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Introduction: This essay explores various themes. The first section explains how banks deal with their debt and ways in which mismanagement of debt can lead to financial crises, like the 2008 financial crisis. The following segment discusses how economies around the world have changed and behaved in the aftermath of the 2008 financial crisis, particularly the rise of populist and anti-globalism sentiment. Finally, this essay examines the state of the eurozone economy considering economic stagnation, austerity, quantitative easing and flaws of the monetary union. Debt and financial crises Financial Intermediation is described by (Juneja, n.d.) as the transferring of money “between those who have the resources and those who want resources”. (Diamond D, 1983) mention that “banks produce short-term debt to allow households to smooth consumption”, highlighting the role banks play in creating credit for firms and households to finance their immediate needs. However, an important aspect of financial intermediation is debt, which is the money owed to lenders (banks) that needs paying back. (Cowen, 2016) explains leverage ratio as “the ratio of debt to equity” and how high leverage means the price on your collateral asset need only fall a relatively small amount before the value of your collateral asset is less than your unpaid debt. Meaning that if you were to default on your loan and give up the collateral asset to the bank, the proceeds from selling the asset would not be enough to pay off the bank. (Cowen, 2016) notes that during the 2008 financial crisis banks were highly leveraged, meaning “they were buying assets using more debt and less of their own cash”. The Fractional Deposit Creation System is a banking model, whereby customers deposit their savings to a bank, from which banks use a portion of these deposits to finance loans given out to turn a profit. The issue with this model is if too many customers try to withdraw their deposits, the bank won’t be able to repay everyone at once and may have to declare bankruptcy, which is known as a ‘bank run’. Furthermore, financialization and the interconnectedness of the finance sector create the issue of contagion risk, which is “the risk that financial difficulties at one or more bank(s) spill over to a large number of other banks or the financial system as a whole” (Schoenmaker, 1995). A prime example is how the collapse of the real estate bubble in the United States and bankruptcy of Lehman Brothers during the 2008 financial crisis affected financial institutions around the world, including Northern Rock Bank in the United Kingdom which experienced a bank run and was eventually nationalised as a result. Furthermore, (Cowen, 2016) points to the concept of ‘Fire Sales’ which can occur during financial crises. When financial institutions experience a ‘bank run’ and still require money to finance their operations, they may start selling their own assets. The ‘Fire Sale’ occurs “as they all sell, that selling pushes asset prices lower … and those lower asset values pushes even more financial institutions closer toward bankruptcy”. This concept ties closely to the theory of excess supply illustrated in Figure 1 , showing that if the supply of a good were to increase the price would fall, ceteris paribus.
Figure 1: De-globalization and populism Financial de-globalization has been prevalent following the 2008 Financial Crisis. Reducing foreign transactions can be a method to decrease the exposure of the domestic financial sector to the contagion risk of the more volatile international financial system. (James H. , 2018) explains how European governments have “pushed initially to tighten regulation and to impose particularly hard national standards in order to make their banking systems even more secure”. Stricter banking standards can be justifiable policies to limit the risk of investments made by banks but enforcing harsher regulations can have the effect of discouraging foreign financial investment. These regulations might act as protectionist policies, known as ‘Red Tape’, meant to discourage foreign institutions from participating in the local economy. This disentanglement of European financial institutions contributes to a wider global financial de-globalization. Furthermore, de-globalisation has been accelerated by countries adopting more beggar thy neighbour policies. The trade war between China and the United States has negatively affected global trade through its disruptions to supply chains, with (Edwards, 2018) predicting that the trade war could “cost the global economy $800 billion, or 4% of global trade”. Along with the rise of Euroscepticism reflected by the surge in popularity of the Brexit campaign in the United Kingdom and the Front National party in France, that advocates France leaving the European Union. The aim of these campaigns is to improve the terms of trade, net exports, and pressure on labour markets of the domestic economies through protectionism and de-globalization. In the case of China, the US accuses China of benefitting from “unfair and harmful acquisition of U.S. technology (President Donald Trump)” (Goldstein, 2018) contributing to the current account surpluses seen in China’s Balance of Payments for many years. The rise of populism in developed economies can be attributed in part to the spike of cyclical unemployment following the 2008 Financial Crisis. (Sonno, 2017) suggests that “economic insecurity affects intentions to vote for populist parties”. Notably (Uchitelle, 2009) reported that “U.S. employers shed 2.6 million jobs in 2008, the worst year since 1945” with the unemployment rate reaching 10% in 2009 and remained relatively high afterward as shown in Figure 2. The Financial Crisis had the effect of globally wiping out the wealth and incomes of many people, which caused a fall in global aggregate demand as households cut their consumption and business investment consequently fell. This concept of demand deficiency - AD↓ = C↓ + I↓+ G + (X-M) is illustrated in
Figure 4: Populist politicians like Donald Trump and Marine Le Pen have been able to rally people who’ve been affected by the economic downturn of the global economy. (Tabellini, 2019) discusses how “survey data from the German SOEP confirm that voters who have become very dissatisfied with their economic situation tend to become very risk-loving and switch towards right-wing populist parties”. The current state of the Eurozone economy The Eurozone has been shaken by the sovereign debt crisis. Some Eurozone countries like Greece, Portugal, and Spain have accumulated large debt burdens, that required bailouts which came with austerity measures, meaning they were required to raise taxes and/or reduce their government spending. Particularly in Greece’s case “various European authorities and private investors have loaned Greece nearly 320 billion euros” (Amadeo, [Greek Debt Crisis Explained], 2019). (Grauwe, 2015) links the implementation of austerity measures to economic stagnation currently seen in the eurozone, he says that: “The burden of the adjustments to the imbalances in the Eurozone has been borne almost exclusively by the debtor countries in the periphery. This has created a deflationary bias that explains why the Eurozone has been pulled into a double-dip recession in 2012-13, and why real GDP has stagnated since 2008, in contrast with what happened in the non-euro EU countries and in the US”. From a Keynesian perspective, the austerity measures shrunk aggregate demand in these eurozone economies, which had the knock-on effect of shrinking national incomes and pushing these economies into recession, shown in Figure 3 and Figure 4. Falling national incomes in debtor economies also mean governments collect less in taxes to pay off their national debt. This concept is known as ‘The Paradox of Thrift’ created by John Maynard Keynes. The Eurozone currently “seems to be stuck into a low-growth high-unemployment equilibrium” (Grauwe, 2015). According to (Micossi, 2016) the state of the Eurozone can be attributed to the structure of the monetary union of the Eurozone. With the use of a single currency, it was expected that “exchange-rate risks would vanish and payment disequilibria within the area would be smoothly offset by private capital flows” (James H. , 2012) but instead “the sovereign debt crisis in the Eurozone in 2010-12 started as a fully-fledged balance-of-payments crisis (Baldwin, 2015), prompted by the accumulation of large payment imbalances between its members and reflecting persistent
underlying divergences in prices and costs”. Meaning that debtor economies like Greece would be better off with a more undervalued euro, in which case their exports would be more price competitive and imports more expensive, which could improve its current account deficit. However, the euro being a shared currency with large exporting countries like Germany artificially appreciates Greece’s currency. (Micossi, 2016) promotes the solution that “the Eurozone should aim to achieve a full integration of labour and capital markets. This is only feasible with budgetary and structural reforms in its member states”. Other than the breakdown of the Eurozone and reverting back individual national currencies, Micossi advises that the EU needs to further integrate its fiscal policies in line with it’s monetary, in order to prevent fiscal overspending and excessive debt accumulation from its members. Though this would require that Eurozone countries relinquish a lot of self-governing right to the EU. What the European Central Bank has implemented instead is the monetary policy of quantitative easing, whereby the ECB printed money to buy securities “worth €2.6 trillion” (Lionel Barber, 2019) from European banks to increase the money supply in the economy, in hopes of raising economic growth, employment and inflation. This tactic has had mixed results, Mario Draghi the former president of the ECB, cites that “the 11m European jobs created in the past decade as proof that these policies are working” (Arnold, 2019). However, critics of Draghi’s policies have primarily come from German savers who have accused the policy of penalising the country’s prudent savers while rewarding profligate southern European countries”. Conclusion: If I were to extend this essay, I would want to investigate the extent of de-globalisation in developing and emerging economies in Africa and Asia. The extent to which emerging and developing economies were affected by the 2008 financial crisis and how they have dealt with its aftermath. As well as, the state and health of other trading blocs like NAFTA and AfCFTA.
Works Cited
Juneja, n.d.: , (Juneja, n.d.), Diamond D, 1983: , (Diamond D, 1983), Cowen, 2016: , (Cowen, 2016), (Schoenmaker, 1995: , (Schoenmaker, 1995), James H. , 2018: , (James H. , 2018), Edwards, 2018: , (Edwards, 2018), Goldstein, 2018: , (Goldstein, 2018), Sonno, 2017: , (Sonno, 2017), Uchitelle, 2009: , (Uchitelle, 2009), Amadeo, [Cyclical Unemployment, Its Causes, and Effects], 2019: , (Amadeo, [Cyclical Unemployment, Its Causes, and Effects], 2019), Tabellini, 2019: , (Tabellini, 2019), Amadeo, [Greek Debt Crisis Explained], 2019: , (Amadeo, [Greek Debt Crisis Explained], 2019),
