Introduction
Economic problems in general and financial challenges in particular are not new on the world stage. It is difficult to imagine of a point in time when there is no country in the world experiencing economic difficulties. Even when large economies such as the United States and China are experiencing booms, there are other countries going through difficult times. But the world economic trouble that is being experienced at the moment has a place of its own in history (Rajan 2010, pp.17-18). Not since the great depression of 1930 had the world witnessed such a devastating financial crisis. As the only superpower in the world, the size of the United States economy makes it a natural root in all countries of the world. Therefore there is no question as to how the rest of the world was caught up in this crisis that was triggered by the actions of American bankers and managers of other financial institutions. Different parts of the world had its own unique problems emanating from the economic trouble. A European country whose financial system is closely connected to the American financial system got affected as much as a small Asian country whose economy is heavily dependent on aid from the United States. What led to this crisis? How was the rest of the world affected by this crisis?
Background
There are so many excuses that have been given by the managers of major financial institutions in the United States in the economic downturn saga. But there is only one major reason that keeps on popping up in public discourse concerning this crisis. This is the fact that some people somewhere were not responsible in the way they were handling the duties bestowed upon them by the public. These irresponsible people whose actions led to the financial crisis are the managers of banks, the mortgage firms as well as other financial institutions (Rajan 2010, pp.19-21). The anger that members of the public have towards these administrators of financial institutions in the United States is not unfounded. They feel that it is both right and justified. The collapse of the American financial system was not a sudden phenomenon. It was a gradual process that was characterized by a systematic encroachment of corrupt actions that led to the loss of so much money from members of the public. The most prominent case that shows how the regulatory systems in the United States weakened is the Ponzi Scheme of Bernie Madoff that led to the lose of billions of dollars belonging to members of the public. The founder of the scheme, Bernie Madoff, had duped them into trusting him with their money in the hope of multiplying it and making them millionaires.
The banking industry as well as the various firms that deal with hedge funds also went on an unregulated or reckless lending spree whereby the laid down procedures were not followed(Rajan 2010,pp.49-51). The top managers rewarded themselves with huge compensations even as their institutions showed signs of weakening. It was not long before the major institutions such as JP Morgan Chase, AID Global and Lehman Brothers turned out to be insolvent. Something had to be done so as to stop the entire economic system of the United States from crumbling. This is the time when the government devised a mechanism of bailing out these endangered institutions by organized lending (Sorkin 2010, pp.76-77). Other equally troubled companies especially the automobile companies such as General Motors were included in the program. The argument for this was that these companies held a significant position in the United States economy to the extent that if they failed, the economy would certainly fail.
As this was happening, the rest of the world was taking its shocks from the actions taking place in the United States. As already mentioned in the summary and introduction, the United States economy is intertwined with the global economy in such a way that if the United States economy makes a gain, there is global optimist of growth. The reverse is true when there is a downturn in the American economy.
The Causes of the United States Financial Crisis
A number of reasons have been given for the collapse of the financial system in the United States. This term paper will give the major causes a brief examination since the major purpose is to explore the effects of the financial crisis on the world.
Unregulated Lending
Banks in the United States engaged in dangerous lending behavior wherein proper procedures were not followed so as to secure the loans (Rajan 2010,pp.67-68). The result for this is that the improperly issued loans ended up becoming a financial burden on these banks.
Unreasonably High Compensation of the Executives
Although not a major cause of the financial crisis, it has been cited in most forums as a display of irresponsibility and greed by the executives. It is therefore justifiable to say that the high salaries and allowances paid to executives had a contribution towards the collapse of the financial system.
A shrinking Market
Although not a commonly stated reason, the shrinking market for some major goods from the United States contributed to the problems that proved too much to the country’s financial system. The time when a huge population of the world consumed machinery such as cars and computers from the United States has gone. China, Japan, and India are now competing strongly in the field of producing these commodities and selling them to the rest of the world at cheap prices. This has cut down the market for United States goods considerably. Companies that have lost market for their goods cannot continue supporting the country’s financial system as they used to when they were the only ones supplying the rest of the world with all the machinery.
Economic Malpractices
The United States has had its share of corruption cases. These cases include insider trading in the stock market and outright fraud. Such practices made millions of Americans lose their hard earned money to conmen who promised to double or triple the money within a short period of time.
Lack of Priorities
There has been concern over the amount of money that the United States is spending in waging war in Iraq and Afghanistan. A hotly contested issue that has attracted partisan political bickering is that the Iraq war was not supposed to be prosecuted or waged in the first place since the person responsible for the September 11, 2001 terrorist attacks was not connected to Iraq in any way (Fallows 2006, pp.34-37). The economic angle to this argument is that the amount of money that was spent in waging the Iraq war would have been used to support the American economy in a better way, and therefore prevented the financial crisis (O’Huallachain & Sharpe 2007,pp.56-58).
The Impact of the US financial Crisis on the Global Economy
There were several effects on the global economy as a result of the United States financial crisis. These effects can be classified into two groups. There is the group of positive effects that came as a result of the financial crisis and the group of negative effects that were triggered by this crisis. Some effects from each of these classes are discussed below.
Slowing Of the Global Economy
As a result of the weakness of the American economy, a number of other significant countries whose economies are closely tied to the American economy were affected in a negative manner. Since these countries play a major role in the global economy, there was no way in which the global economy would be prevented from slowing down. Major countries that took a beating as a result of the American financial crisis include Great Britain and France. It is true to say that Britain and France are some of the major economies of Europe, and if they are affected negatively, there is no way in which the European economy can be strong. The weakening of the European economy affected the other parts of the world that are involved in economic activities such as trade with the countries of Europe (Sorkin 2010, pp.78-79).
To illustrate the above point, the countries of Europe as well as the United States import raw materials for their industries from most African countries. They also import oil from the Middle Eastern countries such as Saudi Arabia and Iran. It is therefore definite that if the purchasing power of the United States and Europe had been reduced by the American financial crisis, the African countries and Middle Eastern countries will not find a ready market for their items. Therefore the world economy had to slow down as a result of this financial crisis.
Increase in Restlessness That Negatively Affected Economic Activities
The American financial crisis had a unique impact on the world economy in that some of the countries that are used to benefitting from the United States and other developed economies were unable to meet their budget targets, a scenario that resulted in increase in lawlessness. This lawlessness made matters worse as it led to more destruction of resources and a disruption of economic activities. For example Latin American, Asian and African countries that rely on aid would not escape the rise in crime due to the reduction in aid from developed countries. An example is the dramatic rise in drug trafficking in Mexico that prompted the government to launch a crackdown on drug traffickers. The crackdown has claimed several lives in Mexico.
Rise in global Joblessness
The disappearance of jobs is a direct function of a slow economy. When the United States economy crashed, American citizens lost jobs. American companies stopped importing raw materials, meaning that the countries that exported these raw materials to the United States had to stop producing them due to the absence of a market. The result of this is the loss of jobs. This is the fate that befell workers in countries that used to export raw materials to developed or industrialized countries such as the United States and Britain.
Weakening of financial systems
As a result of the crisis, financial systems of many countries that rely on the American financial system for support were thrown off balance. They weakened and proved ineffective to handle the economies of the concerned countries. Examples in this category again are the European countries that are closely connected to the American economy such as Great Britain. Great Britain’s financial woes in return affected other European economies such as Greece. This effect was not direct but even the simple fact that the British economy is not strong enough to support the Greek economy in times of economic challenge signifies a connected impact.
The other dimension of the weakening of the financial systems of various countries in the world came in the form of the decline in the value of the dollar. As the preferred currency in reserves of major world banks, a decline in the dollar value is a sure way of weakening the financial system of a country. This is what happened when the United States Economic system collapsed.
Reduction in Aid
Foreign aid is very significant in today’s world. There were times when it is only Latin American, Asian and African countries that kept on receiving aid. But the changing trends that have seen the rise in African economies has led to the reduction of aid that goes to African countries. The rise of Asian economic giants has equally reduced the amount of aid given to Asian countries. However there are other countries whose economies are driven by foreign aid from the developed world. These countries were badly affected by the American financial crisis since a weakened US would not be able to give aid to any of these countries. Other developed economies that are closely connected to the American economy were also equally compelled to reduce their aid to developing countries. This reduction of aid contributed to the rise of lawlessness that is discussed elsewhere in this term paper.
In addition to the above, there are numerous organizations that rely on aid from developed countries for their function. Top on the list is the United Nations. Major donors to the United Nations include the United Nations, China, Japan and Britain. As a major donor, the United States had to scale down its aid to this organization during this moment of grave economic conditions. Other countries that experienced these economic difficulties also had difficulty meeting their aid obligations to the United Nations (Sorkin 2010, pp.101-103).
Reduction of gains in the War against HIV/AIDS
The global war against HIV/AIDS especially in the developing world is purely supported by funds that are donated by developing countries. Due to the economic problems that these developed countries had to deal with as a result of the financial crisis, they had to divert their attention to dealing with their internal economic problems rather than sending funds to halt the spread of AIDS in some Asian or Latin American country. Because of this, the war against HIV/AIDS slowed a bit.
Change in the way the rest of the World Views the United States
For quite some time, the United States had occupied the top position as the strongest economy. No country showed signs of catching up. But the financial crisis has created a new reality that is astonishing to some. Countries such as China and Brazil are emerging as economic powerhouses with immense regional and global influence. China is particularly threatening to topple the United States from the top spot as the strongest economy. Some economic analysts believe that China has actually surpassed the United States.
With the shift in economic fortunes came the reduction in trust in American ways of administration of finances. The trust that world bankers had bestowed on this system was shaken with the financial crisis, and this means that the reverence with which some people viewed the United States has waned.
Another dimension to this point is the blame game that emerged after world leaders decided to look for means to deal with the financial crisis. The French President, Nicholas Sarkozy, was quick to blame the United States as the cause of the financial problems. In other words, he was trying to present the United States to the rest of the world as a country of reckless and untrustworthy bankers whose greed can drive them into endangering the world financial system. There was a degree of tension between the leaders of the United States and those of France and Germany over the financial crisis, with the French and the Germany leaders asking the United States to take responsibility for the financial crisis.
Decline in Living Standards
The benefits of a sound economy to the people include high standards of living characterized by good housing, good education and good healthcare. With the financial downturn, most countries found it hard to sustain high living standards for their citizens. The United States as the first casualty to the financial crisis saw a huge number of people lose their homes as well as health insurance. All over the world, living standards declined as governments struggled to make ends meet as far as budgets are concerned.
Positive effects of the financial crisis
There were positive actions which were taken as a result of the financial crisis. These actions include the reforming of the American financial system, the assessment of various financial systems around the world, the increase in regulation and monitoring, the reinvigoration of key companies in different countries around the world, and the fostering of more cooperation among different countries in the world.
Reforming of the American financial system
Economists have said that the American financial reform was long overdue. They therefore hail the financial crisis as the triggering button in the implementation of laws that have long been needed in the American financial system. The fury of the members of the public whose investment was affected and the leaders who had to find the people responsible for the mess pushed for financial reform. Corrupt managers as well as incompetent ones were dropped and bad practices were stopped. This is a positive move that is likely to strengthen the financial system in the long run. This is one of the positive effects that came from the financial crisis.
The Assessment of Various Financial Systems around the World
Countries that were affected by the financial crisis such as Britain and France had to reassess their financial systems and find possible loopholes that would serve as possible causes of future financial problems. This move was carried out as a way of ensuring that these financial systems are not caught unawares incase of another economic downturn in future. The assessment was also carried out with an aim of determining the level of dependence on foreign financial systems. The target was to try and reduce the degree of risk incase a problem occurred in a foreign financial system that is connected to the domestic system as it had happened with the United States in relation to the world economy.
Increase in regulation and monitoring
The increase in government oversight over financial institutions did not take place in the United States only. Most countries around the world seized the opportunity to ensure that the activities of leaders of financial institutions were kept in check so as to avoid reckless financial activities that can endanger the resources of members of the public. The trust and confidence that most governments had in bankers and leaders of other financial institutions was questioned since these financial institution administrators had abused their trust. It is true to say that this sort of action was triggered by the financial crisis. The monitoring and regulation is a sure way of restoring public confidence in the governments’ ability to take care of their investments.
Strengthening Of Key Companies in Various Economies
The American financial crisis set the tone for bailouts. There was concern among some government leaders that if some companies collapse, the whole economy would be in jeopardy. It is out of this concern that banks, hedge fund managing firms and automakers were bailed out(Sorkin 2010, p.18).. Other countries also took the opportunity to strengthen companies that they felt were significant in their economies out of the concern that if these companies collapsed, the entire economies would collapse (Paulson 2010, pp.36-37). As a result of these bailouts, these key companies have been given a new lease of financial life. They are now on a firm footing, and if they are managed well, they are likely to enjoy sound financial standing for a long time. Chances are that had the crisis not occurred, this kind of action may not have been taken.
Increase in Cooperation among Countries.
The economic troubles that commenced in the United States reverberated throughout the globe. This was not unexpected given the position of the US in world affairs (Rajan 2010, pp.32). This was a way for the world to learn that isolation is not the way to go. Therefore world leaders had to cooperate in trying to come up with solutions to the financial crisis. The interconnected nature of the modern world popularly known as globalization became clear. In meetings such as the G20 the leaders found time to discuss various ways to deal with the financial crisis and avoid future downturns (Paulson 2010, pp.33-34). Cooperation was at a higher level than before.
The Rise of a New Economic Order
The period after the financial crisis is quite different as far as economic might is concerned. Before the crisis, all eyes were on the United States as the economic giant. This is not the case given that countries such as Brazil, China, and India are catching up at a high speed. China is threatening the economic position of the United States since the Chinese economy has experienced moments of growth even as the rest of the world has had tough problems. It is possible that soon China will be the largest economy in the world. But this can only happen if the economy of the United States does not recover accordingly even after all that has been done has taken effect.
Whichever way, the time when the world had to look up to one nation for economic guidance seems to be coming to a conclusion. It is not a one nation business any more but a wide playing field where multiple nations have the opportunity to flex their economic muscles. And this is not only at the global level but at a smaller scale too where different parts of the world have new top countries in terms of economic might. In Africa, Nigeria is now being left behind by South Africa and small countries such as Kenya are doing well economically. In Latin America, Brazil is a regional powerhouse while India is economically too far compared to its neighbors such as Pakistan.
The Current Situation
Latest reports indicate that the American economy may be emerging from the doldrums, but it is still too difficult for families not just in the United States but around the world. It may take a while to get the world economy to a point of strength but its back on track. The measures various governments around the world took maybe responsible for these good signs, but it is not easy to say this with certainty.
Conclusion
Lack of regulation led to the proliferation of unacceptable financial practices in the United States resulting in the worst financial crisis since the great depression of 1930. Due to the primary role played by the United States economy in the global financial system, the world economy had to get affected in a profound way. The effects to the global economic system were both positive and negative (Paulson 2010, pp.121). Positive effects include the assessment of financial systems, the strengthening of key companies, the increase in regulation and monitoring and the rise in cooperation among various countries. Negative effects include the reduction in aid, the weakening of financial systems, increase in crime, and slowing of the global economy. There was also increase in global joblessness, a change in the way the rest of the world views the United States, a slowing in the fight against HIV/AIDS, and a decline in people’s living standards around the globe.
Recommendations
As shown by this term paper, the world economy is still vulnerable. Even with the awe-inspiring technological advancement that the world has made, nothing can replace the human touch in the management of finances in particular and life in general. Sound judgment in investment is necessary. In order to avoid future financial meltdowns, governments are better off with strong means of regulation and monitoring. The reason for this is that there are executives whose values are not strong enough to bar them from carrying out suspect schemes that end up putting billions of public resources at risk. But with regulation and monitoring in place, such officials can be kept in check.
It is also beneficial if the governments adopted more cooperation in dealing with financial crises. In this era of globalization, no single government can claim to be in a position to go it alone. Unity of purpose is a major factor as shown by the ease with which this financial crisis was dealt with when world leaders decided to put their heads together. Lastly, it is recommended that countries try to be as independent as possible in financial administration. The reason for this is that in case of a problem in one country, the entire globe is not put at risk. This does not mean that cooperation in financial matters gets severed. It simply means that if there are systems that can be detached from the rest of the world financial system and still function optimally, then it is better off on its own.
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