Fixing the Global Economy
Myron Scholes Global Markets Forum
March 3, 2009 5:30–7 p.m., Gleacher Center
Focusing on “the emergence of extraordinary global imbalances” over the past decade or so, Martin Wolf gave his views on the current economic and financial crisis. He argued that although two explanations for the crisis widely heard in the United States—failures of regulation and excessively loose monetary policy—were important aspects of the problem, they could not explain “a catastrophe of this magnitude.” Wolf focused particularly on three trends that helped lead to the crisis: global imbalances, a credit boom that accelerated under the influence of those imbalances, and the way financial innovation worked.
Wolf argued that the Asian crisis a decade earlier was an important contributor to global imbalances because it led policymakers in emerging economies to conclude that “running very large current-account deficits to support large investment booms was sensationally dangerous,” especially when the deficits are financed by relatively short-term, foreign-currency borrowing. Over the decade leading up to the current crisis, therefore, many emerging economies, particularly in Asia, shifted to new policy regimes that included aggressively accumulating foreign reserves. The result was a “monstrous recycling of capital inflows and current account surpluses,” Wolf said, with foreign reserves held by emerging economies rising sharply. It also “amounted to a massive flow of capital from poor countries to the richest country in the world,” he added. Asset bubbles, especially in housing, started emerging across much of the developed world, Wolf said. Particularly in the United States, household debt rose sharply because of the capital inflows.
In addition, Wolf argued, these imbalances “came on top of what was already an astonishingly rapid credit expansion across the developed world, which had started in the early 1980s, when debt ratios to GDP were extremely low, and accelerated rapidly.” The third trend he highlighted was that, in an environment of low returns for safe assets, investors demanded higher returns for safe investments. Innovators in the financial system found ways to meet this demand, which eventually helped lead to the financial crisis.
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