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The way all the bubbles burst
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Predictions about the future determine today's share prices that is basically how prices are named on the stock market. Currently the US financial crisis is causing havoc in stock markets all over the world, sending share prices up and down like crazy and foretelling the global economy is heading deeper into a fog so thick one can predict nothing but uncertainties.

And such uncertainties directly reflect that the physical economy is "no longer the buyers'" and the financial economy is "the dysfunctional lenders'".

Today the US financial crisis is characterized by "securities and banking crises". In a nutshell, a "securities crisis" is a typical "borrowers' crisis"; while a "banking crisis" is one of the "lenders". A "securities and banking crisis", therefore, can be seen as a "financial system crisis" that assails both the borrowers and lenders.

As a matter of fact, the US securities markets have not been functioning normally since the subprime crisis broke out in August 2007, as direct financing by issuing stocks all but stopped for a while.

Take the New York Stock Exchange for example. There has been no initial public offering for the past 10 weeks or so, which means this particular channel of financial for enterprises planning to expand has been cut off and this may also affect the birth of new enterprises.

Back in the 1990s the US staged a rousing production known as "the new economy" very much to the envy of the whole world. One of the prime reasons for this success was the support from an extensive and very sophisticated financial market, which enabled emerging enterprises to go public anytime they wanted with the lowest possible cost guaranteed. This is also one of the fundamental forces that drove Japan's financial system reform at that time.

Nowadays, however, the system of direct financing is in a shambles and enterprises have to rely on the old ways for direct financing by borrowing mostly from banks. The problem is that the crisis is spreading deeper into the banking industry, crippling the banking market as well. The two pillar systems of securities and banking are both in big trouble, causing the whole financial system to go haywire.

As such inter-bank transactions are now extremely cautious, and banks have raised the bars for lending money to enterprises. The European market even experienced a brief blackout of US dollar supply, while the Japanese market gave way to the return of financial protectionism as lending rates went up for foreign banks borrowing from their Japanese counterparts. It's ill-functioning lenders for all to see.

Thus the financial crisis centered in the US has naturally evolved into a global shortage of US dollar liquidity.

The international monetary system has been in fact the "US dollar system" and, be it the Bretton Woods System before 1971 or the factual "US dollar system" since 1973, the US dollar has been playing the role of the "pivotal currency" of the world. The New York market has maintained the dollar's hegemonic position by providing "dollar liquidity" throughout the world.

Today, the tight dollar liquidity means there is a shortage in a denominating currency in global trade and financial transactions, and in an intermediate currency in the exchange market. This will no doubt lead to handicaps in the clearing of international credit and debt as well as in the denomination of international trade, capital and foreign exchange transactions. And this will inevitably threaten hegemonic position of the US dollar.

Back to where it all began, the root of the US financial crisis has stemmed from the loopholes in the US-led "financial capitalism" format, with the bursting of "the real estate bubble" serving as the fuse. The "reverse asset effect" created by the bursting of the real estate bubble directly caused the "bursting of the consumption bubble".

It is widely known that the biggest characteristic of the US economy is consumption in overdrive, to the point that people would rather bury themselves in debts than cut back spending. As of August this year, the total value of individual consumption in the US accounted for over 70 percent of the country's GDP. If that is not a pillar of the US economy, I don't know what is.

After the "IT bubble" burst in mid-2000, the Federal Reserve, under Chairman Alan Greenspan, made a series of interest rate cuts, which pushed housing price upward. While homes became more expensive, interest rates kept falling and American consumers were able to "trade old mortgage loans for new ones". That was a fantastic time, when free-flowing capital raised consumption and gave rise to the so-called asset effect.

It was this asset effect that created the "consumption bubble", which carried the US economy over the aftermath of the burst "IT bubble" to a fast recovery. And the prosperous US economy drove the world economy toward 10 years of strong growth known as "the golden decade".

Right now, however, the shattered real estate bubble has broken the "consumption bubble", reducing Americans' individual consumption value to about 60 percent of the country's GDP. The United States as the world's "ultimate buyer" has begun to tighten its purse, leaving the rest of the world in a rare "buyer-less" predicament. With two main pillars of the market economy compromised at the same time, the impact on the world economy will probably be felt for a very long time.

Although the US, European and Japanese policymakers all appear tempted to enlist public strength and try to bring the grave situation around, and Japan has even begun to consider expanding its finance in a roll-back to Keynes' policy recommendations, the current situation suggests that so far globalization has not come to an abrupt end as some people predicted the crisis would cause it to. On the contrary, globalization has turned over a new leaf, where rising nations are directly involved in finding solutions and, to a certain extend, playing a leading role.

This is a time when enterprises reach beyond national borders for more business opportunities and even monopoly, while the scope of intra-industry trade expand explosively with the volume far exceeding that of inter-industry trade. This means the "industry correlation effect" generated by the traditional policy of financial expansion will definitely spread out along with the globalization of enterprise activities. It will be very difficult to keep it "at home".

Apparently it is very hard for this "thin and scattered financial expansion" to generate "real and effective demand" as soon as it is launched. As such, I am afraid it won't be simple and easy like a stroll in the park when we set out in search of an exit from the maze the financial crisis has thrown us in.

The author, Liu Junhong , is a researcher with China Institute of Contemporary International Relations

(China Daily October 29, 2008)

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