There have been far reaching effects on the global financial crunch on the market. The monetary policy has been very much lenient in the past resulting in a credit bubble. It is feared that the burst of this bubble would lead to a reiteration of the Great Depression of the 1930s at the global level.
The Bank for International Settlements , the esteemed financial institution of the world has cited the following reasons behind this global financial crunch:
1. Issue of new varieties of credit instruments at a mass scale.
2. Increasing household debts
3. Increase in the risk loving attitude depicted in the investors
4. Asymmetries in the currency system of the world
The Bank for International Settlements has also explained the role of China in contributing in the global financial crunch. According to BIS the Chinese economy is characterised by the following aspects:
1. Asset boom
2. Huge investments in the heavy industries sector.
More than 40% of the industries in China are loss making units and due to this the banking sector has accumulating Non Performing Assets .
Most countries are in favour of the building asset bubble since according to them they can be “cleaned up” in the future. The failure of this approach is evident from the Great Depression that followed in US in the 1930s and the situation faced by Japan in 1991. The debt and the huge investments that are accumulated during the boom years would have negative effects on the economy when the recession sets in.
The figures given in the following table indicate the vulnerable financial position of US .
Table 1. Figures Depicting Credit Crunch of US
Parameters |
Statistics |
Current Account Deficit |
6.5% of GDP |
External Liabilities |
$4 trillion from 2001 to 2005 |
Issue of CDOs |
$470 |
Issue of Synthetic CDOs |
$524 |
The above figures indicate a highly unbalanced US economy. Again with the issue of Collateralized Debt Obligations the lending spree had increased. Borrowers could obtain Mortgage credit at easy terms.
Given the present situation, any time the credit cycle can reverse and the situation like the dotcom bust can arise.
A solution to the problem of global credit crunch is a cut in the rate of interest but this would only lead to wealth transfer from the creditor to the borrower. This could lead to a more vulnerable situation in the future.