The Financial Crisis 2009 Part IV
Tighter regulations require – to varying degrees – international cooperation to be fully effective. Without such cooperation, banks may threaten to move to where they receive the most favorable terms. We can have what is called a race to the bottom. In the previous round, Iceland and Icelandic banks won this race. Then it narrowed, and the inhabitants of the island now have a huge bill. This experience has led some to believe that it is dangerous to place too much emphasis on the idea of international harmonization. The best can be the enemy of the good. Or it can be a pretext for not doing anything.
8: Underlying conditions
The financial crisis is linked to the flow of large sums of money from countries with a surplus in the foreign economy to countries with a deficit (simply put, countries that buy more goods and services abroad than they sell the other way around).
Many countries are investing in export surpluses. But not everyone has it – it will be impossible. For some countries to have a surplus, others must have a deficit in foreign trade (the foreign economy). Today’s surplus countries include everything from oil-rich states (including Norway, which lends huge sums through our pension fund) to Sweden, Germany, Japan and not least China. Among the most important deficit countries are the United Kingdom and the United States.
The most important relationship between two countries in the world economy is that between the United States and China. In the last 10 years, a strange interdependence has arisen between the communist-controlled – but also partly market-oriented – export machine China and the capitalist deficit economy of the United States. The logic is as follows:
To create growth and stability, China has brought people out of the countryside and into cities and “export zones” where they simply work in factories that first make products where it is a great advantage that labor is cheap, such as textiles and the toy industry. But China is developing rapidly, and eventually the country is producing advanced technological equipment and cars as well. Regardless: China will export.
To achieve this, the country has lent much of its savings to the United States, money the United States needs to maintain imports from China. Specifically, this is done by the Chinese central bank buying US government securities (government bonds – fixed-rate loans issued by the US Treasury Department). At the same time, China is helping to prevent the dollar from falling dramatically in value. Other countries that run deficits in both their public finances and in their foreign economies quickly experience two problems: The exchange rate goes down (because people sell more of their currency than they buy) and the interest rate goes up (necessary to attract money to a country with a weak exchange rate and large deficits).
But the United States has not suffered such a fate. Instead, the country has – for several years – been “subsidized” by Chinese taxpayers and exporters. In this way, China has collected enormous amounts of dollars “on the books” through gigantic profits in trade with the United States. Then suddenly a new problem arises. What happens if confidence in the dollar falls? Yes, then the Chinese state wealth will be much less valuable. It’s our dollar, but their problem, it’s said in an old American saying. There is a core of truth in that statement. But that does not tell the whole truth. If the dollar falls sharply in value, it could force the United States to raise interest rates sharply and the United States end up on a painful horse cure.
Countries that are already staring at a horse cure are currently called PIGS (Portugal, Ireland, Greece / “Greece” and Spain.
9: Dirty government finances
According to SECURITYPOLOGY, these countries currently have huge deficits in their public budgets. The financial crisis (or perhaps we should say the financial sector) has played an important role here. First, they have gone through bubble conditions in the economy. Bubbles inflated by cheap interest rates and lax banks. Bubble conditions provide good tax revenues, and it will be easy for the state to postpone spending cuts and / or tax increases. Then the bubble bursts and the economy is hit by a sharp fall. This thins public finances in two ways. Tax revenues are falling, and the state must spend money on supporting the financial sector in the respective countries.
Before the euro was created, these countries would certainly have devalued – dropping their national currencies so that imports became more expensive (and smaller) and exports cheaper (and larger). After joining the eurozone , this is no longer possible. The EU also has no clear rules for dealing with debt crises in a country with euros. Rich EU countries, led by Germany, talk about organizing a rescue operation, but here the rules must be created while walking.
If we look at it a little big, we can say that the financial sector now “thanks” some of its rescuers by speculating against them. Among other things, there is speculation about the PIGS countries’ government debt in the market for CDSs as described above. Funds that do not necessarily have any investments in the country use the CDS market to monetize the uncertainty created by the large deficits. In this sense, we can say that the financial crisis is rolling on. But now with states, not banks, in the lead role.