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JOURNAL OF CHINESE ECONOMICS, 2015 Vol. 3. No. 1, pp 58-69 http://journals.sfu.ca/nwchp/index.php/journal An Overview of Causes for the Financial Crisis and Implications: from the Perspective of China Yufei Bai1 Yijiao Liu2 Xiaoyu Du3 and Zejing Li4 Abstract: Although it has been over six years since the latest financial crisis broke out, studies on its causes are still prevalent in Chinese academia. This paper reviews related literature and categorizes the discussed causes into five types, namely, the Theory of Overproduction, the Theory of Economic Imbalances, the Theory of Improper Monetary Policy, the Neo-liberalism View on Government and the Theory of Forces of Political Factors. Study on these causes brings about the following implications: socialism will eventually replace capitalism, which urges us to adhere to socialism with Chinese characteristics; with an objective cognition of the prevailing international currency system, we should actively push forward the process of RMB internationalization; the relationship between virtual economy and real economy should be correctly addressed, and the transformation of the economic development pattern should be accelerated. Keywords: financial crisis, Theory of Overproduction, Theory of Economic Imbalances, Theory of Improper Monetary Policy, Neo-liberalism View on Government, Theory of Forces of Political Factors. JEL Classification: E52, E69, F39, G01 1. Introduction Marked by the bankruptcy of Lehman Brothers, a giant U.S. investment bank, a subprime crisis originated from the U.S. rapidly spread to the globe, and eventually spawned a once-in-a-century international financial crisis. There has already been a tremendous amount of relevant literature in Chinese academia since its explosion. This paper attempts to make a review of discussions on causes of the crisis in an effort to understand more comprehensively, systematically and deeply this round of financial crisis, thereby better promoting the constant, robust and fast development of Chinese economy in the long run with the lessons drawn. Both the angles from which Chinese scholars study causes of the financial crisis and their corresponding conclusions are different and they can be divided into five types in general. 2.The Theory of Overproduction The explosion of the financial crisis exerted serious impacts on the economic development and people’s livelihood in all countries, which triggered profound 1 2 3 4 Associate Professor of Finance, Associate Dean of the School of Economics、Trade and Event Management, Beijing International Studies University, Beijing, China. Email: [email protected]. Lecturer, the School of Economics、Trade and Event Management, Beijing International Studies University. The School of Economics、Trade and Event Management, Beijing International Studies University Postgraduate, the School of Economics、Trade and Event Management, Beijing International Studies University. An Overview of Causes for the Financial Crisis and Implications 59 reflection on the capitalist mode of production. Scholars who believe in the theory of overproduction hold the opinion that the crisis was caused by the basic conflict in the capitalist system, that is, the conflict between production socialization and the capitalistic private ownership of production means. Concrete manifestations of this conflict are overproduction and deficiency in effective demand, in other words, the excessive supply of real estates and inability of consumers to pay. Hu and Wei (2009) pointed out that this crisis had never gone beyond Marx’s theoretical logic on economic crises. It was nothing but the contradiction of the capitalist mode of production, which is precisely the conflict between the tendency towards infinite enlargement of production and the deficiency in demand, that led to the explosion of this overproduction crisis --- in order to help capitalists solve the problem of overproduction, bankers designed financial derivatives that transcended the real products, luring consumers to consume beyond their ability, and stretching the whole credit chain, which buried hidden troubles of chain reactions in later financial crisis. Han and Li (2011) stated that the fuse of this crisis was the price plunge caused by relative surplus of the real estate market, and that the fundamental reason why the subprime crisis evolved into a financial crisis that went global resides in capital’s greedy and cross-border pursuit of profits. Able to rely on the global market, capitalist countries avail themselves of virtual capitals as the tool to break the restriction in production, leading to a widespread credit expansion and overproduction, which finally resulted in the global crisis. Zhang and Li (2009) stressed that the most direct reason of the crisis was the surplus of virtual capital commodities led by the combination of excessive speculation and credit expansion. However, with the burst of price bubbles of virtual capital, the capacity in consumption and payment of society in capitalist countries had been struck. Hence, the nature of the crisis changed from independent crisis within the financial system to a financial crisis preceding the crises of production and business, and the contradiction of overproduction was then highlighted. Therefore, the conclusion can be drawn that this crisis was rooted in the fundamental economic system of capitalism, and it manifested the irremediable institutional defect within the capitalist system. Wu and Feng (2012) sketched the explosion chain of the financial crisis as “insufficient effective demand - overproduction - overdraft consumption - rising default rate - economic crisis”. They believed that in fear of overproduction, the U.S. tried to stimulate residents, especially those with low and middle income, to overdraw by immoderately expanding the consumption credit. When the insolvency of these debts became overwhelming, the financial chain fractured, the social purchasing power contracted, the true fact of overproduction was exposed and the crisis came along. The financial crisis is nothing but a special manifestation of economic crises after the independence of financial capital from industrial capital, and its essence is still a crisis of relative overproduction, which was also a positive proof for the scientific and proactive Marxist theory of economic crises. Wei and Sun (2011) compared the Great Depression to this financial crisis and 60 Bai, Liu, Du, and Li found that the Great Depression originated from real economy and was manifested directly as relative overproduction and under-consumption, whereas this financial crisis stemmed from the financial area and had an evident symptom of consumer debts and overconsumption. Different as their generating paths and representations seemed, they shared the same essence: relative overproduction. Just as Marx said, “The ultimate reason for all real crises invariably lies in the poverty of the masses and their restricted consumption. Despite of this, capitalist production drives the productive forces to extremes, as if nothing but the absolute consuming power of society constituted their limit.” 5 LIU Shibai (2010) regarded this crisis as a new form of capitalist periodic crises, the origin of which was still the contradiction in the real economy between the expanding production capacity and insufficient endogenous demand. The monetary and credit expansion dominated by the government could certainly create and expand the short-run demand, but by no means could it eliminate the contradiction between enlargement in production capacity and deficiency in effective demand, rather, it can breed an abnormal economic structure with exorbitant financialization and virtualization, which will cause financial crises. 3. The Theory of Economic Imbalances The relationship between economic imbalances and financial crises has always been a hot topic for scholars and it has been heated again since the financial crisis broke out in 2008. Among the research, discussions from the perspective of economic virtualization and drawbacks of international currency system are most representative. Hou and Leng (2009) analyzed various ratios of the U.S. GDP and found out that private consumption was its biggest contributor, while most of the private consumption depended on bank loans, which means “money begets money” was a pivotal power in the GDP. Judging from this, the American economy had a serious problem of virtualization. With its successive overexpansion, the virtual economy became increasingly disconnected with the real economy, and the bubblization of asset prices grew rapidly, which led to an intensive outburst of systemic risk. Zhang and Liu (2009) pointed out that the special circulation of economic operation in the U.S. led to its deindustrialization and virtualization, and that the divergence of virtual economy from real economy was the essential cause of the crisis. This was certainly inseparable with current international currency system and the long-term selfish domestic and foreign policies of the U.S. They illustrated with data lists that the three pillar industries in post-war America --- automobile, steel and construction, were no longer brilliant, all replaced by finance, insurance and real-estate services. Virtual economy had become the core profitable sectors of America before this crisis erupted. Since the 1990s, on one side, the financial innovation capitalized the income flows to the greatest extent, bringing about the inflation of virtual capital and the virtualization of the whole economy; On the other 5 Collected Works of Marx and Engels, Volume 7, published by People’s Publishing House, Beijing, China, 2009, Page 548. An Overview of Causes for the Financial Crisis and Implications 61 side, the process of economic virtualization pushed the financial lever to all fields of the American society, which resulted in the interweaving of various financial levers and formulated a butterfly effect in the American economic system. Therefore, even if the subprime crisis had never happened in the U.S., another financial crisis was bound to take place originating from leveraged cutting-edge financial products. Huang and Huang (2012) also agreed that the dominance of virtual financial capital was the root cause for the international financial crisis. They held that for the latest thirty years, there had been a number of factors boosting the rapid inflation of virtual financial capital, and capitalism had entered a stage of virtual financial capitalism. The dominance of virtual financial capitalism greatly intensified the basic contradiction of capitalism so that the outburst of the financial crisis would consequently bring enormous harm to the entire society. Chen and Wang (2011) pointed out that only when virtual economy and real economy match each other can market economy develop harmoniously. But before the crisis, the U.S. highly relied on virtual capital for circulatory earnings, marked by the high degree of bubblization of asset prices and the serious departure of virtual economy from real economy. [10] Since the 1980s, the U.S. had been transferring the manufacturing sectors in real economy overseas through industrial restructuring and upgrading. At the same time, the development of financial derivatives has enjoyed powerful support at home, which led to a successive rise of economic virtualization. This economic layout, in which virtual economy got excessively disconnected with real economy and the level of virtualization went too high, was liable to collapse once a sign of trouble appeared. Financial crises, economic imbalances and international currency system are closely interconnected with each other. The global financial crisis caused by the U.S. subprime crisis put in question again the status of the U.S. dollar as the international central currency, and voices calling for reforming the international currency system became louder and louder. Hua and Liu (2008) attributed this international financial crisis to the lack of international currency system after the collapse of the gold standard system. In fact, local financial crises had never ceased ever since the Bretton Woods System broke up. Luckily, before the year 2000, as investment opportunities could still be located in global real economy for the excess supply of U.S. dollars, the problem of excess liquidity seemed not too serious. Nonetheless, with the collapse of the NASDAQ Stock Market in 2000, global opportunities for industrial investment tended to vanish. Counter-cyclical expansionary policy mix of the U.S. even aggravated the problems of dollar glut and global liquidity excess, which was rapidly followed by asset price bubbles and the international financial crisis. Shi and Zhao (2011) held the opinion that defects of the Jamaica system was the hotbed for the international financial crisis. Under the Jamaica system, the U.S. dollar was disconnected with gold and the issuing of dollars was no longer under restriction. All countries wished to have more dollars reserved to stabilize the foreign exchange market. As a result of such internal reason and external demand, the Federal Reserve issued too many dollars. It was through the current account deficit and capital 62 Bai, Liu, Du, and Li account surplus that the U.S. maintained its dollar circulation. In order to ensure the backflow of U.S. dollars, the financial assets of the U.S. should possess higher investment value than those of any other country. For this purpose, the U.S. financial market kept creating new financial products for global investors. While the prices of financial products were continuously pushed up, the finance sector was marching away from the normal track of economic development, and bubblization kept increasing. When the bubbles burst, the U.S. and its partner countries that used U.S. dollars were all affected. Based on the process of subprime mortgages’ occurrence and evolution, Zhu (2010) summarized that the source of the international financial crisis was the imbalance in global economic structure under “dollar circumfluence”. Dollars circumfluence under the dollar-based system constantly aggravated three types of imbalances in the U.S. society --- de-industrialization, coexistence of trade deficit, fiscal deficit and savings deficit, negative NIIP (Net International Investment Position) and positive FDI of equal values with the trade deficit, thereby incurring a passive imbalance of world economy and the global liquidity excess as well. Losses expanded to the whole financial markets the moment that the U.S. subprime mortgages market went wrong. In the wake of a sharp fall of foreign countries’ confidence in U.S. dollars, the financial crisis in the U.S. infected other countries along the negative direction of dollars circumfluence, thereby causing the global financial crisis and economic recession. Wang and Fan (2011) analyzed the balance of payment under current international reserve currency system and indicated that the currency system was not only an important cause of global economic imbalance, but also one of the causes of the financial crises that had frequently occurred during the past thirty years. They established an N-country balance of payment currency analytical framework, which was constrained by the principle that the sum of net export and net capital of the reserve currency country and the non-reserve currency countries both equaled zero, and that sovereign currency served as the international reserve currency. They found that under the international currency system in which sovereign currency served as the international reserve currency, any efforts to thoroughly solve the problem of long-term trade deficit and global imbalance in the reserve currency country by exchange rate policies was invalid. Whatever policies the reserve currency country chose or had to choose, external surplus, deficit or balance, financial crises and global economic instability were inevitable. 4. The Theory of Improper Monetary Policy The explosion of the financial crisis had once pushed the Federal Reserve and Greenspan, who had already retired after winning merit, to the forefront. The New York Times named Greenspan “Mr. Bubble” and said that the Fed, led by him, should be responsible for this crisis, since continuous monetary ease had made undeniable contribution to real estate bubbles. Lu and Liu (2009) systematically analyzed the logical relationship between the An Overview of Causes for the Financial Crisis and Implications 63 currency policy of the Fed and the subprime crisis, and came to a conclusion that the mistake of the monetary policy did not lie in cutting the interest rate when the macro-economy turned down, but lie in the large extent of the cuts. The empirical research showed that in an ultra-loose monetary policy environment, the short-term interest rates had a remarkable correlation with real house prices and extra-long-term increase in new houses building as well, in other words, the Fed’s ultra-loose monetary policy had a significant contribution to real estate bubbles in the U.S. He (2008) regarded the financial crisis as a heritage of the Greenspan era. Greenspan had successfully come through a series of crises during his nineteen years’ control over the Fed. But he had made the very same mistake in each crisis that the interest rates were cut too much and the low interest rates lasted too long. After the crash of the NASDAQ Internet bubble, Greenspan continued the approach of both sharply cutting the interest rate and keeping it at a low level over quite a long time to stimulate the U.S. economy, as well as supporting the non-fixed interest rate loans developed by home finance agencies specifically for consumers with low income and low credit ratings, believing that the borrowers could save a lot of money under the circumstance of interest reduction. However, default rates soared when house prices fell and homeowners realized that their loans had well outnumbered the value of their houses. Zhang (2009) would rather say that the financial crisis was the failure of government monetary policy than to say it was the failure of the market. Based on the Business Cycle Theory of the Austrian School, this financial crisis and the Great Depression had little difference, both of which were caused by the central bank. The trigger of the crisis was that people who were tempted by the low interest rates and real estate bubbles borrowed money to buy houses when they were not supposed to. The origin of such phenomenon was exactly the wrong monetary policy. When the interest rate signal was distorted by the central bank, the pricing mechanisms went out of order for both financial assets and physical assets, and the whole economy accordingly fell into disorder. Chang (2010) agreed that this crisis was rooted to a large extent in the mistake of the monetary policy. The Fed initiated a long-term low interest rate policy in 2001, which directly generated asset price bubbles and the credit boom. It became the key policy which incurred the crisis and after that, stock and real estate bubbles broke down when the Fed had to stop monetary expansion due to the pressure of inflation, and the crisis then started. 5. The Neo-liberalism View on Government The stagflation in 1970s offered an invaluable opportunity for the neo-liberalism to step onto the historical stage, which was then still on the edge. Marked by Thatcher New Deal and Reagan Revolution, neo-liberalism gradually became the mainstream ideology of economics and occupied a leading position for decades. The 1994 Mexican financial crisis and the 1998 Asian financial crisis first revealed the inherent disadvantages and intrinsic defects of the neo-liberalism view on government. This 64 Bai, Liu, Du, and Li round of global financial crisis caused by the subprime crisis partly declared the failure of the economic theory of neo-liberalism, especially the ideological trend and policy propositions of neo-liberalism. Zhou (2009) presented neo-liberalism’s practices in the U.S., and considered this crisis as the consequence of the U.S. government’s implementation, even to the extreme, of neo-liberalism policies over decades. The multi-effects of neo-liberalism’s emphasis on consumption, objection to government intervention in the labor market, and less government adjustment on income distribution, gradually created the situation of abnormal high level of the U.S. domestic demand and lasting stagnancy of increase in resident income. Under the overall background of financial deregulation, consumers flocked into the housing market through mortgage lending despite the fact that they had little ability to repay, exaggerating the U.S. real estate bubbles and ultimately brought on the crisis. Zhang and Wang (2009) blamed this financial crisis on the consumption mode, financial liberalization, capital financialization, and the neo-liberalist lifestyle of the Americans, which were all guided by the neo-liberalist economic policies. The explosion of the financial crisis was a strong proof of the disadvantages of neo-liberalism. It was unsustainable, considering the harm of this crisis. Nie (2012) thought that the negative and conservative view on government pursued by neo-liberalism, which was called “small government, big society”, was one of the critical reasons why the financial market got out of control and caused the global economic crisis. When human stepped into an era of a risky society, it became an unavoidable necessity to pay close attention to and respond to risks. Yet the neo-liberalism’s policy claim of passive inaction and laissez faire was incapable of responding to uncertain risks to meet the basic requirement of a risky society. Passive inaction made the government lack of valid forecast and judgment of risks and unable to get prepared before the risks appeared, while laissez faire made the government unable to effectively control the risks after their arrival. From this angle, it is rather fair to say that the neo-liberalism view on government was the initiator of the global financial crisis. Tan (2009) ascribed the explosion of financial crisis to the defects of neo-liberalism. Under the ideology of neo-liberalism, the financial circle held a prejudice against financial crises and suffered from serious defects with respect to financial regulation and risk precaution, thereby failing to attach sufficient significance on and correctly assess the risks that had already been ceaselessly accumulating even before the crisis, so that the entire circle was caught unprepared by the eruption of the crisis. 6. The Theory of Forces of Political Factors The financial crisis is a political issue as well as an economic issue. It is partial to concentrate only on one side in the modern world of economic and political integration. He and Gao (2011) regarded this financial crisis as a typical political and An Overview of Causes for the Financial Crisis and Implications 65 institutional crisis, which had an impact with wide scope, long time, and profound significance. It was rooted in western political system and had gone far beyond the traditional scope of finance and economy. Questions such as why a wrong policy had been implemented for so long, why individual greed could evolve into institutional greed without limitation, and what made capitalist society paralyzed facing the inherent defects of its economic system, can only be answered from the perspective of political institution. Ye (2009) insisted that American hegemony, the two wars and the political system in the U.S. were the three political factors for the financial crisis. The essence of this crisis was that the bubble of supremacy fostered the bubble of finance. It was the U.S. hegemony that had forced other countries to pay for its overconsumption, while the wars in Afghanistan and Iraq were the medium and catalyst for the American hegemony to form the financial crisis. Those two wars showed to the world the super military power of the U.S. and intensified the aspiration of investors from all countries to invest in the U.S. and their mindset of speculation. At the meantime, those two wars affected the U.S. economy by raising the military expenditure and aggravating the financial burden of the U.S., which had a negative impact on the economy. The U.S. government tried to stimulate the economy by continuously cutting the interest rate and issuing bonds, resulting in an unprecedented liquidity surplus and a mass of financial bubbles, which created an illusion of prosperity. To depress the bubbles, the Fed had to raise the interest rate. Finally the bubbles broke down and the financial crisis broke out. Painstakingly, the financial crisis also revealed the defects of the political system that governors were serving the interest group. The U.S. government loosed regulation on the financial capital operation in the Wall Street and allowed its free operation, while those two wars greatly benefited economically the military and energy groups of the U.S. Associating not only the economic issues involved in this crisis with political issues, but also the domestic politics involved in this crisis with international politics, Wang (2009) found out that during the past thirty years, the U.S. domestic religion conservatism, neo-conservatism and monopoly consortium closely integrated together and provided social motivation, ideological motivation and economic motivation for the U.S. to expand outwards and pursue hegemony. But meanwhile, new characteristics of the world economy, such as the enhancement of economic integration and the multi-polarization trend in the structure of economic authorities, were also challenging the global economic and political order dominated by the American hegemony. As the lust for hegemony got increasingly stronger while the cost of maintaining hegemony became increasingly higher, all sorts of conflicts kept accumulating, and the crisis finally broke out. Accordingly, this crisis was a centralized release of the intensifying structural contradictions in the existing international political and economic system. 7. Implications for China’s economic and social development Causes of this once-in-a-century financial crisis were exceedingly complex and a deep 66 Bai, Liu, Du, and Li investigation can provide fundamental implications for China’s economic and social development. First of all, socialism will eventually replace capitalism, so we should firmly adhere to socialism with Chinese characteristics. The eruption and expansion of the financial crisis again reflected the inherent defects of capitalism. The basic contradiction of capitalism, disadvantages of its political system and the limitation of neo-liberalism theories were fully exposed. It would not be possible that capitalism disappears completely from the stage of history, just as in the Great Depression of the 1930s, people were convinced that capitalism would come to an end but it resurrected. But there are ample reasons for us to gain a clearer knowledge and more comprehensive understanding of the superiority of socialism, to be more convinced of the historical inevitability that socialism will replace capitalism, and to adhere more firmly to the road of socialism with Chinese characteristics. Second, an objective cognition of international currency system should be formed and the internationalization of RMB should be actively pushed forward. The international currency system dominated by the U.S. dollars is an important pushing force of economic imbalances and financial crises. So an effective international currency system should be reconstructed to promote the rebalance of the world economy and to maintain the stability of international finance. Although the reconstruction will take a long time and the dominance of the U.S. dollars are still unshakeable for now, a new journey of the international currency system would definitely be achievable provided that all governments and central banks can cooperate and pay joint efforts. As a responsible economy, China should also play a role in this process, which is, to give great impetus to Currency Swap and make RMB another currency for international settlement and reserve in the world trade and economic dealings, thereby contributing to the construction of a brand new international currency system. Third, the relationship between virtual economy and real economy should be correctly addressed, and the transformation of the economic development pattern should be accelerated. Virtual economy is the product of market economy in a certain stage. The emergence and development of virtual economy can promote the market economy only when it is well matched with real economy. If virtual economy inflates abnormally and deviates severely from real economy, economic instability or recession will be inevitable. On the contrary, if virtual economy develops too slowly and cannot keep up with the pace of real economy, it would also turn a drag on the effective operation of market economy. One important cause of this crisis was that virtual economy developed too fast in the U.S. and became disconnected with real economy. Drawing lessons from the crisis, the U.S. government started the policy of reindustrialization, attempting to regain previous glory of real economy and help along a harmonious development of real economy and virtual economy. Our virtual economy suffers a problem too, though different from theirs, which is the incapability in scale and speed to support the development of real economy. 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