Financial Crisis: Effects of the Financial Crisis

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Introduction

There have been some major financial crises in the world in the recent past. The crisis is the European Monetary System that occurred in 1992-1993, The Mexican crisis 1994-1995, the Asian crisis 1997-1998, and the recent global financial crisis 2007-2009. The recent financial crisis has affected international trade. The financial crisis began in the United States in 2007 in the housing market resulting in foreclosures. The crisis continued to grow and eventually turned into a global financial crisis as well as an economic crisis. As a result, some major banks, insurance companies and investment houses faced bankruptcy while others needed financial aid to continue operating. Many businesses involved in international trade have been struggling in their financial management during the credit crunch because a business is supposed to remain successful even during crisis times. The managers in businesses involved in international trade have had to make decisions to help their organizations stay afloat during the financial crisis.

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Economists are of the opinion that a financial crisis results from feeble economic fundamentals, for instance, fiscal deficit, reduced foreign reserve, and increased foreign debt among others. The financial crisis eased in 2009 but its effects were felt globally. The effects on international trade occur because of the trade links among countries at the global market through a contagious effect (Glick & Rose, 1999). The contagious effect means that when a financial crisis occurs in a country it creates a crisis in another country even if that other country has sound economic fundamentals. The financial crisis affects international trade greatly and this paper will focus on the effects of a financial crisis on international trade and barriers around the world.

Effects of the financial crisis

Macroeconomic effects

The financial crisis causes a recession in the macroeconomy of countries. The financial crisis effects are felt all over the globe and no country escapes the crunch. Countries are affected on a macroeconomic level and immediate problems are experienced such as bankruptcy. In addition, the financial crisis leads to problems in other sectors and affects investors, firms, productions, households and the whole economies. The economies of developing countries suffer most as they experience wide capital flight as investors pull out their investments.

Furthermore, countries experience low prices in their exports. The prices go down as the banking system in a country experience the financial crisis that leads to its weakening and may lead to a collapse. The weakened banking system may make a country weaken in its export capability. Thus, such effects make it necessary for governments in various countries to come up with rescue packages. Moreover, the banks require the guaranteeing of their deposits. Other actions taken by the government are injecting capital and restricting debts. The actions are taken to shield economies and cost the governments a lot of money and as they try to contain the panic phase that result from the financial crisis. For example, governments across the globe took measures to contain the recent financial crisis. However, it is important to note that the cost of the actions that governments in both developed and developing countries took during the financial crisis are yet to be fully determined (Nanto, 2009).

Exchange rates

During financial crisis, the exchange rate becomes uncertain as countries lose their grip on fixed exchange rates. The uncertainty of the exchange rate makes both importers and exporters vulnerable to greater risks at the international trade hence some avoid taking the great risks involved through reduction of trade volumes to minimize the exposure to risks. Thus, the crisis affects the international trade through exports and imports negatively (Ma &Cheng, 2003).

Recession

The financial crisis affects the international trade through recession. If a country’s economy has imperfect trade it is likely to result in sudden stop. Sudden stop means that the capital account becomes goes through reversal. A country that experiences the sudden stop sees its domestic demand for goods and services drops as well as its export and output capability. Moreover, the recession leads to bank runs as both local and foreign investors panic and rush to withdraw their money from the banks even before the projects they had invested in matures. Some investors manage to rescue their money while others suffer losses. The foreign investors withdraw their money and bring the economy down. The banking crises created by the financial crisis affect the international trade in three ways (Ma &Cheng, 2003).

One way through which the international trade is affected is through the income channel. The income channel is affected when bank runs arise and banks are forced to liquidate their long term investments projects prematurely thus the depositors experience some losses. The local investors get lower incomes from their bank deposits and their demand for imports drops. Thus, through the income channel the international trade is affected by the decline in foreign trade. The way through which the international trade is affected is through the foreign capital flow. Even if bank runs do not occur, foreign investors withdraw their deposits from banks after the maturity of other projects. The withdrawal brings about an inflow of foreign investors but a bank run leads to premature withdrawal and leads to a reduced foreign investment. Therefore, the through the banking crisis the international l trade is affected through short-term stimulation of exports and a reduction in the same after the crisis eases. The third way through which the financial crisis affects the international trade is through the investment demand. During a financial crises investment declines and the demand on foreign goods takes a hit. The financial crisis affects imports in the long term via the investment demand channel. Thus, a country must look for ways to increase it exports in order to supplement the declining investment output. The international trade is affected as exports are stimulated by the financial crisis (Ma &Cheng, 2003).

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Political effects

The financial crisis affects the politics of a country within the political leadership as well as the regime. The crisis leads to discontent from citizens of many countries across the globe. Many people to lose employment and have trouble in finding new employment as many businesses lay off their workers as times became hard. In addition, people lose their wealth in both the real and financial assets. The crisis also leads to the decline in product prices hence businesses accrue loses and cannot operate efficiently. Consequently, due to the above problems people lose faith in the leadership and regimes in their countries, which they accuse of failing to do enough to protect them. The loss of faith in the regimes leads to political opposition in the countries democracies as people crave for new leadership to take the country out of its financial mess and save the livelihood of the people, which is threatened. As opposition of the current regime builds up extremist movements also come up to oppose the leadership of the country. Such movements thrive well in developing and poorer countries because the people become very vulnerable hence, it is easier for the extremist movements to recruit them. Moreover, the unemployed young people are often influenced by radical religious movements to join the groups and oppose the western system through terrorist activities because the system is demonized and accused f the current problems facing such a country (Nanto, 2009). The people are told that the only way out of the financial crisis is by opposing the western society. For instance, in the U.S. many people lost faith in the current President because immediately after he took office the financial crisis hit hard and many people lost employment as businesses sank. They doubted the ability of the president to lead them as they had a high expectation that things would change. Therefore, the financial crisis causes political instability in country and the instability affects international trade as investors pull away from the unstable countries. The unstable countries also find it hard to get loans from international bodies to enable them trade at the international market. The financial crisis affects the country negatively leading to recession as all sectors become entangled in the crunch. Once individual countries are affected by the financial crisis, positive global economic growth is affected as shown by its decline during the year 2009 (Cottier & Delimatsis, 2011).

On the other hand, the financial crisis causes the product prices to go down. It means that many countries’ export products lose value and the countries fetch low prices at the international market. The low prices lead to instability in the home countries as the economy of the countries stagnant. Such countries are hence not able to get money to accomplish their target interests leading to negative consequences. Other products such as oil become very expensive during crisis times and the high prices in oil affect every sector in a country as everything else becomes expensive due to the high cost of oil. On the contrary, financial crisis can lead to an increase in a countries export in the short team after they devalue their currencies after the financial crisis ends. Meanwhile, the results of the high prices lead to inflation in a country. Many people are left suffering as they fail to make ends meet and become very frustrated leading to demonstrations as experienced on the Arab world as people accuse reigning regimes of oppression that had led to many problems such as unemployment and high cost of living, which they could not afford anymore (Nanto, 2009).

The other effect of the financial crisis on the ruling regimes comes in through the actions they take to deal with the problem and hold on to power. The crisis helps the government by making it more powerful as people look to the state for financial rescue. For example, many nations across the world blame the United States for creating the financial crisis through its financial elite. The governments are able to reignite nationalism in their citizens by blaming the U.S. for the crisis and hence strengthen their position through the support of the people. Moreover, as the economy is hit and the crisis bites, hard people expect the government to come in and take action. When the government rescues the country, it earns people’s support. The dictatorial regimes are able to take advantage of the financial crisis to consolidate power (Nanto, 2009).

Economic neoliberalism

The financial crisis also leads to decline in economic neoliberalism. As the financial crisis affects a country’s economy, it becomes mandatory for the government to step in and come up with regulations. The interference of the government in business goes against the spirit of neoliberalism that supports a free market and non-governmental interference especially in the private sector. However, the recent financial crisis made governments across the world interfere even in the private sector in trying to control and avert the credit crunch. It is also important to note that the market structure in the international trade will not change overnight because the governments have interfered but with the rise of regulation, the international trade is bound to experience a major setback as investors pull away due to the increase in trade barriers. Furthermore, many countries that had shifted from their socialist market model and adapted the western capitalist model may revert to their old model as they question their shift to the western model (Nanto, 2009)

Trade barriers

The financial crisis leads to increased government regulation in trade and the private sector. The interference of the government in the trade means that the political class directly gets involved in decision making in companies because of the capital they inject to companies. The ability of the political class and bureaucrats to make decisions at the company level is opposed by many people who accuse the government of favoring some companies at the expensive of more deserving companies. The taxpayer money used to offer rescue packages to some companies makes it the public’s interest in such companies. Hence, the government interferes even with the internal operations of the companies for instance, it has a say on the bonuses the executives in a company take home (Shah, 2009). They may also affect the international trade by import reduction.

Do governments not only interfere in the internal trade within countries, but also interfere with trade at the international. The financial crisis has led some governments to enforce non-tariff barriers in their bilateral and multilateral trade agreements. The governments also resort to protectionism in order to keep their economies stable. For instance, the financial crisis gives countries a leeway for financial regulation abuse. The abuse occurs as governments provide their domestic firms with liquidity through bailouts in order to protect their domestic firms and in the process leave foreign firms vulnerable. The nationalization of financial institutions could also open doors for politicians to use the institutions to fulfill their political interests. Some of the measures taken by the governments come with conditions such as buying local goods, or producing locally to encourage people to support the domestic market and shun import goods. Unfortunately, the citizens end up paying the cost of the public debt through future tax increases. The citizens are made to pay for the mistakes of a few elite who put the countries in the financial crisis (Cottier & Delimatsis, 2011). The government forms trade barriers by restricting imports and hence countries that depend on exporting goods to such countries lose market affecting them negatively. The governments impose trade barriers in spite of the World Trade Organization rules, which seek to minimize trade barriers to give countries an equal opportunity to compete at the international trade. The trade barriers include high tariffs for import goods that make it very difficult for exporting countries to make profits at the international market. Some of the sectors are exempt from the trade agreements hence they do not have to follow any rules and can impose heavy trade barriers. The governments also increase the trade barriers by rescuing domestic firms or even through currency depreciation.

Developing countries

Developing countries feel the effects of the financial crisis greatly. The countries feel the effects concerning trade financing. The countries depend on trade financing in order to participate at the international trade yet the trade financing is related directly to trade transactions across borders. The countries experience a shortage in trade financing because banks are unable to offer them loans due to cash shortage. Experts reported after six months since the beginning of the financial crisis that the finance trade market had deteriorated severely. The reason for the deterioration was the fact that businesses could not get access to short-term loans hence the failure to absorb the shock caused by the economic down turn. The trade finance helps the international trade because it a secure mode of finance that has a short maturity and thus goods can be used as collateral for the loans. Hence, the financial crisis has made the international trade to deteriorate as countries lack financing because they require money in order to participate at the international trade (Nanto, 2009; Ma & Cheng, 2003).

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Consequently, the financial crisis has made international trade difficult by exacerbating the ability of countries to acquire trade finance through the shortage of liquidity. The crunch has increased the gap between supply and demand hence dropping trade at the international market. The other effect of the financial crisis on the international trade is making banks reluctant to take any financial risks hence their unwillingness to finance business even if they could. Thus, it becomes very difficult for businesses to stay afloat and trade at the international arena. As a result the developing countries are facing a harder time in trying to acquire trade finance was not easier even before the financial crisis began because they struggle to qualify for international financing. The countries suffer most because they require the trade financing to sustain their economic growth hence they suffered a lot due to the financial crisis with their economies becoming stunted (Nanto, 2009).

Trade relationships

The financial crisis affects economic relationship between countries. The reason for the effect on economic relationship comes in because countries depend on one another in this era of globalization that has seen countries drawing close in trade. A good example of how the financial crisis has put a strain on international trade partners is the relationship between the United States and China. The two economies are dominant and their relationship affects the entire world with far-reaching implications because they are integrated by the flow of goods, people and financial capital.

The two countries need each other during the financial crisis because china needs a market for its export and the United State is a major market for Chinese products. China must ensure that it protects its export market to ensure that it maintains its social stability. On the other hand, the U.S needs China to buy its Treasures to be able to finance is budget deficit, which rose with the fiscal stimulus plans. The two trading partners are wary of each other as they see that the other partner benefits disproportionately from each other (Prasad, 2009).

The problem can be seen as China tightens its grip on its exchange rate creating tension with the United States. The bilateral deficit between the two countries has been increasing and China is under sharp scrutiny for its exchange rate. The tensions has bee increased as China trade surplus rises and its foreign exchange reserves. On the other hand, the U.S has a protectionism clause that accompanies its stimulus package called “Buy American” thus it affects China’s exports straining the relationship further (Prasad, 2009). Thus, economic relationships affect the international trade during financial crisis.

Rise in debts

Following the financial crisis, many financial institutions fall including some of the biggest largest financial institutions. Other companies were bought out at low prices because they could not stay afloat. The wealth nations such as the U.S. came up with stimulus packages to help the surviving financial institutions and banks stay afloat. The amount of money that governments across the globe used in stimulus packages rose rapidly and by October 2009, the figure of the word credit loss was at $2.8 trillion (Shah, 2009). Moreover, the financial crisis has reduced the value of companies across the globe by 33% or $14.5 trillion and the figure is expected to soar (Shah, 2009). The reduction in the companies’ value has a negative effect on other things as shown in the following paragraph.

Job cuts

The effects of the crisis have not only been felt by the banks and other financial institutions but also by everyone else including employees. The financial crisis transformed into an economic crisis making it difficult and expensive for companies to obtain loans and hence they resulted to job cuts as they try to weather the financial crisis. Furthermore, it is difficult for smaller businesses to get stimulus packages from the government and must cut jobs or risk getting out of business. The problem of job losses was so big all over the world and the International Labor Organization called the situation a global job crisis (Shah, 2009). As people lose employment, they are unable to meet their needs such as paying their mortgages. On the other hand, those who bought houses during the crisis faced a likelihood of the value of their houses falling and “leaving them in negative equity” (Shap, 2009, p. 1). Consequently, demand for goods at the international market reduces, as people fear putting their investments in risky projects.

Conclusion

Finally, financial crisis affects international trade negatively by the decline in both imports and exports as investors become wary of making losses and hence choose to reduce business at the international market. Once business is reduced at the international trade, countries experience problems that trigger political and social instabilities. The instabilities make the situation worse as foreign investors pull away for the economy resulting to a capital outflow and the capability of such countries to trade at the global market is affected negatively. The financial crisis reduces consumers’ incomes, which reduces their demand and ability to buy foreign goods. Thus, affects both exports and imports are affected which in turn affect the international trade. Moreover, world trade barriers increase during a financial crisis as countries impose non-tariff barriers and introduce protectionism that affects the international trade negatively.

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Reference List

Cottier, T., & Delimatsis, P. (2011). The Prospects of International Trade Regulation: From Fragmentation to Coherence. New York: Cambridge University Press.

Glick, R. & Andrew, R. 1999. Contagion and Trade: Why Are Currency Crises Regional? Journal of International Money and Finance 18, 603-617.

Ma, Z., & Cheng, K.L. (2003). The effects of financial crises on international trade. Web.

Nanto, K.D. (2009). The global financial crisis: Analysis and policy implications. Congressional Research service Report, 1-153, 157p.

Prasad, E. S. The effects of the financial crisis on the U.S-China economic relationship. Cato Journal, 29 (2), 223-235.

Shah, A. (2010). Global financial crisis.

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