Financial Contagion and the Global Financial Crisis

International Financial Market
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International Financial Market
Advantages of Financial Globalization
Financial globalization has a number of advantages. First and foremost, it has improved the flow of capital from one country to another. This means it promoted different nations to engage in the international trade, thereby promoting development in such countries. On a similar note, it has not only allowed the capital to flow, but it has increased the amount of capital flow among nations (Stulz, 2005). As a result, it has, therefore, created a well-organized and efficient world allocation of money. Furthermore, it has had a positive impact on the standard of living of the people. Since it promotes the international trade, leading to improved economic growth and development, it has; therefore, changed the living standard of the citizens. A major point to note is that through financial globalization, countries’ national shocks have been safeguarded.
Disadvantages of Financial Globalization
Apart from the merits mentioned above, it is important also to note that financial globalization has its demerits. To start with, countries whose economy is weak are likely to be negatively impacted with the emergence of globalization. This means it could be affected by financial shocks from countries with an improved economy. Secondly, financial globalization makes countries to liberalized their system and integrate it to international financial market (Stulz, 2005).

In case, there is an imperfection in the international financial market; this would lead to herding behavior, bubbles, and a speculative attack on the exchange rate. Thirdly, if a country over-relied on foreign capital as a result of financial globalization, in case there is a sudden shift in foreign capital flow, then this would lead to financial difficulties and economic downturn.
How Financial Globalization led to Financial Crises
The financial globalization played a pivotal role to the global financial crises of 2007-2008. The US financial institutions permitted their clients to easily access loans mortgage loans, which was followed by poor repayments and defaults. Consequently, there was a decline in credit ability in the financial institutions that significantly the trade in the stock market (Gorchels, 2011). The confidence of both the domestic and foreign investors was damaged, thereby impeding world trade. As a result of the turbulence in the international financial market, there was a decline in the flow of foreign capital. Since many countries depend on foreign capital, they faced financial difficulties and economic downturn that leads to the global financial crises.
Impact of the fall of AIG on Financial Contagion
American International Group is one of the global insurance companies that protect many individuals and financial institutions. Its fall was evident during September 2008 when it heavily insured collateralized debt obligation. Out of expectation of AIG the number of foreclosures rises, this compelled it to payout for the huge amount it had agreed to cover. As result of this pay, the company was in a financial crisis. Its rating on the stock market went down, thereby making the shareholders’ bond to trade at a lower value (Gorchels, 2011). Similarly, the confidence of both foreign and domestic investors went down which further placed the company in a financial crisis. Since it was a major player in the global financial market, it financial crises spread among many nations. Notably, if there is a financial link between two countries, then one country faces financial crises this would lead to a financial shock to the other nation. In essence, the financial crises of the AIG spread globally to institution and countries that depended on or traded with it, leading to financial contagion.
Importance of bailout to AIG
The AIG had played a vital role in protecting and insuring a number of individuals and institutions. Also, many institutional investors such as pension funds, mutual funds, hedge funds, and investment banks had heavily invested in it. Its insolvency means an economic loss the mentioned firms. This is among the reasons as to why the government had to salvage it. Moreover, the international financial market needed the stability of AIG to avoid financial contagion; by US government saving the company, the foreign nations that had to integrate their financial system were saved from the spread of further financial crises (Gorchels, 2011). Additionally, by purchasing the company, the government had restored the confidence of both foreign and domestic investor and also protected the shareholders from any financial loss as result of the probable solvency of AIG.
Regulations to Prevent Future Financial Crises
In preventing future financial crises, there should be regulations on financial institutions that offer loans to clients. The maximum amount that client can borrow should be set. As such would prevent irresponsible borrowing in the financial institutions. Also, a clear guideline should be provided to assist in establishing only the qualified borrowers (Cavusgil, Knight, Riesenberger, Rammal, & Rose, 2015). This is in return would forestall chances of loan default, thereby saving banks from financial crises. The Federal Reserve or the Central Bank should be mandated to not only supervise the financial institutions but also to supervise and regulate the financial activities of the non-bank institutions that offer financial products to clients. Owing to this, it can access their financial information and advice them accordingly.
Benefits of Adopting Euro to Counties in the Eastern Europe
There are a number of benefits for countries that adopt Euro as their currency. First, this would be significant to small counties once they integrated their financial system to international financial market. Adopting the euro would strongly protect them against international financial turbulence. During financial disturbance countries with small economy suffers as a result of external shocks (Portes & Rey, 1998). In this respect, the new currency would provide a shield, thereby enabling them to enjoy the trade in the international financial market. Secondly, the counties mentioned above would have a potential to promote foreign trade. Euro is noted to have exterminated the exchange rate instability and evincing complete price stability; this has privileged the countries that use euro in the international financial markets. Consequently, there has been a rapid increase in trade integration among countries, thereby promoting intra-euro trade and foreign direct investment (Portes & Rey, 1998).
Advantages and Disadvantages of using a Single Global Currency
The use of a single global economy would generate benefits to the countries that have integrated their financial market. To start with, the single currency would exterminate the transaction cost involved in the global financial operations. This would reduce the cost to multinational corporations that engage in the international transactions. Also, the barriers such as the fluctuations in exchange rates caused by the use of different currencies are eliminated (Rose & Engel, 2000). Furthermore, it removes the risk in currency brought about by natural disaster and other factor factors. In most cases, the foreign investors and stock holders have to hedge out this risk. The single currency, therefore, removes the risk that leads to exchange rate fluctuations. As a result of this, there would be a reduction of the foreign exchange transaction. Moreover, the use of single global currency would remove cases whereby a central bank of various countries manipulates their domestic currency to have an advantage over others in the international financial market (Rose & Engel, 2000).
Conversely, the use of a single currency also has some demerits. It is important to note that different nations have different or varying economies. For instance, countries such as America, Britain, and France amongst others have a strong economy, while most of the African countries have weak economies. The implementation of a single currency among these countries would disadvantage the developed nations, or some financial resource would be used to stabilize the economy of developing nations (Rose & Engel, 2000). Similarly, the use of a single global currency would inhibit countries from controlling their financial and monetary policy to initiate economic growth.
Roles played by Various Institutions after 2007-2008 Financial Crises
In solving the financial crises, the International Monetary Fund (IMF) provided frantic efforts with the aim of fostering stability, cooperation, and economic growth across the globe. In the year 2009, it provided more than 100 billion US dollars as loans and credit to the countries that were affected by the financial crises (Cavusgil et al., 2015). The mentioned loans and credit was to assist them to boost their financial markets and promote demand for their exports. Also, it provided both the financial aid and technical assistance to many developing nations affected by the crises. On the other hand, Central Bank decreased the interest rate on loans giving to commercial banks. Also, it uses it a macroeconomic policy to stabilizing the exchange rate as a way of stabilizing the price of products (Cavusgil et al., 2015). Banks also provided loans at fair interest rates to small business as a way of supporting them and increasing the economic growth. Firms, such as the investment banks reviewed their financial policies and came with strict, clear guidance on those who qualified for home mortgage loans.
Role of Government in Promoting National Economic Growth
As a way of promoting countries’ economic growth, the government has set aside growing requirements for finance. In this respect, special financial institutions have been established to provide agricultural, export finance, and industrial. Additionally, the government has also come up with economic planning to assist it in the achievement of its economic goal (Johnson, 2016). For instance, the government does engage in imparting the youths with technological knowledge to boost its production and innovations. Also, it channeled its resources on the infrastructure as a way of stimulating the economy. Moreover, the government has engaged in the public undertaking by establishing and launching industries that are of strategic importance.
References
Cavusgil, S. T., Knight, G. A., Riesenberger, J. R., Rammal, H. G., & Rose, E. L. (2015). International business: The new realities.
Gorchels, L. (2011). The Product Managers Handbook. McGraw Hill Professional.
Johnson, O. E. (2016). Economic diversification and growth in Africa: Critical policy making issues. Cham: Springer International Publishing.
Portes, R., & Rey, H. (1998). The emergence of the euro as an international currency. Economic Policy, 13(26), 306-343.
Rose, A. K., & Engel, C. (2000). Currency unions and international integration (No. w7872). National Bureau of Economic Research.
Stulz, R. M. (2005). The limits of financial globalization. The Journal of Finance, 60(4), 1595-1638.