World Recessions

The adjustment to the increase in the inflow of foreign saving would result primarily in an increase in household consumption. Household wealth continued to improve for as long as the domestic savings would not decrease in order to equal the increase in the inflow of foreign saving. The economic boom would consequently lead to a noticeable increase in consumption spending which is brought about by the increase in household wealth (Aliber, 2000).

The pattern of cash flows in the growth or expansion period is not likely to be continuous or sustainable; some of the borrowers obtained new loans to pay the interest on outstanding loans. To address the situation, some form of adjustment eventually would be necessary to reduce the rate of increase of indebtedness. That adjustment would affect or result in a decrease in the foreign exchange value of the country’s currency. During recession period, there was a reversal in the direction of the cross-border flow of saving and the currencies depreciated sharply and “undershot” the equilibrium value as the countries developed trade surpluses. The large depreciation of the currencies could trigger massive revaluation losses on loans (Aliber, 2000).

The last thirty years saw the most tumultuous in international monetary history. More national banking systems collapsed in several different waves than at any other period. The deviations of market exchange rates from real exchange rates-the “overshooting” and “undershooting” and the fluctuating ratios of trade balances to the GDPs have been bigger than previous periods (Goldstein, Morris & et al, 1994).

It also saw four major asset price bubbles; the “mother of all bubbles” was in Japan in the second half of the 1980s. These world events: failures of national banking systems, the large shifts in market exchange rates compared to the real exchange rates, the large fluctuations in flows of national saving across national boundaries, the bubbles in asset prices were methodically related to each other (IMF).

A marked increase in the cross-border flow of saving to a country would result in an increase in the price of that country’s currency in the foreign exchange market and could cause “overshooting” of its currency; the price of securities traded in that country also increased. The pattern of cash flows was non-sustainable but somehow this pattern was able to continue for a longer period. A shock will occur if there is reversal in the cross-border flow of capital and the price of that country’s currency in the foreign exchange market declined greatly and the price of securities traded in that country lessened. There is a close correlation between change in the value of a country’s currency in the foreign exchange market and the change in the value of the securities traded in that country. The adjustment process to inflows of foreign saving causes significant increases in the prices of domestic securities and leads to a prolonged economic expansion that could mask its non-sustainability. Thus, this resulted to cyclical modern world recessions (Hunter etc al, 2003).