Are Stocks and Forex Reserves a Buffer to Global Instability?

In 2009, it was proposed the global financial crisis occurred because of a conglomerate of factors, however, two main reasons seem to fit the crisis – they were macroeconomic policies and the supervision and regulation of financial institutions, which wasn’t only in the United States, but in many other countries as well. The problem was, countries around the world weren’t prepared for what was about to burst, including the U.S. The lessons to be learned from the crisis have yet to surface because several years later, it’s still evolving. Macroeconomic policies and the failure of regulation, however, remain key points.

The Culprits of the Global Meltdown

Countries around the world clashed when it came to macroeconomic policy. In the U.S. the monetary policy was lax while fiscal policy became the reason for the savings rate. Whereas Japan threw its fiscal and monetary policies into the same pot, other countries’ monetary policy mirrored the U.S.’s laissez faire attitude. At the same time, the countries were acquiring huge amounts of foreign exchange reserves, distorting the actual financial picture and curtailing restrictions on macroeconomic policies that should have been in place. The supervision and regulation of financial institutions were basically ignored for a very long period of time. It happened over decades of neglect. All types of funds, investments, private equity firms and more were leveraged to the point of eventual collapse in the U.S. and other countries.

Nearly unregulated all together, these financial institutions caused traditional banks to change their methods just to stay in the race. The failure of the financial structure in key countries was a recipe for disaster. It is said the U.S. is at the core of the collapse because of skyrocketing economic factors central to the rest of the world, or what is called globalization. When the inevitable happened, the U.S. waited to be bailed out. It depended on the strength of the Asian market, but globalization means that all countries are intertwined and if one fails, they will all suffer.

The International Monetary Fund

The role of the IMF came to light during the onset of the crisis despite its continuous need for reform. Its purpose is to assist in monetary cooperation from around the globe, financial stability, trade, employment and growth, and poverty in 188 countries. In other words, it needs money. In 2009, its debt was $32.5 billion. Countries through IMF membership made allowances for the IMF to borrow, but critics argue the lending doesn’t solve the entire issue with IMF. A number of financial requirements are needed for reform, and vital is the need for a better global adjustment process.

The Myth of Self Insurance

Holding a bulk of foreign exchange reserves is one way to self-insure, although the buffer can’t alone solve the global issue. For example, Korea was in good standing with foreign exchange reserves, in fact, the fifth largest amount in the world. The country was in dire need of refinancing and its reserve alone couldn’t save it from a slow-down. Its gross inflows overshadowed its net surplus.  The good news is that a recovery is on the cards, albeit slow and steady.