The Silver Story - The existing global economic dynamics

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Investment looks to Latin America, but forecasts are not encouraging Turkey: Erdogan has cemented his grip on power - now what about the economy? Prelude to a Crisis? Latin America moves toward increased integration as U. How will Saudi Arabia's economy benefit from lifting the women's driving ban? Which countries are the most prepared for the upcoming digital revolution? India Under Pressure from the U.

April What impact would a trade war between the U. February Regional Disparity: The story of the world's most abundant fossil fuel Gold: December Increasing poverty in Latin America takes a breather thanks to improving economic dynamics What will be the most miserable economies in ? Is Spain doing enough to address its high youth unemployment rate?

Has Latin America gone far enough in reducing barriers to international trade? Economy at a tipping point? Is the UK really "shackled to a corpse"? Which countries will have the highest and lowest inflation in ? How vulnerable is Latin America to economic crises today? Is it still grim up north? The Icelandic economy and Game of Thrones: Just what the maester ordered Tulip Mania: Are Central Banks Nationalising the Economy? Latin America's challenge of sustaining spending without causing debt to skyrocket.

July Are uranium prices making a comeback? How will emerging market economies perform in ? Chilean Economy in Focus: The economy that continues to silence the critics Latin America: The Most Unequal Region in the World. Has it been a Success? What to look out for in Driving Growth in Latin America: Commodity exporters face challenging times. Why is productivity growth so low? Mexico's outlook as Trump nears day mark Interview with Oxford Economics Senior Economist on implications of the possible outcomes of the French Presidential Election The anxiety of the small saver in a world of negative interest rates Brexit negotiations.

Implications of high population growth in Latin America. January What are the prospects for Emerging Economies in ? Global growth to edge up in December The latest on the economy of Latin America Italy referendum: Who will really benefit? Interview with Chief Economist of Banco Fator: November Set to breach targets again?

How will emerging markets perform in ? The economic impact of a break in U. Base metals surge due to infrastructure plan 5 updates on the Venezuelan economic crisis Canada: A look at French labor reform and economic growth. How India's latest monsoon is affecting the economy Innovation in Latin America: There's no end in sight to the Venezuela crisis. Weak banks pose risk to already faltering domestic demand How much money do migrants from Latin America send home? Robust GDP growth cannot mask the persistent structural deficit. August Assessing Vietnam's economy: June How will the UK economy fare after Brexit?

The Most Precious of Metals Part 2. April Emerging Markets Growth Divergence Continues Gold: The Most Precious of Metals How will energy commodities perform this year? What is really going on with oil prices? Which region contributes the most to global GDP growth? Which 15 countries will lead in growth in ?

December How will emerging markets perform in ? Ahead of the curve: Two sides of the same coin When China sneezes who catches the cold? September No Sign of Recovery: July Forward Guidance, a primer China: Economic Progress and Integration. How will the South African economy weather recent challenges? During this era of remarkable economic growth, world trade in goods and services has expanded at nearly double the pace of world real GDP. As a result the volume of world trade in goods and services the sum of both exports and imports rose from barely one-tenth of world GDP in to about one-third of world GDP in By this measure—and by others as well—there has indeed been an increase in the degree of global economic integration through trade in goods and services during the past half century.

The two fundamental factors that appear to have driven this increasing global economic integration are continuing improvements in the technology of transportation and communication and a very substantial, progressive reduction in artificial barriers to international commerce resulting from public policy interventions.


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For transportation, the most dramatic improvements have been for air cargo, which except for airmail, did not exist as a commercially important phenomenon fifty years ago. Now, for a wide array of products from fresh flowers to electronic components to airplane parts, air cargo is the speedy and cost effective means of international transport.

For some of these products, international trade would not be feasible without comparatively cheap air cargo. Also, it is clear that many modern production management practices including just-in-time inventory techniques utilized by different divisions of multinational corporations are heavily reliant on the use of air cargo. Ocean shipping costs have fallen substantially in the past half century, perhaps by as much as a factor of four or five. Oil tankers of roughly 10, tons displacement have been replaced by supertankers of up to , tons, with no increase in crew size.

Merchant steamers of 5, to 8, tons have been replaced by containerized cargo carriers displacing , to , tons. Loading and off-loading by large crews of longshoremen has been virtually eliminated. Integration with the domestic transportation networks of road and rail is speedy, efficient, and less prone to disruption.

Land transportation costs are directly important for a good deal of international trade between contiguous countries and indirectly important for connecting international trade with domestic production and consumption. Land transportation costs trucking and rail have clearly declined during the past half century, although proportionately much less than for air cargo. Communications costs—for voice, text, and data—have dropped enormously in the postwar era, and are continuing to fall precipitously under the influence of rapid improvements in information and communications technology. Although not often given much attention in traditional trade theory, this has had broad implications for international trade, as such trade generally necessitates a good deal of communication between actual and potential buyers and sellers and a variety of middlemen and facilitators.

Probably the most important effect of improvements in communications has been felt on trade in services. For a variety of services, modern communications technology makes it possible and cost efficient to separate production and use in ways that were not previously feasible. Design of new computer chips can be done in Silicon Valley and implemented in production facilities in East Asia.

Software can be written under contract in India or Ireland and e-mailed back to the United States. Doctors can diagnose patients using transmitted MRI images and other data. Methods are even being created whereby operations can be performed robotically by a specialist surgeon thousands of miles away from his patient. Financial services to be discussed below are a particularly important area where modern communications technology is helping to transform the arena for international trade in services. More broadly, the decline in communications costs is surely one of the important reasons why for the United States exports of non-factor services in recent years has been growing more rapidly than either GDP or merchandise exports; see Chart 3.

For government imposed artificial barriers to international trade, the postwar era has undoubtedly seen a dramatic reduction. The extent of the reduction is hard to measure with great precision. The disruption of the war and of postwar reconstruction and the widespread use of exchange restrictions and other non-transparent policies during and for some time after the war are one special set of problems.

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Resort to import quotas, voluntary export restraints, and other non-tariff interventions in more recent years is another difficulty. Also, trade flows undoubtedly respond with lags, perhaps quite significant lags, to changes in the level of barriers to trade. Nevertheless, assuming that there was a significant overhang effect from the war and war time measures that tended to restrict trade shortly after the war, and taking account of the decline in tariff rates for the main industrial countries since the war to very low levels today, it is possible that levels of protection for domestic manufacturing industries in industrial countries have declined by as much as 90 percent since World War II.

This includes the fact that tariffs have been eliminated within the European Union and within Nafta and that inflation has eroded the ad valoren equivalent of many specific tariffs. While significant import protection remains for industrial countries, it is concentrated on a few key sectors, most notably agriculture, and also textiles and a few manufactured goods.

For developing countries, the situation is more mixed and levels of protection generally remain higher than those in the industrial countries. However, during the past twenty years there has been a significant move by most economically important developing countries to liberalize their trade regimes. Taking account of the fact that, measured at market prices and market exchange rates, developing countries account for only about one-fifth of world output and world trade, it is probably not much of an exaggeration to say that artificial barriers to international trade from government policy interventions have fallen by between 80 and 90 percent since World War II.

This is obviously an enormous accomplishment in the direction of public policies that seek to secure the benefits of a more efficiently integrated world economy. How much the of rise in the volume of world trade relative to world GDP might plausibly be explained by this accomplishment? A back of the envelope calculation sheds some light on this question. Suppose that the combination of the reduction in artificial barriers to trade from government policies the main factor and reduction in natural barriers to trade a much more modest factor in the postwar era have reduced the total barriers to trade from an effective average of 35 percent to an effective average of only 5 percent.

Suppose that these figures apply to the United States. Standard estimates of trade elasticities see Goldstein and Khan suggest that the volume of imports would rise by roughly 2 percent of U. This is much smaller than the actual increase in the share of imports in U. GDP from under 5 percent in to nearly 15 percent in For more open economies with high initial ratios of trade to GDP, the estimated increases in the trade to GDP ratio would be larger than for the United States, but the actual trade share gains are also generally larger.

Part of the resolution of this conundrum comes from recognizing that when trade barriers are reduced all around the world economy, there is a mutually reinforcing effect not captured by considering each country individually. Taking account of this interaction effect and relying on standard estimates of relevant elasticities, the assumed reduction in artificial and natural trade barriers might plausibly explain as much as a doubling in the volume of world trade relative to world GDP; that is, an increase in the share of imports from 6 percent to 12 percent of world GDP or an increase in the combined share of imports and exports from 12 percent to 24 percent of GDP.

The actual increases in these world trade shares, however, amount to a tripling—which is beyond the range of reasonable results using standard estimates of relevant elasticities. Three things might plausibly explain the substantial remaining gap. It is possible that because of the disruptions of the war and its aftermath and the policies pursued before, during, and shortly after the war, that the effective barriers influencing volumes of trade in were much higher than has been assumed and that, correspondingly, the reduction in these barriers should be substantially greater than the assumed average effective reduction from 35 to 5 percent.

Alternatively, it is possible that, even though the empirical estimates are quite robust, the relevant elasticities are actually a fair bit larger than the consensus suggested by the bulk of empirical studies. Then, there is the possibility that the standard theory linking trade volumes to relative prices and income or expenditure levels leaves out something important, especially in a longer-term context.

Specifically, if trade between two countries tends to rise proportionately with respect to each of their economic sizes and diminish with the distance between them, then the suggestion is that doubling the size of both economies should raise their bilateral trade by a factor of four rather than by a factor of two. Regardless of which, if any, of these explanations is correct, the conclusion remains that the massive reduction in artificial barriers to trade and the substantial, although quantitatively less significant, reduction in natural barriers to trade in the postwar era contributed very importantly to increasing global economic integration.

Surprisingly, however, the extent of global economic integration through international trade today is, by some key measures, not much greater than it was a century ago. Specifically, the rising shares of trade relative to GDP in the postwar era have only just recently restored these shares to about where they were just before World War I.

This seems surprising because artificial barriers to trade would appear, on balance, to be lower than they were at that time, and natural barriers to trade are surely much lower than they were then. However, as discussed by Bordo, Eichengreen, and Irwin and summarized in Crafts , the result is less surprising when account is taken the massive change in the structure of national outputs during the past century.

Around , roughly two-thirds of GDP was in the goods producing sector of the typical industrial country. Now that situation is reversed, and roughly two-thirds of GDP is in the service sector of the typical industrial country with a somewhat higher services share in the United States. This supports the view that international integration of markets for goods is significantly greater today than a century ago.

Looking forward, how might the fundamental factors of technological developments affecting natural barriers to trade and of public policies affecting artificial barriers to trade be expected to evolve and thereby to influence the extent of global economic integration through international trade in goods and services. Almost surely, technological improvements will continue to reduce the costs of transportation and communication, both domestically and internationally.

For transportation, because costs cannot go negative, further absolute cost reductions cannot generally be as large as what has been achieved in the past century. Even in proportional terms, it seems likely that the pace of advance will slow from the pace of the past century. In fact, during the past quarter century, while there have been continuing efficiency gains in transportation, the main technologies of land, sea, and air transport have not changed. Nevertheless, as the natural barriers to international trade for most goods arising from transportation costs are already quite low, technological limits on the likely pace of future cost reductions will probably not be very important, at least for the industrial countries.


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  8. For developing countries, where the infrastructure of modern transportation is generally less well developed, opportunities for reductions in transportation costs that would enhance economic integration both within the domestic economy and internationally are clearly greater. For communications as discussed further below , the situation is very different. A technological revolution is underway and appears likely to continue for some time. Costs of communication, domestic and international, have fallen rapidly; and these declines also seem likely to continue.

    International trade surely benefits from improvements in communications. As previously discussed, the areas likely to benefit the most are those that rely particularly heavily on communications, with financial services being an important example. Concerning the future of public policies toward trade, the successful postwar effort to reduce trade barriers has virtually eliminated most significant restrictions on trade in most goods among industrial countries, with notable exceptions for a number of agricultural products and a few manufactured products.

    To make further meaningful progress, the industrial countries need to address the few remaining hard cases especially agriculture in goods trade and deal with a complex of restrictions that artificially suppress opportunities for trade in services—trade that is increasingly being made feasible by advances in communications and other technologies. For developing countries, the agenda includes both reducing import restrictions that remain relatively high for products where industrial country barriers are already quite low and securing from the industrial countries reductions in barriers against exports of products for which developing countries have an important comparative advantage.

    We have found that these international links have been increasing over the past decade — especially for high-grade, financial instruments traded actively in the wholesale markets of major financial centers. Capital markets in developing countries too are becoming more closely integrated with markets in the rest of the world, although they have progressed less far in that direction than the industrial countries.

    It is still way too early to speak of a single, global capital market where most of world saving and wealth are auctioned to the highest bidder and where a wide range of assets carry the same risk-adjusted expected return. Some important components of wealth like human capital are scarcely traded at all, and currency risk, the threat of government intermediation especially during periods of turbulence , and the strong preference for consuming home goods and investing in more familiar home and regional markets, still serve to restrict the range and size of asset substitutability. But the forces making for stronger arbitrage of expected returns are already powerful enough to have made a large dent in the autonomy that authorities have in the conduct of macroeconomic and regulatory policies.

    We see little in the factors underlying the evolution of international capital markets to suggest that this increased clout of private markets will reverse itself in the future. We would not go so far as to suggest that the growth and agility of private capital markets now makes it unrealistic to operate a fixed exchange rate arrangement durably and successfully. But we do believe that these factors have made the conditions for doing so more demanding With the benefit of perfect hindsight, it is not hard to identify instances over the past decade or so when international capital flows like domestic ones did not pay enough attention to fundamentals.

    Toward this end, two conditions in addition to open capital markets themselves are worth emphasizing. More comprehensive reporting of off-balance sheet borrowing by private firms and sovereigns alike , greater transparency in the obligations of related entities in conglomerates and the like , greater international harmonization of accounting standards more generally, and more prompt disclosure of losses, would all be helpful. Second, market discipline cannot be effective if market participants believe that the borrower will be bailed out one way or another in the case of an actual or impending default.

    None of this implies that authorities should be indifferent to the potential prudential and systemic risks that may be associated with the trend toward global capital market liberalization and innovation. The message however should not be to try and halt financial liberalization and the international integration of capital markets but rather to accompany that liberalization and integration with a strengthening of the supervisory framework that permits the attendant risks to be properly priced and that encourages risk management programs to be upgraded.

    As the debt crisis of the s so powerfully illustrated, these issues of the proper pricing and management of risk in international capital markets are of deep concern to developing countries, as well as to industrial countries. What should be added to these conclusions from Mussa and Goldstein ?

    I would stress four points relatively briefly and develop one key issue at somewhat greater length—namely, the integration of the world economy through the globalization of the financial services industry. First, as suggested in Mussa and Goldstein, during the past seven years, financial markets, especially wholesale markets for high grade instruments, have tended to become more tightly linked internationally, especially among the industrial countries and also including many important emerging market economies.

    Most notably and as a clear example of the influence of public policy on economic integration, the advent of EMU and the anticipation of this event has eliminated exchange rate fluctuations among the eleven participating countries and has led to a dramatic reduction in interest rate spreads and in the volatility of these spreads. For the industrial countries, the only significant suggestion of any weakening in international capital markets linkages relates to Japan. Government measures to help re-capitalize and restructure Japanese banks was subsequently instrumental in reducing the Japan premium.

    Nevertheless, many Japanese banks have substantially scaled back their involvement in international financial markets. It is noteworthy that the Asian crisis, which effectively began with the attack on the Hong Kong dollar and stock market in mid October , was preceded by a massive surge in gross private capital flows to emerging market countries and a deep compression of spreads for emerging market borrowers; 13 see Chart 5.

    These developments signal a shift in tastes of global investors either toward lower assessments of the risks of investing in emerging markets or toward greater acceptance of such risks. With the onset of the Asian crisis, there was an apparent sudden shift of tastes of global investors away from emerging market risks, especially for Asian emerging market economies; and, as gross private capital flows dropped precipitously especially for Asian emerging markets , spreads for emerging market borrowers spiked upwards.

    In this episode and in later episodes of the series of crises during —99, many emerging market countries lost effective access to global financial markets. In many cases, the loss of access proved relatively brief—in contrast to the experience of many Latin American countries during the debt crisis of the s—but in a few cases access has not yet been restored.

    Consistent with Mussa and Goldstein, while some progress has been made, the linkage of developing countries to global financial markets remains weaker and more tenuous than for industrial countries. Second, although not original to Mussa and Goldstein, the observation that for a country highly open to private international capital flows, the policy requirements for successful operation of a pegged exchange rate regime are quite demanding has certainly proved prophetic.

    For Mexico in the tequila crisis, for Thailand, Malaysia, Indonesia, and Korea in the Asian crisis, for Russia in , and for Brazil in , the combination of a pegged exchange rate regime with a relatively high degree of openness to private international capital flows proved unsustainable and contributed to substantial financial crises. Countries that supported their pegged exchange rate policies with firm commitments to consistent monetary policies and maintained well-capitalized and well-regulated banking systems—notably Argentina and Hong Kong—were able to weather recent crises without collapses in their policy regimes.

    However, emerging market countries that maintained more flexible exchange rate regimes—such as Singapore, Taiwan Province of China, South Africa, and Mexico after —were generally better sheltered from the effect of recent financial crises. The general lesson here and also earlier from the ERM crises of —93 appears to be that the public policies that support the highest degree of international capital market integration—rigidly pegged exchange rates and free capital mobility—are feasible, but only if other key macroeconomic policies, most importantly national monetary policies, are subordinated to this goal of financial integration.

    Where the requisite degree of subordination is not feasible or not desirable, a choice of public policy orientations must be made. For some countries—notably those that have comparatively weak financial systems and have in place systems of controls on private capital flows—maintenance of some restrictions on private capital flows at least for some period of time may be a desirable option that allows greater stability of the exchange rate.

    While it is true that flows of foreign direct investment to developing countries have expanded considerably during the s and have come to dominate net flows of private capital to these countries see Chart 6 ; and flows of FDI have also proved to be quite stable during recent financial crises. Nevertheless, the international financial system was certainly not free of important problems during the past seven years. On the positive side, as previously noted, many of the emerging market countries that lost access to global capital markets in recent crises did rapidly regain it—a sign of enhanced resiliency.

    Bank lending as a source of finance for emerging markets—which proved quite volatile in recent crises—has continued to decline, while FDI has strengthened further and net portfolio equity flows have recovered. In a number of emerging market countries, domestic debt markets have developed considerably and have become an important source of finance for sovereigns and corporates. Although the global investor base for emerging market bonds remains somewhat fickle, emerging market equities seem to be gaining more of an independent foothold.

    Fourth, the emphasis in Mussa and Goldstein on efforts to improve market discipline through better provision of information, heightened transparency, harmonization of accounting standards, etc. Already at this stage important progress has been made in these reform efforts; but much remains to be done on the implementation of reforms.

    It is still to be seen how much these reforms will improve the performance of the international financial system. In my view, the main omission from the discussion of global capital market integration in Mussa and Goldstein is the relative lack of emphasis on the globalization of the activities of providing financial services—a phenomenon which is part of the broader revolution in this sector brought on primarily by rapid advances in information and communications technology.

    The rapid reductions in the costs of storing, accessing, analyzing, and communicating information are both dramatically reducing the costs of producing virtually all existing forms of financial services and creating new products and services such as many OTC derivatives which would have been prohibitively expensive with older technologies. At the national level, the structure of the financial services sector is changing as the distinctions that used to exist between commercial banks, investment banks, securities dealers, insurance companies, and other financial service providers become increasingly blurred.

    There is no doubt that advances in information and communications technology are the most important technological advance of the past quarter century. In the United States, technological advances in these areas account for much of the rise in total factor productivity in recent years. As a result of these technological advances, the costs of processing and communicating all forms of information have been all declining very rapidly; i. By nature, much of the activity in the financial services industry has to do with the processing and communication of information. It stands to reason, therefore, that the financial services industry would be particularly strongly affected by rapid advances in information and communications technology—and, it has been.

    This is readily apparent in a number of phenomena. The cost of bank transactions at the wholesale and interbank level has also dropped precipitously; and this, among other things, is reflected in the continuing rise in the volume of bank transactions relative to nominal GDP. Some indication of how advances in technology are affecting and likely to continue to affect retail banking transactions is suggested by Chart 7.

    As information and communications technology has advanced and the costs of doing virtually all forms of financial business have declined, the meaningfulness of the differences associated with different locations or with different sectors of the financial services industry appear to have eroded.

    This reflects the fact it is much cheaper now than a few years ago to do financial business over a wider geographic range and over a wider scope of activities. As a consequence, there has been a tendency toward restructuring of institutions in the financial sector in the direction of broader geographic and functional scope. It is also apparent the restructuring of banking systems and the integration of banks with other types of financial institutions.

    Financial crisis of – - Wikipedia

    Public policy in most countries has been accommodating or facilitating these developments. In the United States, the last restrictions on nation wide banking have been removed; and, with the passage of the Gramm-Leach-Bliley Act last year, most remaining restrictions on bank holding company participation in the full range of financial services have been removed. In the European Union, under the auspices of directives from the European Commission, the banking sector is becoming more competitive; and the advent of the EMU at the start of is providing important additional impetus to restructuring in the financial sector.

    In Japan, partly as a consequence of difficulties of recent years, public policy is also pushing, reform and restructuring in the financial sector; see IMF Not surprisingly, the same types of changes that have been taking place within the financial service sectors of individual countries have also been occurring internationally—and in response to the same principal driving force. The advances in information and communication technology which make it efficient to do financial business across a wider geographic and functional scope domestically, also operate across national boundaries.

    And, the effects are seen, for example, in the efforts to integrate the activities of stock and commodity markets internationally and in the international diversification of a number of leading firms providing financial services. As in the domestic arena, public policies are, by and large, facilitating these developments or at least accommodating them.

    In particular, seeing the advantages of allowing sophisticated foreign financial institutions to provide services in domestic markets, a number of emerging market countries have liberalized or are liberalizing to permit such participation; see IMF However, AIG did not have the financial strength to support its many CDS commitments as the crisis progressed and was taken over by the government in September It concluded in January The Commission concludes AIG failed and was rescued by the government primarily because its enormous sales of credit default swaps were made without putting up the initial collateral, setting aside capital reserves, or hedging its exposure—a profound failure in corporate governance, particularly its risk management practices.

    AIG's failure was possible because of the sweeping deregulation of over-the-counter OTC derivatives, including credit default swaps, which effectively eliminated federal and state regulation of these products, including capital and margin requirements that would have lessened the likelihood of AIG's failure. The limitations of a widely used financial model also were not properly understood. Because it was highly tractable, it rapidly came to be used by a huge percentage of CDO and CDS investors, issuers, and rating agencies.

    Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Li's formula hadn't expected.

    Financial crisis of 2007–2008

    The cracks became full-fledged canyons in —when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril Li's Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees. As financial assets became more complex and harder to value, investors were reassured by the fact that the international bond rating agencies and bank regulators accepted as valid some complex mathematical models that showed the risks were much smaller than they actually were.

    Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility. Moreover, a conflict of interest between professional investment managers and their institutional clients , combined with a global glut in investment capital, led to bad investments by asset managers in over-priced credit assets.

    Professional investment managers generally are compensated based on the volume of client assets under management. There is, therefore, an incentive for asset managers to expand their assets under management in order to maximize their compensation. As the glut in global investment capital caused the yields on credit assets to decline, asset managers were faced with the choice of either investing in assets where returns did not reflect true credit risk or returning funds to clients.

    Many asset managers continued to invest client funds in over-priced under-yielding investments, to the detriment of their clients, so they could maintain their assets under management. They supported this choice with a "plausible deniability" of the risks associated with subprime-based credit assets because the loss experience with early "vintages" of subprime loans was so low.

    Despite the dominance of the above formula, there are documented attempts of the financial industry, occurring before the crisis, to address the formula limitations, specifically the lack of dependence dynamics and the poor representation of extreme events. Life After Copulas", published in by World Scientific, summarizes a conference held by Merrill Lynch in London where several practitioners attempted to propose models rectifying some of the copula limitations.

    See also the article by Donnelly and Embrechts [] and the book by Brigo, Pallavicini and Torresetti, that reports relevant warnings and research on CDOs appeared in There is strong evidence that the riskiest, worst performing mortgages were funded through the "shadow banking system" and that competition from the shadow banking system may have pressured more traditional institutions to lower their own underwriting standards and originate riskier loans.

    In a June speech, President and CEO of the New York Federal Reserve Bank Timothy Geithner —who in became Secretary of the United States Treasury—placed significant blame for the freezing of credit markets on a "run" on the entities in the "parallel" banking system, also called the shadow banking system. These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls. Further, these entities were vulnerable because of maturity mismatch , meaning that they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets.

    This meant that disruptions in credit markets would make them subject to rapid deleveraging, selling their long-term assets at depressed prices. He described the significance of these entities:. The combined effect of these factors was a financial system vulnerable to self-reinforcing asset price and credit cycles.

    Paul Krugman , laureate of the Nobel Prize in Economics , described the run on the shadow banking system as the "core of what happened" to cause the crisis. He referred to this lack of controls as "malign neglect" and argued that regulation should have been imposed on all banking-like activity. The securitization markets supported by the shadow banking system started to close down in the spring of and nearly shut-down in the fall of More than a third of the private credit markets thus became unavailable as a source of funds.

    Rapid increases in a number of commodity prices followed the collapse in the housing bubble. An increase in oil prices tends to divert a larger share of consumer spending into gasoline, which creates downward pressure on economic growth in oil importing countries, as wealth flows to oil-producing states. Copper prices increased at the same time as oil prices.

    Prices were only just starting to recover as of January , but most of Australia's nickel mines had gone bankrupt by then. Another analysis is that the financial crisis was merely a symptom of another, deeper crisis, which is a systemic crisis of capitalism itself. Ravi Batra 's theory is that growing inequality of financial capitalism produces speculative bubbles that burst and result in depression and major political changes. He has also suggested that a "demand gap" related to differing wage and productivity growth explains deficit and debt dynamics important to stock market developments.

    John Bellamy Foster , a political economy analyst and editor of the Monthly Review , believes that the decrease in GDP growth rates since the early s is due to increasing market saturation. The conventional Marxist explanation of capitalist crises was pointed to by economists Andrew Kliman , Michael Roberts, and Guglielmo Carchedi, in contradistinction to the Monthly Review school represented by Foster. These Marxist economists do not point to low wages or underconsumption as the cause of the crisis, but instead point to capitalism's long-term tendency of the rate of profit to fall as the underlying cause of crises generally.

    From this point of view, the problem was the inability of capital to grow or accumulate at sufficient rates through productive investment alone. Low rates of profit in productive sectors led to speculative investment in riskier assets, where there was potential for greater return on investment.

    The speculative frenzy of the late 90s and s was, in this view, a consequence of a rising organic composition of capital, expressed through the fall in the rate of profit. According to Michael Roberts, the fall in the rate of profit "eventually triggered the credit crunch of when credit could no longer support profits".

    In , John C. Bogle wrote that a series of challenges face capitalism that have contributed to past financial crises and have not been sufficiently addressed:. Corporate America went astray largely because the power of managers went virtually unchecked by our gatekeepers for far too long They failed to 'keep an eye on these geniuses' to whom they had entrusted the responsibility of the management of America's great corporations.

    Echoing the central thesis of James Burnham 's seminal book, The Managerial Revolution , Bogle cites particular issues, including: An analysis conducted by Mark Roeder , a former executive at the Swiss-based UBS Bank, suggested that large-scale momentum, or The Big Mo "played a pivotal role" in the —09 global financial crisis. Roeder suggested that "recent technological advances, such as computer-driven trading programs, together with the increasingly interconnected nature of markets, has magnified the momentum effect.

    This has made the financial sector inherently unstable. He says this stagnation forced the population to borrow to meet the cost of living. The financial crisis was not widely predicted by mainstream economists.

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    A cover story in BusinessWeek magazine claims that economists mostly failed to predict the worst international economic crisis since the Great Depression of the s. For example, an article in the New York Times informs that economist Nouriel Roubini warned of such crisis as early as September , and the article goes on to state that the profession of economics is bad at predicting recessions. Within mainstream financial economics , most believe that financial crises are simply unpredictable, [] following Eugene Fama's efficient-market hypothesis and the related random-walk hypothesis , which state respectively that markets contain all information about possible future movements, and that the movements of financial prices are random and unpredictable.

    Recent research casts doubt on the accuracy of "early warning" systems of potential crises, which must also predict their timing. The Austrian economic school regarded the crisis as a vindication and classic example of a predictable credit-fueled bubble caused by laxity in monetary supply. A number of heterodox economists predicted the crisis, with varying arguments. Dirk Bezemer in his research [] credits with supporting argument and estimates of timing 12 economists with predicting the crisis: Examples of other experts who gave indications of a financial crisis have also been given.

    Karim Abadir, based on his work with Gabriel Talmain, [] predicted the timing of the recession [] whose trigger had already started manifesting itself in the real economy from early In , at a celebration honoring Alan Greenspan , who was about to retire as chairman of the US Federal Reserve , Rajan delivered a controversial paper that was critical of the financial sector. These risks are known as tail risks. But perhaps the most important concern is whether banks will be able to provide liquidity to financial markets so that if the tail risk does materialize, financial positions can be unwound and losses allocated so that the consequences to the real economy are minimized.

    Stock trader and financial risk engineer Nassim Nicholas Taleb , author of the book The Black Swan , spent years warning against the breakdown of the banking system in particular and the economy in general owing to their use of and reliance on bad risk models and reliance on forecasting, and framed the problem as part of "robustness and fragility". A report by the International Labour Organization concluded that cooperative financial institutions were less likely to fail than their competitors during the crisis.

    Similarly, credit unions in the US had five times lower failure rate than other banks during the crisis [] and increased their lending to small- and medium sized businesses while overall lending to those businesses decreased []. It then entered a pronounced decline, which accelerated markedly in October By March , the Dow Jones average had reached a trough of around 6, Four years later, it hit an all-time high.

    It is probable, but debated, that the Federal Reserve's aggressive policy of quantitative easing spurred the partial recovery in the stock market. Market strategist Phil Dow believes distinctions exist "between the current market malaise" and the Great Depression. The past two years ranked third, however. The first notable event signaling a possible financial crisis occurred in the United Kingdom on August 9, , when BNP Paribas , citing "a complete evaporation of liquidity", blocked withdrawals from three hedge funds.

    The significance of this event was not immediately recognized but soon led to a panic as investors and savers attempted to liquidate assets deposited in highly leveraged financial institutions. One of the first victims was Northern Rock , a medium-sized British bank. This in turn led to investor panic and a bank run [] in mid-September Calls by Liberal Democrat Treasury Spokesman Vince Cable to nationalise the institution were initially ignored; in February , however, the British government having failed to find a private sector buyer relented, and the bank was taken into public hands.

    Northern Rock's problems proved to be an early indication of the troubles that would soon befall other banks and financial institutions. The first visible institution to run into trouble in the United States was the Southern California—based IndyMac , a spin-off of Countrywide Financial. Before its failure, IndyMac Bank was the largest savings and loan association in the Los Angeles market and the seventh largest mortgage originator in the United States. The primary causes of its failure were largely associated with its business strategy of originating and securitizing Alt-A loans on a large scale.

    This strategy resulted in rapid growth and a high concentration of risky assets. From its inception as a savings association in , IndyMac grew to the seventh largest savings and loan and ninth largest originator of mortgage loans in the United States. IndyMac's aggressive growth strategy, use of Alt-A and other nontraditional loan products, insufficient underwriting, credit concentrations in residential real estate in the California and Florida markets—states, alongside Nevada and Arizona, where the housing bubble was most pronounced—and heavy reliance on costly funds borrowed from a Federal Home Loan Bank FHLB and from brokered deposits, led to its demise when the mortgage market declined in IndyMac often made loans without verification of the borrower's income or assets, and to borrowers with poor credit histories.

    Appraisals obtained by IndyMac on underlying collateral were often questionable as well. Ultimately, loans were made to many borrowers who simply could not afford to make their payments. The thrift remained profitable only as long as it was able to sell those loans in the secondary mortgage market. IndyMac resisted efforts to regulate its involvement in those loans or tighten their issuing criteria: May 12, , in a small note in the "Capital" section of its what would become its last Q released before receivership, IndyMac revealed—but did not admit—that it was no longer a well-capitalized institution and that it was headed for insolvency.

    IndyMac concluded that these downgrades would have harmed the Company's risk-based capital ratio as of June 30, Had these lowered ratings been in effect at March 31, , IndyMac concluded that the bank's capital ratio would have been 9. IndyMac was taking new measures to preserve capital, such as deferring interest payments on some preferred securities.

    Dividends on common shares had already been suspended for the first quarter of , after being cut in half the previous quarter. The company still had not secured a significant capital infusion nor found a ready buyer. The letter outlined the Senator's concerns with IndyMac. While the run was a contributing factor in the timing of IndyMac's demise, the underlying cause of the failure was the unsafe and unsound way they operated the thrift.

    IndyMac announced the closure of both its retail lending and wholesale divisions, halted new loan submissions, and cut 3, jobs. Until then, depositors would have access their insured deposits through ATMs, their existing checks, and their existing debit cards. Telephone and Internet account access was restored when the bank reopened. IndyMac Bancorp filed for Chapter 7 bankruptcy on July 31, Initially the companies affected were those directly involved in home construction and mortgage lending such as Northern Rock and Countrywide Financial , as they could no longer obtain financing through the credit markets.

    Over mortgage lenders went bankrupt during and The financial institution crisis hit its peak in September and October Several major institutions either failed, were acquired under duress, or were subject to government takeover. Fuld said he was a victim of the collapse, blaming a "crisis of confidence" in the markets for dooming his firm. In September , the crisis hit its most critical stage. There was the equivalent of a bank run on the money market funds , which frequently invest in commercial paper issued by corporations to fund their operations and payrolls. This interrupted the ability of corporations to rollover replace their short-term debt.

    The US government responded by extending insurance for money market accounts analogous to bank deposit insurance via a temporary guarantee [] and with Federal Reserve programs to purchase commercial paper. The TED spread , an indicator of perceived credit risk in the general economy, spiked up in July , remained volatile for a year, then spiked even higher in September , [] reaching a record 4. Bernanke reportedly told them: Bush on October 3, Economist Paul Krugman and US Treasury Secretary Timothy Geithner explain the credit crisis via the implosion of the shadow banking system , which had grown to nearly equal the importance of the traditional commercial banking sector as described above.

    Without the ability to obtain investor funds in exchange for most types of mortgage-backed securities or asset-backed commercial paper , investment banks and other entities in the shadow banking system could not provide funds to mortgage firms and other corporations.

    This meant that nearly one-third of the US lending mechanism was frozen and continued to be frozen into June There is a direct relationship between declines in wealth and declines in consumption and business investment, which along with government spending, represent the economic engine. Between June and November , Americans lost an estimated average of more than a quarter of their collective net worth.

    Further, US homeowners had extracted significant equity in their homes in the years leading up to the crisis, which they could no longer do once housing prices collapsed. In some cases the Fed was considered the "buyer of last resort. In November , economist Dean Baker observed:. There is a really good reason for tighter credit. Tens of millions of homeowners who had substantial equity in their homes two years ago have little or nothing today. Businesses are facing the worst downturn since the Great Depression. This matters for credit decisions. A homeowner with equity in her home is very unlikely to default on a car loan or credit card debt.

    On the other hand, a homeowner who has no equity is a serious default risk. In the case of businesses, their creditworthiness depends on their future profits. Profit prospects look much worse in November than they did in November While many banks are obviously at the brink, consumers and businesses would be facing a much harder time getting credit right now even if the financial system were rock solid. At the heart of the portfolios of many of these institutions were investments whose assets had been derived from bundled home mortgages.

    Exposure to these mortgage-backed securities, or to the credit derivatives used to insure them against failure, caused the collapse or takeover of several key firms such as Lehman Brothers , AIG , Merrill Lynch , and HBOS. The crisis rapidly developed and spread into a global economic shock, resulting in a number of European bank failures , declines in various stock indexes, and large reductions in the market value of equities [] and commodities.

    Derivatives such as credit default swaps also increased the linkage between large financial institutions. Moreover, the de-leveraging of financial institutions, as assets were sold to pay back obligations that could not be refinanced in frozen credit markets, further accelerated the solvency crisis and caused a decrease in international trade. World political leaders, national ministers of finance and central bank directors coordinated their efforts to reduce fears, but the crisis continued. Several commentators have suggested that if the liquidity crisis continues, an extended recession or worse could occur.

    The United Kingdom had started systemic injection, and the world's central banks were now cutting interest rates. UBS emphasized the United States needed to implement systemic injection. UBS further emphasized that this fixes only the financial crisis, but that in economic terms "the worst is still to come". Relative to the size of its economy, Iceland's banking collapse is the largest suffered by any country in economic history. At the end of October UBS revised its outlook downwards: The Brookings Institution reported in June that US consumption accounted for more than a third of the growth in global consumption between and For the first quarter of , the annualized rate of decline in GDP was Some developing countries that had seen strong economic growth saw significant slowdowns.

    Bruno Wenn of the German DEG recommends to provide a sound economic policymaking and good governance to attract new investors []. The World Bank reported in February that the Arab World was far less severely affected by the credit crunch. With generally good balance of payments positions coming into the crisis or with alternative sources of financing for their large current account deficits, such as remittances, Foreign Direct Investment FDI or foreign aid, Arab countries were able to avoid going to the market in the latter part of This group is in the best position to absorb the economic shocks.

    They entered the crisis in exceptionally strong positions. This gives them a significant cushion against the global downturn. The greatest effect of the global economic crisis will come in the form of lower oil prices, which remains the single most important determinant of economic performance. Steadily declining oil prices would force them to draw down reserves and cut down on investments. Significantly lower oil prices could cause a reversal of economic performance as has been the case in past oil shocks.

    Initial impact will be seen on public finances and employment for foreign workers. The average hours per work week declined to 33, the lowest level since the government began collecting the data in With fewer resources to risk in creative destruction, the number of patent applications flat-lined. Compared to the previous 5 years of exponential increases in patent application, this stagnation correlates to the similar drop in GDP during the same time period.

    Typical American families did not fare as well, nor did those "wealthy-but-not wealthiest" families just beneath the pyramid's top. On the other hand, half of the poorest families did not have wealth declines at all during the crisis. The Federal Reserve surveyed 4, households between and , and found that the total wealth of 63 percent of all Americans declined in that period. On the same day, the Bank of England and the European Central Bank , respectively, reduced their interest rates from 4. As a consequence, starting from November , several countries launched large "help packages" for their economies.

    Conditions in financial markets have generally improved in recent months. Household spending has shown further signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Businesses are cutting back on fixed investment and staffing but appear to be making progress in bringing inventory stocks into better alignment with sales.

    Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

    The US Federal Reserve and central banks around the world took steps to expand money supplies to avoid the risk of a deflationary spiral , in which lower wages and higher unemployment led to a self-reinforcing decline in global consumption.

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    In addition, governments enacted large fiscal stimulus packages, by borrowing and spending to offset the reduction in private sector demand caused by the crisis. The US Federal Reserve's new and expanded liquidity facilities were intended to enable the central bank to fulfill its traditional lender-of-last-resort role during the crisis while mitigating stigma, broadening the set of institutions with access to liquidity, and increasing the flexibility with which institutions could tap such liquidity.

    This credit freeze brought the global financial system to the brink of collapse. The response of the Federal Reserve, the European Central Bank , the Bank of England and other central banks was immediate and dramatic. This was the largest liquidity injection into the credit market, and the largest monetary policy action, in world history. However, banks instead were spending the money in more profitable areas by investing internationally in emerging markets. Banks were also investing in foreign currencies, which Stiglitz and others point out may lead to currency wars while China redirects its currency holdings away from the United States.

    Governments have also bailed out a variety of firms as discussed above, incurring large financial obligations. To date, various US government agencies have committed or spent trillions of dollars in loans, asset purchases, guarantees, and direct spending. United States President Barack Obama and key advisers introduced a series of regulatory proposals in June The proposals address consumer protection, executive pay , bank financial cushions or capital requirements, expanded regulation of the shadow banking system and derivatives , and enhanced authority for the Federal Reserve to safely wind-down systemically important institutions, among others.

    The proposals were dubbed "The Volcker Rule ", in recognition of Paul Volcker , who has publicly argued for the proposed changes. These bills must now be reconciled. The New York Times provided a comparative summary of the features of the two bills, which address to varying extent the principles enumerated by the Obama administration.

    European regulators introduced Basel III regulations for banks. Major banks suffered losses from AAA-rated created by financial engineering which creates apparently risk-free assets out of high risk collateral that required less capital according to Basel II. Lending to AA-rated sovereigns has a risk-weight of zero, thus increasing lending to governments and leading to the next crisis. At least two major reports were produced by Congress: Anatomy of a Financial Collapse released April As of September , no individuals in the UK have been prosecuted for misdeeds during the financial meltdown of As of , in the United States, a large volume of troubled mortgages remained in place.

    It had proved impossible for most homeowners facing foreclosure to refinance or modify their mortgages and foreclosure rates remained high.