Global Financial Crisis: Nature, Causes, and Consequences

free essayModern society seeks to constantly improve the level and conditions of life that can only be provided via sustainable economic growth. However, observations show that long-term economic growth cannot be guaranteed. It is constantly interrupted by the periods of economic instability and even crises. The last of them, the global financial crisis of 2008, forced economists to reconsider traditional beliefs about the causes of financial crises and stimulated the development of measures aimed at preventing their occurrence in the future. The rotation of periods of growth and recession inthe economic activity, following one after another, are usually called the economic cycle.

One can found cycles everywhere. The life and the career of a modern human usually develop cyclically. Everything in the Universe is arranged in the form of cycles, for example, the night and day sequence, summer and winter, and so on. The economy also tends to develop cyclically. It has its own crises, periods of growth, recessions, and thriving. People always strive to the greatest heights of their well-being while the governments always try to reach the peak of the development of the state’s economy. However, the economy cannot be always at the height, it is inevitably followed by a decline, a crisis.

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The Concept of a Financial Crisis

The financial crisis is a dangerous and hardly predictable economic phenomenon, which appeared along with the emergence of the financial system. Initially, it periodically covered separate countries or groups of countries that led an effective economic relationship among themselves. Today, the financial crisis has taken global dimensions due to the economic integration of countries around the world. According to American economists Carmen M. Reinhart and Kenneth S. Rogoff, “crises are a recurring problem everywhere. They are an equal opportunity menace, affecting rich and poor countries alike” (Reinhart and Rogoff, 2009, p. 161). Thus, the threat of a crisis has increased exponentially for each country. No country is immune to the crisis.

The following interpretations of the crisis can be considered relevant. First, the financial crisis is a situation or a state in which the functioning of political, socio-economic, and other spheres is not possible due to the lack of financial resources within the framework of the previous model of financial functioning or organizational behavior, even if it suited this socio-economic system very well (Ciro, 2012). Second, the crises can be defined as a situation where the functioning of an economic system or a particular sphere reveals a problem of the critical discrepancy between the desired and actual state of its financial resources (Ciro, 2012). At present, the financial crisis is considered in several contexts in terms of its effect. The financial crisis can be regarded as a source of financial damage and a chance to improve the functioning of the financial sector, or it can be also viewed as a moment of urgent adoption of relevant financial decisions, including changes in the financial performance of the organization.

The sources of the financial crisis may be of different origin. They can be natural, technological, socio-economical, and so on. The mechanism of the financial crisis includes the sources of the crisis, the way of development, and the consequences (Ciro, 2012). Regardless of the nature of the sources and the way the crisis develops, the outcome of every crisis is the financial damage. Therefore, diagnostics of the crisis is an important step in reducing economic losses. It is aimed at identifying the reasons for the deterioration of financial parameters or the results of socio-economic activities and their transition to an unacceptable state (Ciro, 2012). The diagnosis is an important element in assessing the status quo since it lays the foundation for devising recommendations for overcoming the financial crisis.

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The financial crisis performs the following functions in the process of the socio-economic development: it demonstrates hidden financial sources and conflicts of elements or stages in the functioning of the financial sector; it develops and implements measures to restore balance in financial relations; it updates financial and socio-economic environment and methods of financial and market management; and it minimizes the total financial damage from the crisis (Ciro, 2012).

Crises functions depend on their types. The basis for the classification of financial crises includes geographical location, the extent of damage, duration, and so on. Based on these factors, the crises can be global, regional, national, or industrial. The financial crisis at the level of the region or the state can be manifested in the form of a loss of the economy’s ability to operate in the expanded reproduction mode due to the lack or the inefficient use of financial resources, the loss of financial stability, inefficient state regulation of financial processes, etc. (Ciro, 2012). The total damage from the financial crisis is defined as the sum of direct financial losses during the crisis and the costs of its liquidating. The global financial crisis is characterized by the large number of countries covered; various socio-economic manifestations such as bankruptcy of economic entities, unemployment, inflation, etc.; the depth and the complexity of the reasons underlying it; and geopolitical changes and the desire of more developed countries to shift the burden of damage from the crisis to less developed countries, including using methods of political and military pressure (Ciro, 2012).

Thus, the most complex and dangerous type of financial crisis is a global financial crisis.

The Nature of the Global Financial Crisis

The economy is a complex, multi-level, and evolving system. The economic system of society consists of small economic systems, namely households, and enterprises. A household is a small system that represents owners of resources and consumers within the family. The economic activity of such a system involves the sale of labor and other resources, receiving salary and other income, the acquisition of consumer goods, and the creation of certain economic goods and services such as cooking, repair, construction, growing vegetables and fruits, and so on. A business is a small system within which economic goods and services are created via a set of resources (Gonzalez, 2012). Groups of interconnected enterprises are integrated into the industry. The industry is a larger system that unites all enterprises that produce certain products. Industries are combined into larger systems. In addition, the economic system of society may include other elements (Gonzalez, 2012). Thus, the multilevel nature of the economic system of society means that it, like any other system, is the part of a larger system. For example, an enterprise as an economic system is related to the activities of the industry as a whole and the economic system of society, and the latter, in turn, is influenced by international economic relations and economic systems of other countries.

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The more complex the system of society is, the stronger regulation is required. At the same time, the more highly organized the economic system is, the greater the need for autonomy and the relative freedom of its major parts is expected. The social division of labor requires coordination. There are two main ways of coordinating economic activity in the system, namely spontaneous order and hierarchy. The first means voluntary cooperation through market interdependencies, and the second means centralized management (Gonzalez, 2012).

The economic development of countries is not straightforward but rather wave-like. This is expressed in regular alternations of periods of economic prosperity and rapid growth of production with periods of sluggish economic conjuncture and slow production growth or even its absolute reduction. This concept is called the economic cycle. Economic cycles are periodic recurring imbalances in the national economy, which are accompanied by the contraction, followed by an increase in the volume of production and aggregate demand with occasional rebalancing (Gonzalez, 2012). Such a cyclical nature of economic development is due to the following reasons.

The first is the imperfection of market self-regulation. Economic environments involve additional resources in production and create new incomes and increase demand. When consumption reaches saturation, the production cannot react instantly to this condition. For example, the saturation of consumer demand for cars will cause the reduction in demand along the technological chain: cars ? components ? equipment for their production (Gonzalez, 2012). The information on the need for reducing the volume will flow through this chain to the manufacturers of machine tools and equipment in the last place. They will produce extra products for some time by inertia (Gonzalez, 2012). The second is the development of disproportions in the structure of the national economy (Gonzalez, 2012). The natural aging of some industries, the development of others, the peculiarities of the location of productive forces across regions cause an increase in disproportions and, consequently, the decline in production.

The third is the nature of the movement of facilities. Scientific progress leads to the improvement of existing and the emergence of new models of machines and equipment. The need to replace facilities because of its natural aging and moral depreciation determines the cyclical nature of production in the branches that create the means of production. It leads to a cyclical nature of investment in industries that produce consumer goods (Gonzalez, 2012). The periodic increase in investment causes a multiplicative expansion of producing the means of production and a further multiplicative increase in the economy as a whole.

Not all fluctuations in business activity are explained by economic causes. There are also external reasons. These factors are the economic system and include sunspots, wars, revolutions, population growth, the discovery of new lands and resources, and, finally, scientific and technical innovations (Gonzalez, 2012). For example, there are seasonal fluctuations in business activity, namely the consumer booms before Christmas and Easter. This leads to significant annual fluctuations in the rate of economic activity, especially in retail trade.

There are several types of business cycles. The most basic of them are annual ones that are associated with seasonal fluctuations under the influence of changes in the natural and climatic conditions and the time factor. Other cycles include the Kitchin inventory cycle, the Juglar fixed-investment cycle, the Kuznets infrastructural investment cycle (or the building cycle), and the Kondratiev wave or long technological cycle (Gonzalez, 2012).

The Kitchin inventory cycle is a short-term cycle of about 40 months (Gonzalez, 2012). It is caused by time lags in information exchange. In its turn, it affects the process of decision making of all commercial companies. The Juglar fixed-investment cycle is a medium-term cycle of 7 to 11 years long, although the classical type covers a 10-year period (Gonzalez, 2012). It is associated with a multifactorial model of breaking and restoring economic balance and proportionality. The Kuznets infrastructural investment cycle covers a 15-20-year period (Gonzalez, 2012). The cycle tends to decrease under the influence of scientific progress factors, causing an obsolescence of the equipment and the implementation of the accelerated depreciation policy. The long technological cycle is of 45 to 60 years long (Gonzalez, 2012). It consists of alternating intervals between high sectoral growth and intervals of relatively slow growth. In each cycle, the economy experiences certain stages. Each of them characterizes the specific state of the economic system. The stages include recession, expansion, recovery, and crisis.

The recession is characterized by the stagnation of production and the obsolescence of machinery and equipment, which is an important prerequisite for reducing production costs in order to adapt to the established low level of prices. Low prices contribute to the resorption of accumulated inventory, although some of them are destroyed (Gonzalez, 2012). The low level of the economic activity causes massive unemployment. The specificity of the movement of interest rates and stock prices lies in the fact that, despite the fall in the interest rates, stock prices do not grow due to the stagnation of production that does not provide dividends.

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The expansion is due to the intensification of economic activity, an increase in production volumes, an increase in the level of prices, profits and interest rates, and the adaptation of the economy to the newly formed price level. The duration of this phase of the cycle is based on the achievement of the level of social production that corresponds to the pre-crisis state (Gonzalez, 2012). At this phase, the unemployment rate declines, the circulation of capital accelerates, the demand for credit increases, and the interest rates rise (Gonzalez, 2012). The prices and profits of enterprises, as well as the stocke prices and other securities, start to rise.

The recovery is determined by the continuation of economic growth started in the previous phase, the achievement of relatively full employment, the expansion of production capacities and their modernization, and the creation of new enterprises. Interest rates continue to rise under the impact of the investment growth. Despite the enhancement in the level of interest rates, there is an increase in the price of securities as it has a positive impact on the growth of profitability of enterprises (Gonzalez, 2012). In addition, the high yield of securities triggers an increase in investments in fictitious capital. A special role at the stage of recovery is played by trading capital, which, in an effort to purchase more goods with a view to further price increase, forms a speculative boom in demand pushing the production to further expansion (Gonzalez, 2012). As a result, the gap between production and the effective demand of the population begins to grow.

The crisis is the internal mechanism of the forcible adaptation of the sizes of social production to the volume of solvent demand of economic entities. This is a universal overproduction and a deep shock to the entire economic system from the top to the bottom. The market that absorbs all produced goods freely becomes overcrowded at some point. Goods continue to flow while demand decreases and, finally, ceases. However, many enterprises continue to work, producing more and more new goods to the market. The crisis is also characterized by the fall in prices and growing distrust towards the participants of the market economy (Gonzalez, 2012). Many enterprises go bankrupt, but the ruin of technically weak enterprises leads to an increase in the overall level of production efficiency. The center of economic activity shifts to the money market due to the growing demand for money resources, which, in turn, is due to the need to repay debts (Gonzalez, 2012). The growing demand for money capital triggers an increase in interest rates, which inevitably leads to a further drop in the price of securities, primarily shares. The curtailment of economic activity is accompanied by a reduction in employment and an increase in unemployment. The crisis phase gives rise to a new economic cycle or can interrupt the phases of recovery or expansion.

The History of the Global Financial Crises

During almost two centuries of the formation and the development of the world industrial society, crises occurred in the economies of many countries. There have been cases of the increasing decline in production, the accumulation of unrealized goods on the market, the fall in prices, the collapse of the system of mutual settlements, the collapse of banking systems, the ruin of industrial and trade firms, the sharp increase in unemployment, and so on. Economic crises were limited to one, two or three countries until the 20th century, and then started to become more international and less constrained by national boundaries. Despite the fact that in recent decades the world community has created mechanisms such as strengthening the state regulation of economic processes and the creation of international financial organizations, the history of world economic cataclysms demonstrates that it is not possible to accurately predict them or avoid them.

The first global financial crisis was in 1857 and damaged the national economy and public life of the United States, Germany, Britain, and France (Jones, 2009). The crisis resulted in massive bankruptcies of the United States railway companies and the collapse of the US stock market. Consequently, problems at the stock market became a reason of the American banking system crisis. At the same period, the economic crisis started in England, and then spread all over Europe. A wave of stock market turmoil took place even in Latin America (Jones, 2009). During the crisis, iron production in the United States fell by 20% and cotton consumption fell by 27% (Jones, 2009). In the UK, the industry that suffered the most damage was shipbuilding, which fell by 26% (Jones, 2009). In Germany, the consumption of iron decreased by 25% (Jones, 2009). The production of iron in France fell by 13%, just as the consumption of cotton (Jones, 2009). However, it was just the beginning of the history of global crises.

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The next world economic crisis began in 1873 in Austria and Germany. The crisis is known as the Depression of 1873-79 and regarded as a major international financial crisis (Jones, 2009). The precondition of the crisis was the credit growth in Latin America fueled from England, and the increase of speculation in the real estate market in Germany and Austria. The Austro-German rising trend resulted into the collapse of the stock market in Vienna in 1873 (Jones, 2009). The crisis passed from Germany to the United States after the refusal of German banks to roll over the loan (Jones, 2009). Since the US and European economies experienced production decline, Latin American exports fell sharply leading to a drop in state budget revenues.

In 1914, the other international financial crisis took place. It became a result of World War I beginning (Jones, 2009). One of the reasons of the crisis outbreak was the fact that the governments of Britany, the United States, France, and Germany started selling securities of foreigners to be able to invest money in military operations. This crisis, unlike the other ones, did not spread from the center to the periphery but began almost simultaneously in several countries after the belligerents began liquidating foreign assets. This led to the collapse in all markets, both commodity and financial ones (Jones, 2009). Banking panic in the United States, the United Kingdom and some other countries was mitigated due to timely interventions undertaken by central banks.

The Great Depression was the worst financial crisis till 2007–2008. The crisis of these years was manifested by a sharp decline in shares on the New York Stock Exchange on October 29, 1929 (Jones, 2009). It marked the beginning of the biggest global financial crisis in the history. The value of securities fell by 60-70%, business activity declined sharply, and the gold standard for major world currencies was abolished (Jones, 2009). After the World War I, the US economy developed dynamically, millions of shareholders increased their capital, and consumer demand grew at a rapid pace. However, everything had suddenly collapsed. The biggest large-cap stocks lost up to two hundred points within a week. Firms and factories closed, banks burst, and millions of unemployed wandered in search of work. The crisis continued until 1933, and its effect echoed until the end of the 30s (Jones, 2009). It was the worst financial crisis until 2008.

The Causes of the 2008 Financial Crisis

The first signs of future problems began to appear in December 2005. Prices in the housing market began to decline gradually. The first losses, the first bankruptcies, the first statements about the imminent danger of collapse drowned in the general flow of information. The precursor of the 2008 financial crisis was the mortgage crisis in the United States, the first signs of which appeared in 2005 in the form of a decrease in the number of home sales and in early 2007 developed into a crisis of high-risk mortgage loans (Mason, Obstfeld, & Cho, 2012). The forerunner of the general financial crisis was the mortgage crisis.

The excessively mild monetary policy led to the fact that the mortgage crisis has developed into another phase, namely the liquidity crisis. An important factor in the emergence of the credit crisis was the widespread use of derivatives that lead to the fictitious capital. The consequence was the uncontrolled emission that caused a sharp increase in inflation (Mason et al., 2012). Dangerous tendencies began to appear: the revaluation of risky assets occurs. Simultaneously, the real sector began to weaken and even big banks felt the pressure. Due to the availability, the mortgage was taken by anyone regardless of financial well-being (Mason et al., 2012). They planned to return the loan by raising the price of real estate. Such loans were issued by banks not because of low competence of employees but due to the “more loans, more bonus” system of payment for their labor (Mason et al., 2012). No one cared about what can happen next. Moreover, in conditions of rising prices, there were practically no problems with the return of loans. However, when real estate stopped growing in price, many borrowers experienced a local financial crisis since they had nothing to pay for loans. The wave of non-payments led to the fact that banks began to sell actively collateral real estate (Mason et al., 2012). It further affected the fall in prices and caused the financial and economic crisis in the United States.

All this led to the fact that banks that were too addicted to mortgage lending began to go bankrupt one by one after the financial crisis began. It results in a fact that many people lost their jobs. In addition, loans began to rise in price both for consumer and companies due to the decrease in liquidity (Mason et al., 2012). As a result, many companies that were unable to take credit for the development closed, which caused a new wave of unemployed (Mason et al., 2012). This snowballing led to the fact that the national financial crisis turned into a global one.

However, that is only one side of a coin. The second cause that triggered the global economic crisis was the overproduction of the US dollars. The US dollar has not been supported with anything in recent years. It means that the United States produced goods and services much lower than they consumed. The US GDP has a share of about 20% in global GDP (Mason et al., 2012). At the same time, the United States consumed 40% of all goods and services produced all over the world (Mason et al., 2012). In other words, before the global crisis, the United States produced goods and services for one dollar but consumed for two dollars. That is, at least every second dollar was a piece of unbacked paper (Mason et al., 2012). Moreover, the United States spent enormous amounts of money on various social and medical programs aimed at raising the standards of living of ordinary Americans. This led overall to a decline in the economy and financial crisis on a national level at first, spreading rapidly to other countries.

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The reasons of 2008 crisis can be explained by taking into account the sociological viewpoint. In addition to the above-mentioned reasons, there is also one more issue, which has to be mentions. It may not seem obvious at the first sight, but its importance cannot be underestimated. This reason is overconsumption, which is a process of excessive consumption of different goods that exceeds standard requirements. Consequently, it leads to a sufficient and sharp decrease in the value of the given goods (Gonzalez, 2012). Overconsumption is essentially connected with the underconsumption (Gonzalez, 2012). It deprives people of the most necessary things, including the persons that overconsume. For example, overconsumption reduces the degree of satisfaction connected to such processes as arrogation and extraction of goods. As a result, the causes and effect of overconsumption can be easily traced at all social levels, including macro and microeconomic. At the same time, individual consumption stops performing its role of a stimulus for future development, as well as for economic growth. It results in the fact that markets lose their “pre-established harmony”, which eventually leads to macroeconomic chaos, unlike “pre-consumer” economy, which can easily perform its functions without intervention of a state (Gonzalez, 2012). As a result, overconsumption can be considered a global issue. It outlines general mechanisms of present Western Socio-Economic System, which creates a negative potential for causing economic crisis, as well as and dysfunctions of social and economic character.

The Consequences of the 2008 Financial Crisis

In general, the consequences of every crisis can be divided into two large groups. The first group is the ongoing consequences. They represent a rapid response to the crisis. Their analysis allows one to assess the state of the economy and the society in the short term (Dolezalek, 2011). The most notable consequences are unemployment, inflation, and the rate of decline in economic indicators. The second group of consequences is those changes that await economies in the long term (Dolezalek, 2011). At this stage, the assessment of such consequences of the global financial crisis is related to the area of forecasts.

The global nature of the crisis does not mean, however, that its consequences will be the same for all countries and all sectors of the economy. As in the case of the causes of the crisis, its consequences vary greatly depending on the level of industrial development of states and the anti-crisis measures taken by the authorities (Dolezalek, 2011). This is clearly seen in the 2008 outcomes because the rates of GDP decline in different countries differ comparatively during the same periods (Dolezalek, 2011). Thus, it is natural to assume that the long-term consequences for them will not be the same.

Conclusion

The problem of the cyclical economy for more than a century of its existence has become a focus for the study of many factors that have the most significant impact on the development and the functioning of the world and national economy. The cyclical development of the economy is accompanied by a high level of the economic activity for a long time, and then by a decline in this activity to a level below the permissible one. Periodic recurrence of economic downturns leads to impoverishment, hunger, and suffering of people, which disturbs the civilized society. Therefore, the problem of cyclicity has always attracted the attention of economists and today remains one of the central problems of economic theory.

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Cyclicity appears as a form of movement of the national economy and the world economy as a whole. The modern mechanism for self-adjustment of the market economy through cyclical crises changes under the influence of state policies. There is the intertwining of the spontaneous market mechanism of the economy functioning in the form of cyclical crises with a conscious state impact on the reproduction process.

The history of world crises shows that they occur unexpectedly. Moreover, they are explained by different reasons, which always lead to devastating consequences to the world economy. Currently, the world economy is in a long recession. It is evident by the fact that many people around the world suffer difficult economic conditions and become poor. At the same time, the rich, even though their number is comparatively small, increase their wealth. Such tendencies can be seen in all world countries and they require taking immediate measures. Otherwise, there is a great possibility that the next global financial and economic crisis can prove fatal for the whole world. The global financial crisis is a challenge not only for the United States but also for the whole world. It is difficult to accurately determine the consequences of the crisis or, even more so, to give its unambiguous forecast, especially in present conditions of global instability where the global crisis is firmly rooted in all spheres of economy.

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