.
Sovereign debt (i.e., national debt) is what government owes to creditors.
Major bailout packages from the IMF, European Union, and European Central Bank were required, spurring further local and regional government crises. Even now, the economies of these countries are still in recovery.
For the APHG Exam, make sure to understand the linkages in the world economy!
Global Financial Crises Negative Effects
Global financial crises' negative effects are usually felt in the form of recessions. A recession is a period of economic decline, where there is little or negative growth. As a result, higher unemployment, less consumer spending, and higher government debt can often occur.
Consumer spending can be postponed, reduced, or eliminated, leading to fewer profits and business growth. Businesses may lay off workers to save money and resources, increasing unemployment rates. Governments can also assist businesses and workers by offering compensation packages or unemployment benefits. However, this can increase government debt. Some countries can also experience major government upheavals and protests, with voters electing new parties or pressuring leadership to step down.
Global Financial Crises Global Financial Crises Negative Effects StudySmarter
Fig. 2 - Unemployment usually increases during a financial crisis
Fig. 2 - Unemployment usually increases during a financial crisis
Global Financial Crises Impact
Global financial crisis impacts can be categorized as either short-term or long-term. In the short-term, negative effects attributed to a recession (i.e., higher unemployment, less consumer spending, and higher government debt) can usually be reversed within a few years after a global financial crisis. However, major long-term impacts depend on the extent to which countries are able to recover. For instance, after the Global Financial Crisis of 2008, the US passed several major legislation pieces to prevent a similar crisis from occurring. Yet, there is concern and criticism around the bailouts that helped the financial institutions that caused the financial crisis to begin with. This can lead to a general erosion of trust in governments, as well as a turn to nationalism and protectionism as a result of the globalization of not just economics, but also adjoining crises.
Global Financial Crises - Key takeaways
- Global financial crises are a combination of failures in banking institutions, fiscal government policy, and fear and anxiety driving consumer decision-making.
- There are three stages to a global financial crisis. It begins with the start of the crisis itself due to the failure of financial systems. The second stage involves the breakdown of financial systems when people or businesses can't pay back their debts to financial institutions. In the last stage, debt increases and assets devalue, usually followed by a recession.
- The Asian Financial Crisis of 1997 was caused primarily by complexities in global exchange rates and affected many Southeastern Asian countries.
- The Global Financial Crisis of 2008 triggered the European Sovereign Debt Crisis of 2009.
- Global financial crises usually lead to a global recession (i.e., higher unemployment, less consumer spending, and higher government debt).
References
- Fig. 1, Diagram of the cause of the mortgage crisis (https://commons.wikimedia.org/wiki/File:Subprime_crisis_-_Foreclosures_%26_Bank_Instability.png), by Farcaster (https://en.wikipedia.org/wiki/User:Farcaster), licensed by CC-BY-SA-3.0 (https://creativecommons.org/licenses/by-sa/3.0/deed.en)
- Fig. 2, Unemployment usually increases during a financial crisis (https://www.freepik.com/free-photo/young-female-her-unemployed-husband-with-many-debts-doing-paperwork-together-kitchen_9957099.htm#query=unemployment&position=2&from_view=search), by wayhomestudio (https://www.freepik.com/author/wayhomestudio), licensed by FreePik (https://www.freepik.com/)
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