Wednesday, November 18, 2009

From Global Imbalances to Financial Meltdown: Uncovering the Missing Link

Last January, I presented a paper at the ASSA meetings offering my own take on the state of the world, entitled “The Financial Crisis Through the Lens of Global Imbalances”. My main point was that dollar recycling broke down as many of us expected it would, but not at the international level; rather, the breakdown occurred in the transmission mechanism that linked households to capital inflows. There were other surprises too, but nothing that would alter the conclusion that astronomic US current account deficits were ultimately culpable.

I revised the paper over the summer with the intention of publishing it, but, having received a request to make additional changes, decided it was a creature of its moment, and I should just let it be. The next iteration is on my calendar for December; I will consider the arguments of Obstfeld and Rogoff, among others, and try once more to slay the conventional wisdom. Meanwhile, if you want to see what I was thinking back in the day, you can find it here.


Myrtle Blackwood said...

Peter, regarding your paragraph:
"Begin by recognizing that this question cannot be settled by appealing to accounting identities. The fact that at any moment a country’s current account deficit or surplus must be the exact opposite of its net national savings (savings minus investment, both public and private) says nothing about the direction of causation.

Actions that alter one alter the other automatically as a simple matter of bookkeeping. For instance, if I purchase an import from another country, and if this is the only perturbation in the trade balance, then my outflow of currency can only be spent (by its recipient, or more likely, a counterparty) on an asset, and the
supplying of this asset (issuing a new equity or bond, selling an existing asset) is simultaneously a reduction of net national saving. No additional theory is required; indeed, there is no logical space for such a theory.
We can’t base the existence of identity relations on behavioral responses that may or may not take place."

This sounds logical except for the emergence of giant global intra/inter-corporate networks. Transactions taking place across national borders but within the same corporation or corporate network. Possibly using a single currency despite the existence of international/cross-border currency flow. said...

As the official commenter on it when Peter presented it last January in San Francisco, I suppose I should weigh in. No major disagreement. I would simply note that the matter of exchange rates is very much in here, with the whole Asia-as-export-platform (further pushed after the 1997 crisis) also pushed the idea of keeping currenies down, with the key one here being the Chinese yuan/rmb. Indeed, that they are keeping it pegged to the US dollar right now is relevant to the discussion on my most recent post.

Anonymous said...

"To sum up the argument thus far, the actual crisis deviated from the predicted one for several reasons, the foremost being that, while it was assumed that recycling vulnerabilities would reveal themselves at the international level (currency recycling), it turned out that the domestic component (credit recycling) was the one that failed. Borrowers overshot their sustainable credit limits, and securities whose ultimate value depended on debt service soured. This overshooting was facilitated by regulatory failure and a general excess of leverage throughout the US financial system."

I think the very neutral tone of the description of the process at work here is unfortunate. It is clear that what took place was a deliberate impoverishment of average Americans by Washington and the Smart Money - i.e. big capital. The collapse took the form of hapless sub-prime borrowers because they were the bagholders for an unsustainable drive to maximize profits. This is the sad unvarnished truth of the thing.

It truly is unfortunate that the resort to euphemisms and dog whistles persists even among economists least benefiting from this outrage.

Anonymous said...

Somebody had to pay the price here. It could have been the smart money who moved their production off-shore, it could have been Washington and the dollar, or it could have been the suckers in Saddleback Canyon in California.

Why not simply come out and connect the dots here?

TheTrucker said...

Anonymous said...

"Why not simply come out and connect the dots here?" The oversimplified answer is that chairs of economics are not endowed by the people in Saddleback Canyon California. Economics is not just "the dismal science". It is also a dojo for cynicism. If Adam Smith or David Ricardo would have pressed the issue of land rent as the proper vehicle for financing the public purse, they would have been displaced by those who were more inclined to lie about the difference between land and capital. As it turns out they were eventually displaced anyway in order to crate a two factor model of equilibrium that finances calculus while ignoring reality.

Bottom line: If the only source of general tax revenue in the state of California was a land tax, the state would not be the basket case that it is.
And if this were true in every state there would have been no bubble. But the bubble economy and the fake "business cycle" are the mainstay of the non-productive.

Anonymous said...

SIGH! I was actually just thinking out loud. The piece is astonishing despite the jargon which makes it inaccessible to people like members of my family - who live in Saddleback and attend the mega-church there...

If they only could see how this scam worked - send your job overseas, push you into debt, sell your mortgage to Iceland, then hit you up to bail the banks when it goes left.

No matter how fast you dig, the sh!t just keeps getting deeper...

Anonymous said...


Your paper is a fascinating account. It is the link in the chain of events which begins with the work Tom Walker is doing on Eisenhower, Truman and NSC-68 - the thread of which is picked up by John Perkins from the inside, with his memoir, Confessions of an Economic Hitman.

Perkins ends his narrative just at the point you pick up with the neo-liberal world order. And you carry it right up to today.

NSC-68, which Tom is examining had two objectives: the first was to contain the Soviet Union, but the second, and more important, objective was to create a world order conducive to the expansion of the American style economic system.

Your work provides the necessary narrative which allows us to connect the one with the other.


Myrtle Blackwood said...

Regarding Peter's opening paragraph:
"This is not the financial crisis we had expected. During the middle of the current decade, many of us were increasingly concerned about the stainability of the US current account deficit. By the fourth quarter of
2005, this outflow had reached 6.5% of GDP and was being financed almost entirely by dollar reserve accumulations of foreign central banks.

Where is the evidence that the US deficit is being financed by foreign central banks?

CHAPTER 5 - Trade myth five : foreigners finance America

EXCERPT: "Foreign ownership figures misleading. At the end of 2006, the stock of U.S. Treasury securities outstanding was U.S. $8.7 trillion. Of this ,52% was held by the Federal Reserve and government accounts, while private investors, "Foreign and International." These foreigners held 25% of all Treasury securities. While this is up from 1995's 14% share, remember that Americans sound alarms that "foreign ownership of nearly half of U.S. debt was a source of great vulnerability," and that "the economy can be held hostage to the economic decision being made in Beijing , Shanghai and Tokyo, they are referring to only the portion of U.S. Treasury securities that are held overseas. This statement is not only misleading, but it is also perplexing. Why should foreigners, in this age of globalization, not own some of the debt issued by the world's most sophisticated treasury? Besides, what does "foreign" really mean? Are we talking about "pure" foreigners, or also about U.S. citizens as well as MNCs with overseas financial vehicles? My suspicion is that "foreign" refers to anyone whose firm is located outside of the U.S.; however, the nationality that actually owns that overseas money is irrelevant...."