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Kip Beckman
Principal Research Associate
Economic Services |
The turmoil in financial markets and the possible U.S. Treasury plan to spend $700 billion to purchase bad mortgage debt from financial firms has given valuable ammunition to opponents of American economic leadership and the free market approach emphasizing deregulation. In South Korea, the massive U.S. government intervention in financial markets has been used by opponents of government plans to liberalize Korean financial markets. German Chancellor Merkel has used the crisis to bolster her defense of a German law that provides the government with a veto over potential takeovers of Volkswagen. The ongoing efforts by the U.S. government to convince the Chinese government to let the yuan float in world currency markets could also be undermined by developments over the past few weeks.
In a global economy where financial market linkages are much more prominent compared with a few decades ago, the crisis has raised serious concerns regarding the U.S. approach to economic policy. The developments in financial markets over the last few weeks have shaken confidence in the U.S. dollar among foreign investors who contend that the bailouts will increase already sky-high debt levels. These worries could hurt the U.S. dollar’s status as the number one currency in the world. China, Japan and other holders of billions of dollars worth of U.S. securities could move assets out of the dollar and into other currencies like the euro over the next few months due to fears about the health of the U.S. economy.
Some economists in China have been urging the government to reduce its role in the economy and follow the U.S. approach. However, these efforts may come to naught considering what has transpired in the United States recently. Chinese economist Xu Xiaonian contends that the government’s move in September to halt a sell-off in equity markets by purchasing stocks from state-controlled companies – one of the greatest market interventions in years – occurred, in part, based on the U.S. government intervention in its own markets. It could be that Asian governments now view the American free market model as a failure.
The extent of the damage to the U.S. model will depend on the length and severity of the current crisis. If the recent moves by the Fed and Treasury succeed in boosting the fortunes of the housing market and the economy recovers quickly, faith could be restored in the free market approach. It is worth noting that the U.S. economy came back quickly from previous financial crisis such as the Savings and Loan fiasco in the late 1980s. There is no doubt, however, that America’s difficulties could undermine support for its international goals over the short term. These initiatives include gaining greater access for U.S. financial companies in foreign markets and encouraging greater deregulation in continental Europe.
According to the Wall Street Journal, the United States has also opened itself up to charges of hypocrisy especially regarding the Asian financial crisis in the late 1990s. At the time U.S. and other western leaders advocated for tough, market-oriented solutions to the crisis. The former prime minister of Malaysia, Mahathir Mohamad, remembers how U.S. officials urged him to never bail-out failing financial institutions. It is somewhat ironic that the United States has bailed out dozens of failed banks, mortgage corporations and other firms over the last seven months.
After many years of being criticized by U.S. officials for increasing government intervention in the Russian economy, President Medvedev wasted little time in highlighting America’s about-face on market intervention. Russia is exposed to U.S. mortgage-backed securities in its $600 billion reserves from oil earnings.
There is little doubt that the ongoing crisis in U.S. financial markets has given critics of free market economics and globalization a huge shot in the arm. Yet, it would be wrong to conclude that there will be a sharp move towards re-regulation in light of recent developments in the United States. The majority of economists in Europe are still of the strong belief that the region needs much greater deregulation, especially in labour markets. Let’s also not forget that globalization has lifted millions and millions of people out of poverty in China, India and parts of Latin America. Yes, it is true that financial markets in the United States will require greater regulation to avoid a repeat of the fiasco that saw people without income or assets receiving mortgages from unscrupulous lenders. But let’s not throw out the baby with the bathwater.