Mechanism Research About Financial Crisis Based On Fictitious Economy

Financial crisis is one of the most discussed topics in economics. In the long history of human civilization, especially during the years after Industrial Revolution, financial crisis emerged as a ’serious illness’ and has been entangling the global economy along the way. All financial crises that occurred in history have left economists pondering and contemplating endlessly.This paper explores the mechanism of financial crisis in the era of’fictitious economy’ or ’financial deepening’. Since the U.S. subprime mortgage crisis erupted in2008and soon spread into a global financial crisis, extensive research has been conducted from multiple angles by the academic circle and yielded substantial results. Too much attention, however, has been placed on finding direct causes of the crisis and its influence on global economy, rather than a comprehensive study from the point of view of dynamic economic development. How to interpret the2008financial crisis? We, of course, shouldn’t neglect the history. Since1825when the first global crisis of overproduction swept over Britain, capitalist economies have found themselves caught in a seemingly endless procession of periodical financial crisis. An observation is not difficult to draw that: economic crises of different times broke up in different forms and displayed distinctive characteristics. This was quite obvious after World War Ⅱ that as the capitalism-led global economy experienced profound changes, reoccurring economic crises differentiated themselves from each other in terms of frequency, strength, and forms. While before the twentieth century economic crises mostly appeared in the form of overproduction, stagflation in the1970s, and financial crises in emerging markets in the late twentieth century, the one, more recently, presented itself by emerging first as the U.S. subprime mortgage crisis in2008and then developed into a global financial crisis. So how do economic crises of different times internally relate to each other? Do they have the same origins? What is the logic of their evolution? Not only are these questions worth continuous discussion, they are also significant theoretical and practical queries that economics ought to answer.Admittedly, various explanations provided by the academic circle indeed have revealed the direct causes of the U.S. financial crisis, we, however, still have to query:what factors caused the subprime mortgage and derivatives bubbles in the U.S.? How did the global economic imbalance and the U.S. economic imbalance relate to each other? What factors were responsible for such imbalances? If to explore these questions further, the U.S. financial crisis may not be satisfyingly clarified by simply listing both dominant and recessive structural problems existing in the economy.It is an undeniable fact that modern financial crisis is contagious. Since US dollars are a global currency, the contagiousness of U.S. financial crises accordingly has its uniqueness. The history of global financial crises reveals that crisis’contagiousness displays different features under different monetary systems: under the gold system and Breton Woods Monetary System, financial crisis usually led to global or regional deflation. Yet under Dollar Standard, due to factors of interest rate fluctuation becoming a long-term trend, the not-yet-perfectly-formed international balance of payments regulation mechanism and the US Dollar hegemony, financial crises appeared to occur and spread more rapidly, especially after1990s when economic globalization accelerated and financial crisis started to draw broader influence on global economy; moreover, with the actual establishment of the dollar standard system, U.S. financial crises displayed an obvious transmission effect at a large scale. Under Dollar Standard, the U.S., dependent on its economic power, transferred its financial crises to the rest of the world through trade, finance, monsoonal effect and psychological expectations.These questions undoubtedly hold great theoretical and practical significance. This paper, under the background of the deepening of fictitious economy, explores ’the mechanism of financial crisis in fictitious economy’. The study is built upon Marxist economic crisis theory and based on the history and current situation of capitalist economy. The focuses of the study is the development of fictitious economy and the strengthening of government intervention, two major trends of contemporary capitalism. Both normative and positive analysis methods are used. Through the comparison between transformation of capitalist governmental functions and new trends of economic crises arouse from acceleration of fictitious economy deepening, this paper considers that the macroeconomic regulation imposed by capitalist governments after World War II has transferred into a conscientious, proactive, and active act from an inactive and passive one. The lengthening of macroeconomic regulation will inevitably bring structural change to economic operation, a switch featured with the formation of consumption society and debt countries and expansion of fictitious economy. However, fictitious economy’s expansion and financial innovation will inevitably lead to an unstable financial market, replacing existing economic crisis with financial crisis. Here, discussion on the financial crisis mechanism is conducted at three levels:first to demonstrate the meaning of fictitious economy and trends in its development, second to analyze topics such as the deviation tendency between fictitious economy and real economy, characteristics of modern financial crisis and the financial crisis mechanism, third to briefly elaborate how China can maintain its financial security. There are seven chapters:Chapter1, the introduction, identifies research background, objectives, and methodology. After reviewing existing research on fictitious economy and financial crisis, the paper finds its key questions that what changes have been brought by capitalist economic development? Why did such changes occur? What impact did these changes place on capitalist economy?Chapter2analyzes the trend of deepening of fictitious economy, which is the logic starting point of this paper. Discussion about fictitious economy paves the way for further study on fictitious economy itself and financial crisis. This chapter discusses about the concept, characteristics, mechanism of internal evolution, and complexity of fictitious economy, the relationship between its development and expectation, fictitious economy’s impact on real economy, the origin of fictitious economy, and the causes of it becoming an economic driving force and its evolution process accordingly in particular.Chapter3examines deviation between real and fictitious economies and both macroeconomic and microeconomic factors that cause such deviation. The development of fictitious economy, from the point of view of economic development process, appears in three facets:deviation between fictitious and real economies, functioning of fictitious economy becoming more and more independent, and fictitious economy evolving into a driving force to real economy. Deviation between fictitious and real economies is inevitable, which will inevitably lead to occurrence of bubble economy. The extreme form of bubble economy is financial crisis.Chapter4reviews key features of financial crisis, their embodiment in real life and previous financial crisis theories. Essentially, Marxist economic crisis theory identifies capitalist economic crisis as an economic phenomenon with unique social origins, based on the fact that capitalist is an existing production mode and has its own inner contradictions. The logic of Marxist economic crisis theory can be summarized as:capitalist economic crisis is a result of production restricted by insufficient effective consumption demand, and insufficient demand is resulted from income disparity between capital and labor. Such disparity is. caused by ownership of production materials by capitalists. Since capitalist economic crisis is essentially caused by capitalist economy’s inner contradictions, which decides the periodical occurrence of economic crisis. Early western theory’s explanations about financial crisis commonly lacked micro-foundation and to a large extent had to rely on inference drawn from quasi-psychology. Therefore, these explanations could only be viewed as hypothesis. Two trends have emerged from the development of modern financial crisis theories:’fictionalization’ and integration. This paper, based on previous theory, theoretically expounds the internal mechanism of economic crisis as under the background of fictitious economy it increasingly appears in the form of financial crisis.Chapter5explores the mechanism for formation of modern financial crisis. Fast growth of modern fictitious economy is the cradle of modern financial crisis, which, in essence, is crisis of real economy. The paper further discusses the mechanism of transmission of modern financial crisis. The two mechanisms can be summarized as:inner contradictions of capitalist economy-disparity between capital and labor force-insufficient effective demand-overproduction governmental regulation and effective demand bubble-increase of default rate-eruption of financial crisis. Contagion of modern financial crisis is an integrated result of a series of interactive factors, including trade spillover effect, financial spillover effect, monsoonal effect, and expectation effect. Contagion effect to a certain degree is the most distinctive characteristic of modern financial crisis.Chapter6intends to empirically prove the occurrence and transmission of modern financial crisis. By utilizing theories in previous chapters as explanatory framework, this chapter takes the1997Asian financial crisis and the2008U.S. financial crisis as examples and analyzes the mechanism of formation and transmission of financial crisis in general. Through comparison, this paper has gained a better understanding of the formation, evolution and transmission process: the1997Asian financial crisis was fundamentally attributed to its economic development model and economic bubble, financial market overexpansion and slacking supervision, and inelastic exchange rate system. As a result, its economic internal flaws made speculative attack find its chance to ignite the crisis. US subprime mortgage crisis was originated from indirect consumer financing and subprime housing mortgage bubble; continued strong demand for MBS (mortgage-backed security) and CDO (collateralized debt obligation) began to overflow in the financial market. The paper also demonstrates important points such as characteristics of U.S. economic growth, U.S. governmental regulation mode, structural imbalance in the economy, the relationship between dollar standard system and financial crisis, and establishes a logical framework to explain causes of the U.S. financial crisis.Chapter7mainly explores uncertainties existing in China’s economic reform and opening-up and their impact, both positive and negative, on China’s economy. The paper aims to provide sound policy implications that can effectively guide China’s economic practice under the background of deepening of fictitious economy. The paper lastly analyzes how China can more actively participate in global financial affairs through restructuring its financial stability and opening up its financial market, eternally, to protect its financial security.The paper attempts to make innovation in the following four fields:(1) modern financial crisis is fundamentally caused by capitalism’s inner contradictions---income disparity. The basic conclusion is that financial crisis is directly attributed to the continued extensive increase in default rate; growing default is caused by the smacked expectation of the public upon the future; pessimistic expectation is resulted from the discontinuity of overdrawn consumption by citizen and government; overdrawn consumption arises with the attempt to reduce overproduction; overproduction is originated from insufficient effective demand; and insufficient demand is attributed to capitalism’s inner contradiction. In this way, the logic of modern financial crisis can be clearly seen: capitalism’s inner contradiction-disparity between the rich and the poor insufficient effective demand-overproduction-continuously and extensively growing demand-increase of default rate-financial crisis. Therefore, in the view of Marxist economics, classical crisis and modern financial crisis are the same in essence that both are overproduction. The only distinction between the two is that for classical crisis, overproduction is embodied in insufficient effective demand, while for modern financial crisis, overproduction is displayed through continuously and extensively growing debt default, which is caused by demand bubble. From classical crisis to modern financial crisis, it is only a process that capitalism’s inner contradiction is transmitted from production to finance.(2) Overproduction in capitalist economy can viewed as insufficient effective demand transformed into demand bubble. Although since1930s, Western economies have started using macroeconomic regulation and establishing consumption society to overcome economic crisis, an attempt to stimulate effective consumption by fueling far-fetched demand. Yet as the ever-growing economy has become the foundation to ensure the normal functioning of the society, once production stops expanding and serious economic crisis may occur. Therefore, from the view of Marxist economics, classical crisis and modern financial crisis are the same in essence that both are overproduction. In modern financial crisis, thanks to the establishment of two’fueling consumption’techniques to conquer the crisis, macroeconomic regulation and consumption society, overproduction is embodied as demand bubble instead of insufficient effective demand. From classical crisis to modern financial crisis, it is only a process that the eruption of capitalism’s inner contradiction is postponed from now to the future.(3) Key features and transmission mechanism of modern financial crisis:long latent period, big influence on government, being dominant and advanced, global contagion, more venerable emerging markets. Transmission of modern financial crisis is an integrated result of a series of interactive factors. In a word, the transmission mechanism of modem financial crisis includes trade spillover effect, financial spillover effect, monsoonal effect and expectation effect. Contagion effect, to a certain degree, is the most distinctive characteristic of modern financial crisis.(4) Accumulation and formation processes of modern financial crisis. In terms of production circle, the formation process can be summarized into four stages: stages1, continued economic prosperity leading to investment expansion; stage2, continued price increase in financial asset resulting in bubble economy; stage3, investment and speculation decreasing market mobility, increasing demand for capital and interest rate; stage4, decline in financial asset price and governmental regulation forced by economic downturn, but if government fails to stimulate market confidence, asset dumping will continue, asset price will plunge, and financial crisis will emerge. Briefly speaking, in terms of production circle, financial crisis is typically formed as follows:economic prosperity-debt bubble-increase in asset trade and sudden rise in asset price-increase in exchange rate, capital recovery and debt-sudden decline in asset price-financial crisis.Due to the fact that fictitious economy is a broad subject, along with my limited knowledge and access to resources, this paper may be found with errors of omission, which can undermine its persuasiveness. The discussion, undertaking a multi-angled approach, may appear a bit prolix even to the author as some arguments have been repeated more than once. How to structure and phrase the paper still remains to be discussed. All of these provide me guidance for future improvement. As for the arguments, they are left for the readers to judge. My continuous effort devoted into this paper is to explore the basic law of a healthily-functioning modern fictitious economy, in hope of building a new China with a brighter future.