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Global Financial Crisis and its Solution

By: Dr.Dipak Basu
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(The author is a Professor in International Economics in Nagasaki University, Japan)

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The IMF"s chief economist Olivier Blanchard has warned that the global financial crisis is set to worsen and that the situation will not improve until 2010; he also has said that the IMF did not have the funds to solve every economic problem. Massive withdrawals of investments from emerging countries could represent hundreds of billions of dollars, which is so significant that the IMF alone cannot counter them. The IMF had spent a fifth of its $250 billion fund in the first two weeks of November alone. The only solution he has suggested is that the central banks "should lower interest rates to as close to zero as possible." The gatherings of the Presidents, prime ministers and finance ministers only have offered tall talks but no solution so far. United States and UK have allocated a vast sums of money to give these to the banks and financial institutions to manage their obligations, but without any prospect of renewed lending to the struggling business firms, a massive depression in the scale of 1930"s will set in quite soon leading to mass unemployment in the developed countries and mass starvations in the developing world.

What the economists and leaders of the world are hiding are the real causes of the crisis and as a result they are not brave enough to suggest a solution either. Depression and mass unemployment in the economy does not start immediately after a crash in the stock market. The crash of 1929 took almost two years before it was reflected on mass unemployment. Thus, we should expect the explosion in about 2010, but not a solution, which the Western economists are predicting as they want to safeguard the same system that has produced this crisis. Thus, to obtain a solution, it is essential to look beyond the "box".

It is expected that a number of developing countries along with some developed countries, like Ukraine, Hungary, Poland already did, will seek assistance from the IMF, as they will face severe cuts in their export revenues and the resultant balance of payments deficit. Several large developing countries are planning to stimulate their economies by increasing government expenditure on development and lowering the rates of interest. China, before the G20 met in Washington, announced a massive investment programme of about $600bn. India proposes to expand government expenditure and a lower interest rates. Brazil also is going to use fiscal and monetary policy to promote high rates of growth.

However, if the IMF continues to prescribe the policies it has suggested to the East and South East Asian countries during the last financial crisis of 1998, it will push the developing countries to the opposite direction and the result will be reduction of the rate of growth of the economy and mass unemployment.

The solution adopted by both the UK and USA may not solve their problem either. Both countries are putting massive amount of taxpayer"s money on private banks without asking them to reform. In the UK, a number of banks are now nationalised but the government is taking over their management. In USA, banks receiving taxpayers money will not be nationalised either. The Guardian has reported that at least $70 billion of tax- payers money would be paid as Christmas bonus for the executives of the failed banks and financial institutions of USA, who have caused this crisis. Thus, these banks may continue to follow the same old policies that have caused this crisis and the so-called "bail-out" plan announced by President Bush will not solve anything at all.

The cause of the problem comes from speculation, as it was the cause for the great depression of 1930s as well. Before the 1930s depression for about 15 years there was totally free speculations where most of the companies, banks and financial institutions were free to behave, as they wanted. Since 1980 as well we have seen the same deregulation process to free the companies from much obligations to the society at large. Now added to the speculation in the share market we have also speculations about possible future movements of every financial or economic indicators and prices of commodities and services, which are called "Financial Derivatives". Added to that we also have a new financial innovation called "Mortgage Backed Securities" which are nothing but loan obligations of the American banks, which were sold as assets to the world banking system. People were told that they are buying shares of American properties, but in reality they were sold existing "debts", which are hard to recover because the debtors are poor American who cannot afford to repay their loans.

There are two types of solution short-run solution so that the economic system of the world will not collapse creating mass unemployment. There is also a long-term solution, so that this type of crisis would not occur in future. Short-term solution must look at the immediate causes of the crisis and try to resolve these. The long-term solutions must be aimed at reforming the present system so that this type of crisis would not occur in future.

Immediate cause of the crisis are lack of resources in the banks to maintain the credit system flowing so that companies that depend on the banking system can survive. Another cause is the huge stocks of worthless option, derivatives and mortgage backed securities, which are now reduced to the status of junk bonds. Throwing money to the banks and the companies will not solve the problem, as the US government is trying to do now. Nationalisation of the entire banking system along with the major companies is needed to solve this problem. Even the former Chief Executive of General Motors Jack Welch said recently it is better for the GM to go bankrupt, so that it can be nationalised. UK government has already nationalised a few banks. Nationalisation will help the government to refinance the depleted stock of the banks and to help major companies to survive. That will help their supplier companies and their sales outlets along with the trading companies to survive. It is essential for the governments of most countries to understand that even during the last great depression, the mass unemployment took place about two years after collapse of the stock market in 1929.

For the long-term solution we need to go back to the advice of two great economists, during the 1930s depression, which were so far rejected by the world. In 1934 Ragner Frisch ( Circulation Planning: Proposal for a National Organization of a Commodity and Service Exchange", Econometrica, 1934 ) has suggested a National Exchange replacing the stock market, where the companies will be allowed to sell their shares only if they will provide complete information about their business. Investors must keep these shares for a specified period and cannot do speculation trading with these. If they want to sell the shares they must sell these back to the company itself. The company can sell more of its shares only if it permitted by the National Exchange provided it has good prospect. Thus, the valuation of a company will not depend on the speculation and rumours in the stock market but on the honest information collected by the National Exchange about these companies. This will rule out speculation altogether, as the secondary stock market today do not contribute directly to the investment funds of the companies, but only create artificial often misleading valuation of the companies. Those today depend on these artificial valuations of the stock market and do trading can be ruined easily. This is the situation for most of the large investment funds, pension funds, unit trusts, which were mislead by the stock market and now facing bankruptcies ruining the lives of millions of investors and pensioners. Other speculative instruments like options, derivatives, and future prices must be disallowed as well by the National Exchange, who would advice the banks to invest directly to the companies as they do in both Germany and Japan today. Japanese economy is not facing total collapse, as it is the case for both USA and UK. The reason is Japanese companies receive their funds directly from the banks, not much from the stock market. Germany also is comparatively more stable than the Anglo-American world.

John Keynes suggested another long-term solution in 1948 at the time of the foundation of the International Monetary Fund to redesign the world"s financial architecture
( "Shaping the Post-War World: The Clearing Union", in The Collected Writings of John Maynard Keynes. Vol. XXV. Activities ). The idea is that no country will be allowed to keep more than a certain amount of its surplus from the balance of payments. Today, China"s reserve of foreign currencies has exceeded a trillion US Dollar causing blockages of the financial flows. Keynes idea was that the member countries of the IMF might keep up to one year"s import costs as reserve of foreign currency. The rest they have to deposit to the IMF, so that these surplus can be distributed to the countries in need of investments.

Unfortunately both Ragner Frisch and Keynes were disappointed, as the IMF was taken over by the American financiers who would not accept these restrictions. Today, those who have created this present crisis, the financiers of the Wall Street, are giving advice on how to solve the problem. That is the very reason the problem is not going to be solved but within the next two years the world will see mass unemployment and deprivation that would ruin a number of countries and the IMF would run out of resources to help the developing countries.

Dr.Dipak Basu

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