Martin Wolf: It began with the Asian currency crises, and it's ending with the close of the Reagan-Thatcher era
As already noted here, FT economics columnist Martin Wolf has a new book out called Fixing Global Finance. It's not really about the current crisis, but it is about the giant imbalances in global capital flows that Wolf thinks were the biggest cause of the current crisis. I went to a breakfast with Wolf on Thursday, and he explained with characteristic Wolfian clarity that what set it all off was the Asian financial and economic crisis that began with the collapse of the Thai baht in the summer of 1997.
As local currencies tanked all over Southeast and East Asia, corporations and banks that had borrowed in dollars suddenly stood no chance of repaying their loans. The lesson that these countries--and China, which survived the 1997-98 scare but only just barely--drew from the experience was not just to stop borrowing in dollars but to stop borrowing from the rest of the world, period.
"These were the world's natural capital recipients," Wolf said. "Instead, they started to export capital in a big way." Add that to perennial capital exporters Japan and Germany, and oil-exporting countries that were getting ever flusher as crude prices rose, and you had a vast, sloshing wave of money that ended up flowing to the countries with the most "elastic" banking systems--the U.S., the U.K., Australia, Spain--and financing spectacularly unsustainable house-price booms. (And there are people who want to blame this whole thing on the Community Reinvestment Act?!?)
What needs to happen in the coming years, Wolf says, is for emerging-market nations to become net borrowers again--just not in dollars or euros or any other currency but their own. "We've got to have local-currency bond markets where the risks are shifted to investors," he argues, adding that we also need a much bigger and richer International Monetary Fund that could reassure emerging-market governments that it will help them out when markets turn against them.
Wolf has of course been talking about this stuff for years, and hardly anybody outside the small circle of current-account-imbalance obsessives paid any attention. I know I didn't. I have a copy of a book called G7 Current Account Imbalances that Menzie Chinn gave me last year sitting on my desk. I haven't read a page of it. "I got sort of disheartened writing about it," Wolf says. Now everybody's paying attention, but "it's now too late." (Although not too late to buy his book, I feel compelled to add.)
On a happier note--for the U.S. at least--Wolf says the dollar appears likely to maintain its role as the world's lead currency, meaning we can shove much of the cost of our financial system semi-collapse onto other countries through devaluation of the dollar. The Asian countries hit by the crisis in 1997 and 1998 spent an average of 35% of GDP recapitalizing their banking systems. In the U.S., he says, the cost is likely to be around 10% of GDP.
Finally, Wolf echoes what a lot of people have been saying lately, although he gives it a more global perspective than one usually hears around these parts: "A long era which began with the elections of Reagan and Thatcher--and, more important--the rise of Deng Xiaoping ... is clearly coming to an end."
Wolf lived in Washington D.C. in the 1970s, and remembers the strong sense both there and in London in those days that "governments just weren't working."
We've lived through 30 years of that idea, which I to some extent shared, and as with most ideas people eventually took it too far. It led to the idea that there wasn't anything government could do well except fight wars. ... This great pendulum is now going to swing back.
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"and you had a vast, sloshing wave of money that ended up flowing to the countries with the most "elastic" banking systems--the U.S., the U.K., Australia, Spain--and financing spectacularly unsustainable house-price booms."
I'm still not sure about this connection. It makes it sound like a spigot that can't be turned off. It sounds a bit like completely blaming Greenspan.
Surely the people who made these loans and investments knew they could lose money. After all, if you borrow money at low interest rates, you're still borrowing.
I just feel that without people believing that the government, including the Fed, would bail us out of a huge crisis if we had one, it wouldn't have been so easy for people to ignore the precariousness of their investments.
Again, I can see the incentive to invest this pool of money, just not, immediately, the incentive to invest it poorly.
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Wow! Wolf is blaming the countries that lent money to us for the crisis? It seems to me that the lenders were acting in their best long-term interests --developing their economies by creating/sustaining markets through lending. The biggest risk taken by China et. al. is that the dollar will be devalued... but they figured out that the first reaction to a global fiscal crisis would be a demand for dollars...and now they are sitting pretty -- and can buy up dollar denominated assets at "fire sale" prices by providing those who are "retreating" to Treasuries the bonds that these countries already hold.
Surely the people who made these loans and investments knew they could lose money. After all, if you borrow money at low interest rates, you're still borrowing.
actually, what the borrowers "knew" was that buying a house was a "good investment"... and if they questioned whether they could afford the house, their realtor would tell them (with the appropriate disclaimers) how much the homes in that area had appreciated, and how people who had bought homes were "building capital".
Meanwhile, the lenders knew they couldn't lose, because they could sell the loans they made to bundlers. The bundlers weren't worried because there was a market for bonds backed by "collateral", and that market wasn't worried because these bonds were AAA rated, and they could created CDOs and CDSs with them to other people....
Sure there were "skeptics" talking about "the housing bubble" -- but nobody listened to them....
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I don't know if it began with Reagan (I think Nixon put down some groundwork), but that's certainly when we started pawning and selling ourselves up the wazoo.
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The other problem that gets no mention is that we are engaged in two wars. And while it can make jobs and be profitable for a country....this has mostly be a war of outflows.
We are giving lots of money to Iraq and Afghanistan that could be put to much more productive purposes here.
And before folks say, if we don't step up to maintain order then we will have no oil...this is also true for Europe, Asia and other parts of the world.
It is time to stop being world police. It is time to conserve and keep our powder dry to be employed where we can get the biggest bang.
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[...] on their debt if the recession drags on for too long. But it's also part of the broader point Wolf has been making lately: That without overly frugal countries like Germany and Japan and China, Americans (and Brits and [...]
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[...] now been pretty much persuaded by Martin Wolf's argument that unprecedented flows of capital from China and other big exporters into the U.S. (with [...]
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[...] a while but tends to end in trouble. The global capital-flow imbalances that many economists now say were at the root of the financial crisis are in significant part a product of the dollar's outsized [...]
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