Global Financial System - Invisible Hand

Japan’s catastrophe will not only have serious consequences for Japanese government and businesses but it could also have ripple effects on global financial markets as it is one of the largest creditors in the world. 

Japan’s catastrophe is a big blow to the US economy as it is the second largest foreign owner of US government securities with $877 billion of America’s public debt (China owns $907 billion). To rebuild the quake hit economy, Japan need to borrow plenty of capital. In fact, the quake could not have hit Japan at a worse time. Before the quake, Moody's Investors Service cut its outlook on Japan's debt rating against country’s highest debt burden among advanced economies. 

The world’s third largest economy is struggling to deal with a national debt which is more than twice as large as its GDP. At this backdrop, there is no other option for the Japan’s government and it has sell off a portion of its huge holdings in US treasury bonds.  The disaster in Japan has already caused anxiety across global financial markets. Doomsters are of the view that the earthquake could lead to a flash-collapse of the US economy with a financial tsunami that may cripple Americans for years and decades to come. If the US government could go into default, the consequences of that would be terrible to the US and in turn would shake the basic foundation of the entire global financial system. 

On the other hand, inflation is on the rise in emerging markets like China and India. In the medium and long term, the rise in oil prices could result in a fall in growth and worsening demand across the region.  Accordingly, rising oil prices and the Japanese crisis are worsening the situation in the Europe caused by the debt crisis in the region. In Europe, austerity is being imposed on the heavily indebted countries (Greece and Ireland) by the EU and IMF. If Greece enters the state of default, the consequences will be severe in countries like Britain, Spain, France, Portugal and Italy. The IMF in its latest report on global financial stability report warned that although the global recovery strengthening, but vulnerabilities remain due to high government debt levels in advanced economies that are putting pressure on banks' balance sheets even as the effort to repair the financial system remains incomplete. 

On the other hand, the US is struggling to stabilize its mounting public debt, posing a small but substantial risk of a new global economic crisis. In an unusually stern rebuke, the IMF opined that the US was the only advanced economy to be increasing its underlying budget deficit in 2011, at a time when its economy was growing fast enough to reduce borrowing.

Global Invisible Hand
 
Aristotle - Great Economst
 

At this juncture, doomsters say the crisis of 2008 will be only the harbinger of the next and bigger crisis if the US Federal Reserve continues its present policies of zero interest rates and its program of quantitative easing – forcing more dollar into the system. To avoid looming financial tsunami, Hu Jintao, Chinese President called for the reform of international monetary and financial systems. However, Alan Greenspan former chairman of the US Federal Reserve has argued that it is inherently impossible to fix the global financial system. He suggests that the global policy makers should not even try to reform the financial system because ‘the global invisible hand’ of the free market (as described Aristotle) has created a stable economy over the longer run. Whatsoever, the distressing events in Japan reveal that when an exceptional catastrophe strikes, no amount of preparedness come to rescues.