Stock markets around the world were rocked last week led by the United States. The world economy is facing unpredictable risks.

Aftershocks of the US subprime crisis are still being felt, and are influencing economic entities throughout the world. Where the world economy is heading depends on when the destructive effects abate.

International financial markets are always relatively vulnerable at the start of a year, when even the slightest hiccup can trigger jitters through markets with stocks tumbling.

Earlier this month, two of America's financial flagships – CitiGroup and Merrill Lynch – dropped a bomb by releasing reports of huge losses in 2007. The results were worse than the market anticipated and caused immediate panic in the US stock market.

As the command center, the Federal Reserve should have responded in a timely manner to control market jitters or take proactive measures like cutting interest rates to maintain financial stability. But Federal Reserve chairman Ben Bernanke lost his composure. He told a Congressional hearing that the current subprime crisis had cost the market at least $100 billion and could reach $1 trillion when other damage is taken into consideration.

And if that was not bad enough, Bernanke asked the Treasury Department for financial support instead of relying on the Federal Reserve's own strength and confidence.

This set off panic in global markets as nerves got the better of investors who found their confidence in the Fed slipping.

Of course, it was absolutely right for the chairman of the Fed to tell Congress the truth as required by the "democratic political process" and "honesty". But the market should also have learned enough about numbers to remain calm when bad news breaks.

However, when Bernanke, who is considered the "financial guardian", "threw away his independent authority and esteem" and sought help from the federal government, it was tantamount to sending the market the wrong signal. It was practically telling the market that the Fed had lost its ability to keep things under control.

Although the Fed eventually woke up and cut the interest rate by 0.75 percent, followed by a basket of emergency measures announced by the Bush administration, damage had already been done as far as market confidence was concerned.

Since finance ministers of the five Western powers and central bank governors began secretly fixing exchange rates and coordinating financial policies in 1975, the grouping has now grown to seven members and is known as the "G7". It is safe to say the "G7" has become the central mechanism for developed countries to coordinate international financial policies, and indeed, it has played a vital role as a stabilizing body in the international financial system.

However, since the US subprime crisis erupted in August, the "G7" has not been able to play its role as effectively as it used to. The financial authorities of Japan, the US and the European Union appear to be clueless, as if beset by unspeakable problems.

For example, the International Monetary Fund warned the US of its subprime problem in a report published on August 1. It told the US to make sure the subprime ills would not wreck its economy. On August 9, the EU central bank was the first to inject funds into the market, forcing the Fed to follow suit. Then, on August 11 and 14, Japan's central bank ploughed 1.6 trillion yen into the financial market but later took it all back in a typical show of "short-term intervention". Such a move is no different than telling the market the subprime problem "is just a brief scare".

All this, lest anyone forget, happened despite the pledge made by the central banks of the US (the Fed), Canada, the EU, Switzerland and Britain in a joint statement issued on December 12 that they would take concerted action against any financial crisis. The fact is they not only have yet to take any real action but have also failed to act in sync.

More perplexing to the market is that the new mechanism does not include Japan's central bank, which means the "G7" as a coordination mechanism has been replaced by the five European and North American central banks without actually saying it out loud.

The messy international financial policy coordination gave rise to widespread speculation, sapping the confidence of global financial markets in Japan-US-EU policy coordination efforts.

In fact, the current subprime crisis is a typical product of the financial globalization and liberalization championed by the US. Globalization and liberalization of economic activities should take place on a level playing field.

But the globalization and liberalization of finance led the US is based on power politics. Other countries, including Japan, have no choice but accept the "open market theory" as wielded by the US "the financial cowboy" of the world.

The US format emphasizes market opening and liberalization of financial products and trading without a "common system" based on equality, fairness and negotiations to keep things in order. From accounting rules, market assessment systems, risk control procedures, to financial policies and even market terminology, everything is decided by US. In order to guarantee US capital a smooth ride anywhere in the world, the federal authorities have ignored conventional practices in market evaluation and "played dirty" to whitewash the real risks of such low-credit products as subprime mortgages.

In the financial market painting over real risks inevitably leads to investment bubbles. Once it becomes a crisis, even sound assets could go down the drain. Such is the seriousness of the current subprime crisis.

The Fed seems to have been fooled by watered-down market assessments. The subprime crisis may end up bringing the US out of its wild fantasy and back into the real world, where it has to pursue "financial globalization" with other nations fairly, openly, and on a level playing field.

(China Daily January 28, 2009)