Gearing Up for the next Financial Crisis


October 22,2018

Gearing Up for the next Financial Crisis

by Andrew Sheng

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http://www.eastasiaforum,org

In July 2018, the Bank for International Settlements (BIS) asked whether the world was heading towards a perfect financial storm, with the US stock market heading for record highs even as emerging markets like Argentina and Turkey were running into foreign exchange problems. Twenty years after the Asian financial crisis of 1997–98 and the global financial crisis of 2007–08, storm clouds are gathering once again.

Conventional economic models failed to predict the last two crises because the technical definition of financial risk is measured volatility. The global financial crises proved that current models of financial risk, largely used by banks and financial regulators, are totally blind to Black Swan or Grey Rhino events of unmeasurable uncertainty.

This time round, the consensus is that the Grey Rhino (an event with high probability and high impact, but where the trigger is uncertain) is the looming rise in US interest rates in response to a domestic economy that is running at nearly full capacity, with low unemployment levels and signs of creeping inflation. As the BIS has warned, non-financial borrowers outside the United States owe US$11.5 trillion dollars, of which US$3.7 trillion is owed by emerging markets.

Turkey’s recent currency woes are symptoms of domestic policies badly managed, aggravated by the US threat of economic sanctions. Turkey alone has US$467 billion of foreign debt. As global risks rise, capital is flowing back to the booming US stock market and potentially higher interest rate yields. Emerging markets have no alternative but either to allow exchange rate depreciation or defend themselves with higher interest rates that depress their own growth potential. Recently both Indonesia and Hong Kong had to defend their exchange rates through higher interest rates and intervention, respectively.

The tricky thing about US interest rates is that economies with high domestic and foreign debt are vulnerable to tighter liquidity and financial fragility, because their interest rates and credit-risk spreads rise non-linearly. Doomsayers of East Asia’s financial collapse argue that China’s debt of 250 per cent of GDP is the tipping point.

Financial risks are rising not just in China, but globally. Dun and Bradstreet’s Global Risk Matrix, published in May 2018, suggested that US interest rate rises could trigger a fresh debt crisis, sending the global economy into contraction. Echoing this sentiment, the International Monetary Fund’s July 2018 World Economic Outlook argued that rising trade tensions are threatening growth recovery in Europe, Japan and Britain more than predicted. Any overheating in the United States would trigger currency crises for some emerging markets.

In short, we cannot separate financial risks from geopolitical risks. Any unforeseen event arising from a geopolitical miscalculation, climate change disaster, war or cyber-induced disruption could trigger another round of financial crises.

Global financial fragility comes from two structural imbalances. First, the United States is the leading deficit country in terms of trade and debt, owing the world a net US$7.7 trillion, or 39.8 per cent of GDP. This amount is growing because of rising fiscal debt and the low level of national savings. Second, below-par global growth since 2008 has been underwritten almost completely by central bank unconventional monetary policies, which have brought interest rates to an unsustainably low level.

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Market fears that the large central banks will withdraw quantitative easing — QExit — threaten to jeopardise the current frail recovery, which is why US President Donald Trump is also against the Federal Reserve raising interest rates.

If geopolitical risks trump financial risks, what could go wrong in the coming months?

Western analysts think that the trigger will be a Chinese debt meltdown. But Chinese debt is internal debt, as China has foreign exchange reserves equivalent to 188 per cent of its foreign debt and still runs a current account surplus. China’s debt problem is an internal debt issue, very much like that of Japan. While Japanese debt is owed largely to Japanese households, Chinese debt is largely owed by state-owned enterprises and local governments to state-owned banks. In such a situation, China is well positioned to rewrite its national balance sheet, a privilege not possible for more privately dominated markets.

A possible Black Swan (a low probability but high impact event) is an unexpected sharp increase in the yen–dollar exchange rate. Japan is the third largest economy after the United States and China and has been increasing its overseas assets since the 1990s. Between 2007 and July 2018, the Bank of Japan has grown its assets the most among the major central banks (to US$4.9 trillion, or just over 100 per cent of GDP). By the end of 2017, Japan’s gross foreign and net assets grew to US$9 trillion and US$2.9 trillion respectively, equivalent to nearly one quarter of US growth in gross foreign liabilities during the same period.

US trade deficits have been sustained by foreign inflows (which had central bank origins) in which Japan is a major player. During the Asian financial crisis, sharp volatility in the yen–dollar exchange rate caused a dramatic withdrawal of Japanese bank loans from Asia, aggravating a regional liquidity crisis that was already spurred by speculative currency attacks.

What complicates today’s financial fragility is Trump’s attempt to control the US trade deficits. He assumes that bilateral negotiations can reverse the unsustainable growth of national debt, which tripled in the last decade and may grow to 100 per cent of GDP in another decade. But tariffs only increase inflation for the consumer, which would trigger higher interest rates and jeopardise the fragile financial stability achieved through unsustainable monetary policies.

The next global crisis will most likely be triggered by geo-political mistakes. In an age when politicians are proving fickle in their decisions, central bankers are perhaps the only professionals who appear able to do something about financial risks. But since Trump does not care much about professional advice, Asian markets worry less about measurable financial volatility than unmeasurable personality risks.

Andrew Sheng is Distinguished Fellow at the Asia Global Institute, University of Hong Kong. 

This article appeared in the most recent edition of East Asia Forum Quarterly, ‘Asian crisis, ready or not ’.

Lessons from Europe


October 20, 2015

“In 2008, crisis resolution was also possible thanks to the concerted effort of key central banks. Nowadays the power of unelected bodies is rightly questioned and scrutinised. The main lessons from the long financial crisis in Europe may be lost amid economic nationalism. Experts tend to be the repository of such lessons, but there is little respect for experts in today’s politics “.–Paola Subacchi

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More than a decade on from the most devastating financial crisis since the crash of Wall Street in 1929, politicians and commentators have been extremely careful in offering predictions on when the next crisis will occur. Playing with economic predictions is like playing with fire. Nobody knows this better than former British prime minister and chancellor of the exchequer Gordon Brown, who repeatedly promised ’no return to boom and bust’.

But there are reasons to be concerned. The gradual normalisation of US monetary policy could generate adverse spillover effects and disrupt global financial stability. Red lights are already flashing in Turkey and Argentina. A major correction in the United States’ stock market could trigger a significant shock for the rest of the world. High levels of debt, maturity mismatches and carry trades financed by short-term debt could fuel contagion through financially integrated markets. In addition, the deterioration of multilateral economic relations in the last 18 months might make crisis resolution more difficult than it was in 2008–09.

As things stand, even if we don’t know how the next crisis will materialise, where the epicentre will be and which countries will be hit, we can infer that it will likely be more disruptive than its predecessor.

What lessons can be drawn from Europe and its experience during the global financial crisis?

The European economy is expected to grow, in real terms, by 2.5 per cent in 2018, a slight slowdown from 2.7 per cent in 2017. Countries that were badly hit by the crisis have finally come out of the tunnel and some, like Ireland and Spain, are in very good shape. Against this overall positive background the European Central Bank (ECB) is slowly and gradually preparing to normalise monetary policy.

For years the economy was Europe’s key problem, now it is politics. The integrity of the European Union (EU) and its single currency is being challenged by populist politics that is building consensus on voter disaffection with rising inequality and the deterioration of living standards. Brexit, refugees and tensions between Germany and Italy on fiscal leeway are now threatening the entire EU project.

Europe’s brand of populism is anti-migration and anti-financial globalisation, and resents a supranational construction like the EU that by definition is at odds with economic nationalism.

Italy is the country that could trigger a perfect storm. Some members of the Italian cabinet have been playing with the idea of severing the ties with the Europe’s monetary union in order to regain control of monetary policy. Italy has been struggling for years with poor productivity growth and GDP growth. After some recovery in the past two years, the latter is now slowing down. Youth unemployment is at 35 per cent, one of the highest rates in the EU. Interest rates are on the rise, making it more expensive to pay interest on public debt that currently stands at 132 per cent of GDP. And the expansive fiscal policy promised by the two populist parties now in government is undermining investors’ confidence.

But Italy is not an isolated case. Euro-scepticism is on the rise, especially in countries in eastern and central Europe that joined the EU in 2004. In Britain it has been driven by the idea that an independent trade policy would better serve the interests of the United Kingdom. Having served notice to the EU on March 2017, the UK is due to leave Europe’s single market and custom union in March 2019.

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It is unclear what the new relationship between the EU and the UK will look like. Political rifts inside the British government and the ruling Conservative party have resulted in a deadlock. In the meantime, a number of foreign companies, especially those in the banking and financial sector, have announced that they will relocate to the continent to maintain access to the EU market.

The prospect of a hard Brexit has taken a toll on sterling, which has dropped by almost 12 per cent against the US dollar between mid-April and mid-August 2018. The British economy is expected to grow, in real terms, by 1.6 per cent in 2018. But increasing interest rates forced by inflationary pressures and a weak sterling may pose further constraints on economic growth. The UK is a deficit country, with a deficit in the current account of 5.2 per cent of GDP and a high level of personal debt. A series of corporate collapses — most recently, the bankruptcy of the infrastructure company Carillion — may trigger some financial instability.

If there is a lesson from Europe’s experience with the financial crisis, it is to consider the long-term effects of crisis resolution. In 2011 and 2012, at the peak of Europe’s sovereign debt crisis, that followed the global financial crisis, efficiency in crisis resolution took priority over legitimacy. Draconian measures were imposed on Greece while fiscal austerity became the norm across the whole region. People, especially those in southern Europe whose economies had been decimated by the crisis, felt the hit and resented being told what to do by unelected bodies such as the ECB, the European Commission and the IMF. Today’s dysfunctional politics is significantly a response to those mistakes.

In 2008–09 international cooperation played a key role in crisis resolution. Even if the G-20 did not deliver overall reform of the international monetary and financial system, its broad-based governance system, inclusive of emerging markets, managed to get member states to work together.

Today this cooperation would be more difficult to achieve. While in 2008 politics was fairly neutral, today it is hugely divisive. The United States is in retreat and increasingly unwilling to lead. China is not ready yet to take over and to provide the financial safety net that would be necessary in case of a crisis. Europe, especially the leading countries such as Germany, France and the UK, are primarily focussed on domestic politics.

In 2008, crisis resolution was also possible thanks to the concerted effort of key central banks. Nowadays the power of unelected bodies is rightly questioned and scrutinised. The main lessons from the long financial crisis in Europe may be lost amid economic nationalism. Experts tend to be the repository of such lessons, but there is little respect for experts in today’s politics.

Paola Subacchi is a Senior Research Fellow at Chatham House, Royal Institute of International Affairs, London and a visiting fellow at ANU.

This article appeared in the most recent edition of East Asia Forum Quarterly, ‘Asian crisis, ready or not’.

 

Safeguarding A Rules-based Trading System against America First Trade Economics


October 16, 2018

Safeguarding A Rules-based Trading System against America First Trade Economics

by Dr. Mari Pangestu, Universitas Indonesia

http://www.eastasiaforum.org

 

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“Without concerted effort and a coalition of willing leadership, including from the EU and East Asia, the future of the rules-based trading system will remain under threat.”–Dr. Mari Elka Pangestu

Despite expectations that the US Federal Reserve would raise interest rates, capital flows to the United States have led to the appreciation of the US dollar against most major currencies.

The hardest hit countries are Argentina and Turkey, which are experiencing fiscal issues complicated by their political situations. Brazil, South Africa and the emerging countries in Asia have also been affected — albeit at a lower rate of depreciation of their currencies in the 10 to 12 per cent range. Even Australia and China have experienced depreciation of around 8 per cent and 5 per cent respectively.

The level of depreciation experienced by different economies reflects how investors perceive their different fundamental macroeconomic conditions, especially the level of their current account and fiscal deficits and policy outlooks.

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The rising US dollar raises questions about the capacity of emerging economies to service their dollar-denominated debts and the vulnerabilities this could expose in their financial systems. Even if the current economic conditions point to a low potential for contagion from Argentina and Turkey, IMF Managing Director Christine Lagarde recently warned that ‘these things could change rapidly’. The uncertainty that already exists is a clear and present danger.

The uncertainty in the world economy has been increasing since Brexit and the election of President Trump in 2016, and in 2017 as the United States left the Trans-Pacific Partnership and announced many threats to impose trade restrictions. This uncertainty has heightened since January 2018 when US President Donald Trump made good on his threats to remedy bilateral trade deficits — what he sees as ‘unfair trade’ practices against the United States — by imposing tariffs on imported solar panels and washing machines, followed by aluminium and steel.

Since March, the greatest uncertainty has been from the brewing tit for tat trade conflict between the United States and China, which started with the imposition of 25 per cent tariffs on US$50 billion worth of China’s exports to the United States. China retaliated with the same sized tariffs on the same amount of trade from the United States. Trump then escalated the trade war further in September with the announcement of 10 per cent tariffs on US$200 billion worth of China’s exports to the United States.

The US–China trade conflict and the uncertainty surrounding it is expected to have knock on effects on global trade and investment flows. The impact of the reduction in China’s exports to the United States on China’s growth will reduce China’s imports, which in turn will impact the many countries that China has become a major trading partner for.

This means that China and other countries facing US trade restrictions will look for new markets for their goods. The situation has already led some countries to impose restrictions or initiate trade remedy investigations, for instance on steel. This uncertainty has and will continue to influence trade and investment, as businesses evaluate how the increased restrictions will affect their supply chains.

It is too early to tell how large the disruption will be, as it is not easy to dismantle supply chains. But the costs down the line could be great as businesses re-evaluate their trade and investment decisions to insulate themselves from tariffs rather than to maximise their competitiveness.

The most concerning aspect of all this is that, after 75 years of being its greatest advocate, the United States is now the biggest threat to the future of the rules-based trading system that has provided predictability and fairness in the way the world engages in trade. There is no clear light at the end of the tunnel.

The key question is: what is Trump’s intention? Is it to change the rules of the game to benefit the United States and address China’s ‘non-market-oriented policies’ or is it just anti-trade and America First? Assuming it is the former, there are at least three important responses needed.

First is safeguarding the stability of the World Trade Organization (WTO) as the overarching framework to provide predictability, fairness and stability. To this end, it is vital that the WTO dispute settlement mechanism continues to operate. The test case is the Chinese and EU case against US steel and aluminium tariffs and getting past the blocking of panel judge nominations by the United States.

Ensuring that the United States does not use blunt unilateral instruments to address its concerns also means that reforms to the WTO rule book are needed. More must be done to address concerns around intellectual property rights, investment, the environment, labour, competition policy, subsidies, tax, digital data and the treatment of developing countries.

Second, the process of opening-up must continue, with or without the United States. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership is a good start. And it is of the utmost importance that the Regional Comprehensive Economic Partnership negotiations are concluded in November this year. These are all important processes to signal the continued commitment of East Asia to expanding markets and fostering flows of trade and investment.

Third, and what most will agree is the most important process, is unilateral reforms. Given increased global uncertainty and limited policy space for fiscal stimulus, structural reforms are a must for East Asian countries, especially China. These range from trade and investment reforms, as well as reforms related to competition policy, intellectual property, the role of state-owned enterprises and sustainability. As in the past, unilateral reforms are more successfully undertaken when there is peer pressure and benchmarking from international commitments.

Without concerted effort and a coalition of willing leadership, including from the EU and East Asia, the future of the rules-based trading system will remain under threat.

Dr. Mari Pangestu is former Indonesian trade minister and Professor at the University of Indonesia.

This article appeared in the most recent edition of East Asia Forum Quarterly, ‘Asian crisis, ready or not’.

What Lehman Brothers’ Failure Means Today


What Lehman Brothers’ Failure Means Today

by Harold James

https://www.project-syndicate.org/commentary/lehman-brothers-ten-year-anniversary-by-harold-james-2018-09

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The standard story about the September 2008 collapse of Lehman Brothers is that it led to a deeper understanding of the risks of financial complexity and free-wheeling capitalism. In fact, the ensuing crises in the US, Europe, and elsewhere were more a product of broader changes in twenty-first-century politics and society.

 

PRINCETON – So far this year, the world has marked the 50th anniversary of the Prague Spring (and its suppression), the centennial of the end of World War I, and the bicentennial of Karl Marx’s birth. Against that backdrop, should one really care about the tenth anniversary of the collapse of Lehman Brothers?  

Yes, we should. Lehman may not have been a particularly large bank, and it probably was not even insolvent when it failed. Nonetheless, it nearly took down the global financial system and triggered the Great Recession. Lehman was transformative because it fundamentally altered people’s understanding of the world around them.

After September 15, 2008, the fear of “another Lehman” and a deeper financial catastrophe put the United States on the path toward wide-ranging reform. And Lehman was constantly invoked during the European financial crisis that erupted after 2010, highlighting fears of a “death spiral” stemming from state bankruptcies and defaults. Since then, the scare story seems to have lost its effectiveness. In the US, banking reforms are now being undone; and in the European Union, government debt-to-GDP ratios are well above where they were in 2008.

Still, for policymakers and opinion-shapers, the 2008 financial crisis produced three new grand narratives. First, after Lehman, the American economist Charles Kindleberger’s 1978 masterful book Manias, Panics, and Crashes met with a newfound popularity. Kindleberger had drawn explicitly from the American economist Hyman Minsky’s work on financial cycles, and his arguments were read as a warning against “market fundamentalism.”

The second narrative was that Lehman’s failure had made the Wall Street crash of 1929 and the Great Depression newly relevant. Policymakers drew lessons from the interwar years, and successfully avoided a full repeat of that period. During the Great Depression, especially in Germany and the US, the prevailing attitude was that of then-US Secretary of the Treasury Andrew Mellon: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” By contrast, the response during the Great Recession was to use public debt to replace insecure private debt – an intervention that would prove sustainable only as long as interest rates remained low.

The third narrative held that Lehman’s collapse augured the end of American capitalism. This butterfly-effect story was popular in every country that was tired of being bossed around by the US. As Germany’s then-finance minister, Peer Steinbrück, explained in September 2008: “The US will lose its status as the superpower of the global financial system, not abruptly but it will erode.”

At first, the 2008 crisis was widely regarded as a quintessentially American disaster, owing to the country’s mix of testosterone-driven finance and penchant for promoting home ownership even for those who cannot afford it. Only gradually was it recognized as a truly transatlantic affair. As the economists Hyun Song Shin and Tamim Bayoumi subsequently show, badly regulated, oversized European banks played a key role in the build-up of risk throughout the financial system.

Neither of the first two popular narratives is really correct. The crisis was not a market failure, but rather the product of opaque, dysfunctional non-market institutions that had become perversely intertwined. It exposed the problem of complexity – not of markets as such.

Specifically, the reason that Lehman was such a problem was that it was not really a single corporation. It comprised some 7,000 separate entities in over 40 countries, all of which would need to go through a complex and costly valuation and bankruptcy process. This opacity, which was hardly unique to the US, created the sense that the world was close to another Great Depression when it really wasn’t.

The crisis was the product of escalating short-termism in financial markets. While banks wanted to offload securitized products before they became toxic, other market participants were looking to win on short-term bets, paying little mind to the longer-term viability of the investment. In this sense, volatility was desirable, as it created new opportunities for gain.

After Lehman collapsed, the twin narratives about “market failure” and “another Great Depression” had a massive effect on public perceptions, and fueled the third narrative, which actually happens to be true. America’s financial and political preeminence has in fact waned.

The global primacy of the US was based on economic and political power, but it also depended on something more fundamental: trust in America’s capacity to deliver on its promises over the long term. The crisis undermined that trust, even though US economic and political power remained only slightly diminished. The deeper contagion was intellectual, not financial.

Financial behavior does not occur in a vacuum. The same kind of short-term, hyperactive mindset that felled Lehman was also taking root in the rest of society at the time. Tellingly, the iPhone was introduced in June 2007, just as early signs of the impending crisis were coming into view.

With the smartphone came all kinds of new possibilities. It added dynamism to inchoate social-media platforms like Facebook and Twitter. And it provided the basis for Tinder and other apps which have transformed the social life of millions, pushing dating further in the direction of short-termism and away from longer-term commitment.

The new digital devices and platforms encouraged hyper-individualism. But they also affected political outlooks and behavior, by making it easier than ever to reinforce one’s own views while avoiding alternative opinions. One result, little wonder, is the online culture of demonization, abuse, harassment, and manipulation we see today.

Much of today’s political volatility is a consequence of these new ways of thinking and communicating. Technology and finance adopted the same ethos: destroy continuity and glorify disruption.

Lehman Brothers’ collapse revealed a flaw not just in finance, but in twenty-first-century politics and society. The irony is that, rather than forestalling an era of technologically driven short-termism, the subsequent crisis seems to have accelerated it.

 

NY Times Book Review: Looking Back@Crash of 2008


August 11, 2018

CRASHED

By Dr. Fareed Zakaria

How a Decade of Financial Crises Changed the World
By Adam Tooze
706 pp. Viking. $35.

Steve Bannon can date the start of the Trump “revolution.” When I interviewed him for CNN in May, in Rome, he explained that the origins of Trump’s victory could be found 10 years ago, in the financial crisis of 2008.

“The implosion of those world capital markets has never really been sorted out,” he told me. “The fuse that was lit then that eventually brought the Trump revolution is the same thing that’s happened here in Italy.” (Italy had just held elections in which populist forces had won 50 percent of the vote.)

Adam Tooze would likely agree. An economic historian at Columbia University, he has written a detailed account of the financial shocks and their aftereffects, which, his subtitle asserts, “changed the world.”

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If journalism is the first rough draft of history, Tooze’s book is the second draft. A distinguished scholar with a deep grasp of financial markets, Tooze knows that it is a challenge to gain perspective on events when they have not yet played out. He points out that a 10-year-old history of the crash of 1929 would have been written in 1939, when most of its consequences were ongoing and unresolved. But still he has persisted and produced an intelligent explanation of the mechanisms that produced the crisis and the response to it. We continue to live with the consequences of both today.

CreditTyler Comrie; Photograph courtesy of GSO/Getty Images

As is often the case with financial crashes, markets and experts alike turned out to have been focused on the wrong things, blind to the true problem that was metastasizing. By 2007, many were warning about a dangerous fragility in the system. But they worried about America’s gargantuan government deficits and debt — which had exploded as a result of the Bush administration’s tax cuts and increased spending after 9/11. It was an understandable focus. The previous decade had been littered with collapses when a country borrowed too much and its creditors finally lost faith in it — from Mexico in 1994 to Thailand, Malaysia and South Korea in 1997 to Russia in 1998. In particular, many fretted about the identity of America’s chief foreign creditor — the government of China.

Yet it was not a Chinese sell-off of American debt that triggered the crash, but rather, as Tooze writes, a problem “fully native to Western capitalism — a meltdown on Wall Street driven by toxic securitized subprime mortgages.”Tooze calls it a problem in “Western capitalism” intentionally. It was not just an American problem. When it began, many saw it as such and dumped the blame on Washington.

In September 2008, as Wall Street burned, the German Finance Minister Peer Steinbruck explained that the collapse was centered in the United States because of America’s “simplistic” and “dangerous” laissez-faire approach. Italy’s finance minister assured the world that its banking system was stable because “it did not speak English.”

 

In fact this was nonsense. One of the great strengths of Tooze’s book is to demonstrate the deeply intertwined nature of the European and American financial systems. In 2006, European banks generated a third of America’s riskiest privately issued mortgage-backed securities. By 2007, two-thirds of commercial paper issued was sponsored by a European financial entity.

The enormous expansion of the global financial system had largely been a trans-Atlantic project, with European banks jumping in as eagerly and greedily to find new sources of profit as American banks. European regulators were as blind to the mounting problems as their American counterparts, which led to problems on a similar scale. “Between 2001 and 2006,” Tooze writes, “Greece, Finland, Sweden, Belgium, Denmark, the U.K., France, Ireland and Spain all experienced real estate booms more severe than those that energized the United States.”

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Credit Sonny Figueroa/The New York Times

 

But while the crisis may have been caused in both America and Europe, it was solved largely by Washington. Partly, this reflected the post-Cold War financial system, in which the dollar had become the hyper-dominant global currency and, as a result, the Federal Reserve had truly become the world’s central bank. But Tooze also convincingly shows that the European Central Bank mismanaged things from the start.

The Fed acted aggressively and also in highly ingenious ways, becoming a guarantor of last resort to the battered balance sheets of American but also European banks. About half the liquidity support the Fed provided during the crisis went to European banks, Tooze observes.

Before the rescue and even in its early stages, the global economy was falling into a bottomless abyss. In the first months after the panic on Wall Street, world trade and industrial production fell at least as fast as they did during the first months of the Great Depression. Global capital flows declined by a staggering 90 percent. The Federal Reserve, with some assistance from other central banks, arrested this decline. The Obama fiscal stimulus also helped to break the fall.

 

Tooze points out that almost all serious analyses of the stimulus conclude that it played a significant positive role. In fact, most experts believe it ended much too soon. He also points out that large parts of the so-called Obama stimulus were the result of automatic government spending, like unemployment insurance, that would have happened no matter who was president. And finally, he notes that China, with its own gigantic stimulus, created an oasis of growth in an otherwise stagnant global economy.

The rescue worked better than almost anyone imagined. It is worth recalling that none of the dangers confidently prophesied by legions of critics took place. There was no run on the dollar or American treasuries, no hyperinflation, no double-dip recession, no China crash.

American banks stabilized and in fact prospered, households began saving again, growth returned slowly but surely. The governing elite did not anticipate the crisis — as few elites have over hundreds of years of capitalism. But once it happened, many of them — particularly in America — acted quickly and intelligently, and as a result another Great Depression was averted. The system worked, as Daniel Drezner notes in his own book of that title.

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A trader on the floor of the New York Stock Exchange in February 2009. CreditJames Estrin/The New York Times

 

But therein lies the unique feature of the crash of 2008. Unlike that of 1929, it was not followed by a Great Depression. It was not so much the crisis as the rescue and its economic, political and social consequences that mattered most. On the left, the entire episode discredited the market-friendly policies of Tony Blair, Bill Clinton and Gerhard Schroeder, disheartening the center-left and emboldening those who want more government intervention in the economy in all kinds of ways. On the right, it became a rallying cry against bailouts and the Fed, buoying an imaginary free-market alternative to government intervention.

Unlike in the 1930s, when the libertarian strategy was tried and only deepened the Depression, in the last 10 years it has been possible for the right to argue against the bailouts, secure in the knowledge that their proposed policies will never actually be implemented.

Bannon is right. The crash brought together many forces that were around anyway — stagnant wages, widening inequality, anger about immigration and, above all, a deep distrust of elites and government — and supercharged them. The result has been a wave of nationalism, protectionism and populism in the West today. A confirmation of this can be found in the one major Western country that did not have a financial crisis and has little populism in its wake — Canada.

The facts remain: No government handled the crisis better than that of the United States, which acted in a surprisingly bipartisan fashion in late 2008 and almost seamlessly coordinated policy between the outgoing Bush and incoming Obama administrations. And yet, the backlash to the bailouts has produced the most consequential result in the United States.

Tooze notes in his concluding chapter that experts are considering the new vulnerabilities of a global economy with many new participants, especially the behemoth in Beijing. But instead of a challenge from an emerging China that began its rise outside the economic and political system, we are confronting a quite different problem — an erratic, unpredictable United States led by a president who seems inclined to redo or even scrap the basic architecture of the system that America has painstakingly built since 1945.

How will the world handle this unexpected development? What will be its outcome? This is the current crisis that we will live through and that historians will soon analyze.

Dr. Fareed Zakaria is a CNN anchor, a Washington Post columnist and the author of “The Post American World.”

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A version of this article appears in print on , on Page 1 of the Sunday Book Review with the headline: The Aftershocks.

Global Economy Vulnerable a Decade After


August 1, 2018

Global Economy Vulnerable a Decade After

Ten years ago, deteriorating confidence in the value of US sub-prime mortgages threatened a liquidity crisis. The US Federal Reserve injected considerable capital into the market, but could not prevent the 2008-2009 global financial crisis (GFC).

The 2008 meltdown exposed the extent of finance-led international economic integration, with countries more vulnerable to financial contagion and related policy ‘spillovers’ exacerbating real economic volatility. It also revealed some vulnerabilities of the post-Second World War (WW2) US-centred international financial ‘architecture’ – the Bretton Woods system – modified after its breakdown in the early 1970s.

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Robert Triffin, the leading international monetary economist of his generation, had long expressed concerns about the use of a national currency as the major reserve currency. International liquidity provision using the greenback required the US to run balance-of-payments deficits, ensuring US monetary policy spillovers to the world economy while eroding confidence in the greenback.

The Bretton Woods system was under increasing strain from the late 1960s, as US President Johnson funded the increasingly unpopular Vietnam War by issuing debt, rather than through higher taxes. The system finally broke down when the Nixon administration unilaterally cancelled the US commitment to dollar (gold) convertibility in August 1971.

What emerged was a ‘non-system’ for Triffin. Since then, the US dollar, issued by fiat, has relied on the greenback’s own credibility and legitimacy to continue as de facto world currency.

Current ‘non-system’

In 1985, Triffin identified three systemic problems of the international financial ‘non-system’. First, “its fantastic inflationary proclivities, leading to world reserve increases eight times as large over a brief span of fifteen years” since the breakdown of the Bretton Woods system.

Second, “skewed investment pattern of world reserves, making the poorer and less capitalized countries of the Third World the main reserve lenders, and the richer and more capitalized industrial countries the main reserve borrowers of the system”.

Third, “crisis-prone propensities reflected in the amplitude” and frequency of financial crises such as the 1980s’ debt crisis causing developing countries’ ‘lost decades’. Other critics have identified further flaws.

First is the ‘recessionary bias’, due to the asymmetric burden of adjustment to payments imbalances. While deficit countries are under great pressure to adjust, especially when financing dries out during crises, surplus countries do not face corresponding pressures to correct their own imbalances.

Second is the cost of the perceived need of emerging and developing countries to ‘self-insure’ against the strong boom-bust cycles of global finance by building up large foreign exchange reserves and fiscal resources, especially after the 1997-1998 Asian financial crisis.

Such precautionary measures enabled emerging market economies to undertake strong counter-cyclical measures during the GFC. But they have huge opportunity costs as such reserves are generally held as presumably safe, liquid, low-yielding assets, such as US Treasury bonds.

Hence, Triffin complained that “the richest, most developed, and most heavily capitalized country in the world should not import, but export, capital, in order to increase productive investment in poorer, less developed, and less capitalized countries… [The] international monetary system is at the root of this absurdity.”

Reform appeals

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There were renewed calls for reform of global economic governance in the wake of the GFC, especially by the 2009 UN Conference on the World Financial and Economic Crisis and Its Impact on Development.

Governance reform of the IMF and World Bank should ensure fairer, more equitable representation of developing countries. This should improve the accountability and credibility of the Bretton Woods institutions, enabling them to better address current financial and economic challenges in the world.

The UN also called for a “multilateral legal framework for sovereign debt restructuring”. Without a fair, legally binding, multilateral sovereign debt work-out mechanism, developing countries remain vulnerable to private creditors, including vulture funds.

There were renewed hopes for trade multilateralism and early successful completion of the Doha Development Round of the World Trade Organisation (WTO), giving developing countries better access to external markets, seen as vital for balanced global recovery and development. The promise to keep international trade open echoed G20 leaders’ unfulfilled commitment to eschew protectionism.

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However, only a few of the modest promised reforms have been implemented, with limited changes in international financial governance, still dominated by G7 economies. After all, every financial crisis is followed by appeals for reforms, with complacency setting in with hints of recovery.

Less coping capability

Most developed country governments are now more heavily indebted than in 2008, when they bailed out large financial institutions, but failed to sustainably revive the world economy. Major monetary authorities do not have much policy space left after long pursuing unconventional expansionary policies.

Meanwhile, developing countries have been subject to increasing international integration, e.g., through global value chains, foreign financial institutional investments and increased short-term capital flows induced by the unconventional monetary policies of the US Fed, ECB and Bank of Japan, while debt-sustainability concerns for some are growing again.

These vulnerabilities have been compounded by growing trade protectionism, and dwindling precautionary reserve holdings of many developing economies as global trade has slowed. Even before President Trump’s election, developed countries had effectively killed the Doha Development Round, not least by opting for bilateral and plurilateral, instead of multilateral free trade deals.

Trump’s more explicit rejection of multilateralism in his efforts to eliminate major US bilateral trade deficits are now expected to further set back prospects for world economic recovery. Despite pious declarations to the contrary, most national policymakers typically turn from rhetoric about international cooperation to focus on domestic issues.

It has not been different this last time. A decade after the worst economic downturn since the 1930s’ Great Depression, the world economy remains vulnerable.

Anis Chowdhury, Adjunct Professor at Western Sydney University (Australia), held senior United Nations positions in New York and Bangkok.

Jomo Kwame Sundaram, a former economics professor, was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought in 2007.