The Impacts of Global Financial Crisis on Intercontinental Trade

The Impacts of the Global Financial Crisis on Intercontinental Trade
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The Impacts of the Global Financial Crisis on Intercontinental Trade
Introduction
The global financial crisis of 2008-9 caused an overwhelming financial and economic meltdown to the worldwide market and consumers alike. The crisis was set in motion in August 2007 and reached its peak in September 2008, triggering the subprime mortgage crisis in the United States that subsequently created a severe credit crunch. The severe credit crunch made it impossible for households to borrow, and difficult for businesses and banks to refinance, thus translating into a full-blown global financial crisis. Parallel to the global financial crisis was the total trade collapse of global trade that was associated with a rapid decline in world trade starting in the third quarter of 2008 until mid-2009. The cause of the global financial crisis cannot be attributed to a single cause. Notably, excessive borrowing and risk-taking by households, businesses, and banks, excessive liquidity and massive inflow of foreign money from select Asian and Middle East countries contributed the most. Thanks to the global financial crisis, virtually every economic entity in the world had experienced a downturn, ranging from the financial services industry, the auto industry, and the financial markets, resulting in the collapse of international trade.
What began loosely as a credit crunch in the United States, it quickly escalated into a financial crisis of global proportions. Eun and Resnick (2015) note that many Collateralized debt obligations (CDOs) got stuck in the debt of risky mortgage-backed securities (MBS), which had not been placed as subprime foreclosure rates around the United States escalated (p. 289). Notably, the 2007-8 financial crisis did not spare any country or market sector, including the traditionally independent nations (Viswanathan, 2010). Himpler (2018) asserts that the global financial markets incurred a loss estimated to be $10 trillion within July and August 2007, representing 40% of the worldwide wealth (p.116). Never has the world witnessed such enormous destruction of economic wealth within such a short time. Countries around the world were experiencing a series of the financial meltdown. In China, for instance, 10 million industry-employed employees lost their jobs due to the crisis (Himpler, 2018). Throughout the world, different countries experienced different levels of economic turmoil depending on their respective exposure.
The Onset of the Global Financial Crisis
A summary of the onset and the aftermath of the global financial crisis gives a mere glimpse of the extent of damage the crisis had on international trade. The credit crunch that began in the United States in the summer of 2007 can be attributed to three main factors. These include the liberalization of banking and securities regulations, a global savings gut, and an environment of a low-interest rate that was enabled by the Federal Reserve (Eun and Resnick, 2015, p.285). The liberalization of the banking and securities regulation blurred the functioning of commercial banks, investment banks, insurance companies, and real estate mortgage banking firms, allowing unregulated banking and securities firms to operate opaquely alongside other regulated banks. The repeal of the U.S. Glass-Steagall Act of 1933 in 1999 with the passage of the Financial Services Modernization Act allowed money funds to collect uninsured deposits that were lent to financial firms, while commercial banks started performing investment banks functions and vice versa, and the availability of various derivatives and securitized products providing liquidity to previously illiquid loans (Eun and Resnick, 2015). Consequently, borrowers were unable to obtain credit quickly, leading to the cash crunch.
Another contributing factor is the global savings glut caused by a massive inflow of foreign money from select Asian and Middle East countries. Overseas investments by countries wielding massive account surpluses, namely China, Japan, and OPEC counties, also contributed significantly to the onset of the financial crisis (Eun and Resnick, 2015, p. 285; Shelburne, 2010, p.14). Massive trade imbalances contributed significantly in bringing about the global financial crisis. According to Shelburne (2010), countries with large account surpluses, namely Japan, China, and OPEC countries, accumulated vast foreign reserves, resulting in the availability of subprime loans. For instance, it is estimated that China held $1.955 trillion in foreign currency reserves at the end-year 2008, with 70% of the among being dominated in US dollars. Likewise, OPEC members held substantial investments in US securities, as well as massive investments through sovereign wealth funds (Eun and Resnick, 2015, p. 285). With the excess availability of funds, the U.S. Treasury and other government agency securities helped the United States keep interest rates low.
Lastly, a low-interest-rate environment in the United States allowed many people to become homeowners given the high availability of low-interest rate mortgages. From a drop of 6.5 percent set on May 16, 2000, to 1.0 percent on June 25, 2003, the federal fund reserve rate accommodated many borrowers, including enabling first-time homeowners to afford mortgage financing (Eun and Resnick, 2015). In a bid to attract more customers, many banks and mortgage financiers reduced their credit rating standards, enabling many Americans to afford and make mortgage payments at prevailing low-interest rates. Under stringent credit standards, many of the homebuyers were not qualified for mortgage financing and could not pay mortgage payments using the conventional interest rates. The global savings glut allowed investors to increase their demand for mortgage-backed securities (MBSs), in which the subprime mortgages were held. Consequently, an environment was created that favored lax credit standards and the growth in the subprime mortgage market (Eun and Resnick, 2015). The subprime debtors eventually defaulted, and coupled with a global shrinking of the liquidity; a global financial crisis was created.
Trade Changes during the Financial Crisis
The global financial crisis resulted in significant changes in trade throughout the world. For instance, Shelburne (2010) notes that oil exporters experienced the most significant drop in their terms of trade given that energy commodities experienced the most significant decline relative to other products. Shelburne (2010) argues that since a reduction in terms of trade also translates into a drop in the economic welfare of a country, a decline in a country’s GDP was also accompanied by a signific...