International Security Repercussions of the Global Financial Crisis

In a matter of months the major world economies plunged into the longest recession since the Great Depression. As a result, all countries in the global economic and financial system have been profoundly impacted by the economic crisis, and all by different degrees. This period of economic hardship has also threatened to destabilize the international situation and increase risk of conflicts.

For a number of years the global economy has been driven by cheap credit. Financial distress sown by the bankruptcy of Lehman Brothers made financial institutions more risk averse, severely reducing the availability of credit. Furthermore, soaring risk premiums made the available credit much more expensive. As a result, the corporate sector, as well as private consumers, have cut back on investing and spending, triggering economic downfall.

Thanks to the aggressively expansionary fiscal policy, the global economic freefall was averted within months. On the one hand, developed economies that have responded with unprecedented stimulus packages, still face high unemployment, negative economic growth and soaring public debts. Large emerging economics, on the other hand, accelerated first. China’s output, which never actually fell, was already growing at a rate of 17% in the second quarter. Out of BRIC economies (Brazil, Russia, India and China), only Russia has seen a dramatic economic downfall of a stunning 8 percent this year, despite one of the world’s relatively largest economic stimulus plans. As the world economy seems to have entered a post-crisis revival stage, this stability is an illusion.

There are a number of threats to the current fragile stability. First, the current global economic growth is increasingly dependent on government support. Second, demand in the developed world is to remain weak, especially in the countries with highly leveraged households and dysfunctional banking system. Furthermore, big emerging economies are under serious threat of creating new asset bubbles and other distortions as the governments conduct loose monetary policy. China, for example, keeps its currency artificially weak, which hampers the economy’s transformation toward consumption and makes it increasingly dependent on the rich world. Some expectations for 2010 include sovereign debt defaults, rise in trade protectionism, and even civil unrest and political conflicts.

Current financial distress may provide an opportunity for Russia, China and Organization of the Petroleum Exporting Countries (OPEC) to exert their financial leverage to achieve their political goals. China, for example, is the single largest investor in the U.S. government bonds, which gives the Chinese a great deal of leverage over U.S. interest rate and currency change rate decisions. Furthermore, the BRIC countries’ speculations of a new world currency have a potential to substantially weaken the U.S. dollar. Furthermore, the world’s largest Sovereign Wealth Funds, including major energy exporters, controlled nearly $3 trillion in 2007 and expected to control over $10 trillion by 2012. Driven by high world energy prices, Russia’s wealth and energy markets monopoly has allowed for a increasingly assertive foreign policy toward former Soviet countries as well as the developed world. Such policies eventually led to the war with Georgia in 2008.