Banks in one country are able to invest their dollars rather than sell them. In this case, the investments were of poor quality. Compounding the issue is that other investments backed by U.S. institutions began to lose worth as the ability of those financial institutions to meet their obligations became compromised by subprime exposure. This is one of the main reasons why the government bailed out AIG. Banks around the world owned AIG-backed securities and if those securities were subject to default the global financial system could have collapsed.
The rise in international trade is intended to create more wealth more quickly that what has been achieved before. The international trade in goods has created substantial wealth transfers, resulting in countries around the world having significant exposure to the U.S. economy. Nations like China have essentially built their wealth on American credit. Increased exposure, however, results in increased risk. Freedom of trade does not inherently bring an increase in wealth; it brings an increase in volatility.
Thus, as global barriers to trade in goods and capital have fallen, volatility in the global economy has increased. During the Great Depression -- the best corollary we have to the current situation -- many nations recovered quickly relative to the United States. Some nations had other problems that hampered them -- Germany, for example -- but in general the spread of the crisis around the world was minor and short-lived. There was little impact...
Today's crisis is global in scope. No longer are regional crises confined to their home regions.
By lowering regulations and increasing international trade, we increase global economic volatility. This works well during growth times, but it also means that crisis times are worse. The present economic crisis has spread to more countries, has spread faster, and has hit harder, all as a result of the sharp increases in global trade that we have seen in recent years. Countries are increasingly exposed to each other's risk, a function of easy trade in goods and virtually unfettered trade in capital. This reality must be understood for what it is -- international trade does more good than harm by far, but it does increase global economic risk such that a U.S. domestic crisis can be rapidly diffused across the world.
Works Cited:
Roach, Stephen S. (2006). Save More! Save Less! CNN Retrieved May 1, 2009 from http://money.cnn.com/magazines/fortune/fortune_archive/2006/03/20/8371823/index.htm
Padgham, Jane. (2007). Sub-prime crisis could spread to other markets, IMF warns. The Independent. Retrieved May 1, 2009 from http://www.independent.co.uk/news/business/news/subprime-crisis-could-spread-to-other-markets-imf-warns-444214.html
Frank, Nathaniel. (2008). New Channels Spread U.S. Subprime Crisis to Other Markets. International Monetary Fund. Retrieved May 1, 2009 from http://www.imf.org/external/pubs/ft/survey/so/2008/RES092308A.htm
