The Credit Crunch
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The next discussion will take the recent ‘credit crunch’ as a starting point for thinking about global imbalances and the role of finance in the world economy. These issues are sometimes discussed in very technical terms, but the underlying ideas are fairly straightforward. I want to focus the discussion on principles rather than technicalities.
Global imbalances arise because some regions are producing more than they consume, and others are consuming more than they produce. The producers therefore accumulate surplus money, and the consumers accumulate debt. The net effect is that the producers are lending to the consumers. It is normal and healthy for there to be imbalances in the world economy, but the scale and persistence of imbalances is widely considered to be a major risk to continued global economic growth and stability. It has also been held to be responsible for increased inflation (particularly of asset prices, such as houses and shares), which imposes indirect economic costs. Global imbalances have been prevalent for some time, but the credit crunch that has arisen in the wake of the sub-prime mortgage crisis has put imbalances back in the spotlight.
Most of the time the financial sector acts to balance things out, moving surplus money to where it is needed. But in times of turbulence this is put under strain. Lenders want their money back, and borrows can’t pay. The inability of sub-prime borrowers to pay back their mortgages sparked the recent crisis, but it has spread more widely and may threaten the balance between borrowers and savers globally. If the US cuts its consumption sharply, the result might be a serious global slowdown. Some have held the financial sector responsible for creating these risks.
Key issues and readings
The credit crunch has developed very recently, so there are few accurate, comprehensive and balanced accounts. Wikipedia is a good place to start; it is more comprehensive and accurate than any of the journalistic accounts that I have found. Available at: http://en.wikipedia.org/wiki/2007_Subprime_mortgage_financial_crisis
An overview of imbalances is available here: http://econ-www.mit.edu/files/762
The IMF’s World Economic Outlook is useful background, particularly Chapter 1: http://www.imf.org/external/pubs/ft/weo/2007/02/pdf/text.pdf
This document discusses some of the arguments about the extent to which imbalances matter: http://www.econ.berkeley.edu/~eichengr/matter.pdf
As I alluded to in the last discussion, one view is that imbalances arise not because Americans are voracious consumers, nor even necessarily because the Chinese are consciously trying to promote exports, but rather because there is a savings glut in the emerging markets. It has become the orthodox position in the economic literature.
This recent speech by the Chairman of the US Federal Reserve considers the issue in the context of recent market turmoil: http://www.federalreserve.gov/newsevents/speech/bernanke20070911a.htm It refers back to an earlier speech, available here: http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/
The development between the two is interesting. This article discusses the debate, and the book under review remains influential in the debate:
A final issue to consider is whether the increasing role of finance in the world economy (and especially in the UK economy) is problematic. Popular criticism is widespread (e.g. Naomi Klein’s ‘The Shock Doctrine’, or billionaire investor Warren Buffet’s characterisation of derivatives as ‘financial weapons of mass destruction’). Others argue that financial innovation has supported the growth and stability of the world economy. Alan Greenspan is particularly associated with this view, e.g. in his recent book ‘Age of Turbulence’.
Michael Savage, Head of Credit Policy, FMD Credit Risk, Lloyds TSB Corporate Markets, introduced ‘The Credit Crunch’
Some other accounts of the Credit Crunch:
This is an intelligent ‘catastrophist’ account from a very knowledgeable market participant. It gives a good account of the technical side of the crisis.
An easily accessible guide from the FT.
And the same from the BBC.
This article is more critical of the role of the financial markets in the economy.
Useful speech from the New York Federal Reserve.
Recent European Central Bank paper. Some of this is fairly technical, but there is an accessible summary.
This makes the case that concerns about the US deficit are exaggerated.
Recent article by Martin Wolf in the FT.
C. Fred Bergsten, Peterson Institute
Outline of remarks at the World Economic Forum, Davos