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explaining the crisis in financial markets « Previous | |Next »
January 23, 2008

Martin Wolf, in an op-ed in the Financial Times asks the question: "So how did the world economy fall into its predicament?" He gives three answers. The first view is that this crisis is a product of a fundamentally defective financial system. The second view is that US monetary policy was too loose for too long after the collapse of the Wall Street bubble in 2000 and the terrorist outrage of September 11 2001.

The third view, which I ascribe to, is that the crisis:

is the consequence neither of financial fragility nor of mistakes by important central banks. It is the result of global macroeconomic disorder, particularly the massive flows of surplus capital from Asian emerging economies (notably China), oil exporters and a few high-income countries and, in addition, the financial surpluses of the corporate sectors of many countries.In this perspective, central banks and so financial markets were merely reacting to the global economic environment. Surplus savings meant not only low real interest rates, but a need to generate high levels of offsetting demand in capital-importing countries, of which the US was much the most important.

On this account ( the Fed could have avoided pursuing what seem like excessively expansionary monetary policies only if it had been willing to accept a prolonged recession, possibly a slump. But it had neither the desire nor, indeed, the mandate to allow any such thing.

Wolf adds that the Fed’s dilemma then was that the only way to sustain domestic demand at levels high enough to offset the capital inflow (both private and official) was via a credit boom. This generated excessively high asset prices, particularly in housing. It has left, as a painful legacy, stretched balance sheets in both the non-financial and financial sectors: debt deflation.

| Posted by Gary Sauer-Thompson at 8:01 AM | | Comments (2)


have you seen this article in the Sunday New York Times by Peter S Goodman and Louise Story.They say:

For much of the world, the United States is now on sale at discount prices. With credit tight, unemployment growing and worries mounting about a potential recession, American business and government leaders are courting foreign money to keep the economy growing. Foreign investors are buying aggressively, taking advantage of American duress and a weak dollar to snap up what many see as bargains, while making inroads to the world’s largest market.

Foreign entities last year captured stakes in American companies in businesses as diverse as real estate, steel-making, energy and baby food.

yeah the collapse of demand for US asset backed securities (ie., those without an implicit government guarantee) has forced the US to finance its deficit by selling off its companies to foreign investors.