Big, Big Picture Stuff
I want to continue the interesting debate in the comments on spending cuts/electoral strategy and values that is going on with Don Paskini, Charlie and Paul but first a quick diversion into big picture stuff.
In my very first post I tried to outline how I saw the world economic system working on an international level. My basic argument was that two factors led directly to the current crisis: a global savings/spending imbalance and financial innovation. Brad Setser, over at the US Council on Foreign Relations, has a long post up reviewing a new book on this very issue. It really is worth a read for anyone interested in the big, big picture stuff and understanding how we got where we are. Some extracts:
Like Martin Wolf, Brender and Pisani recognize that globalization took an unusual turn over the past several years: the globalization of finance resulted in a world where the poor financed the rich, not one where the rich financed the poor. And what’s more, this “uphill” flow was essentially a government flow. Despite the talk of the triumph of private markets over the state a few years back, the capital flow that defined the world’s true financial architecture over the past several years was the result of the enormous accumulation of foreign exchange reserves in the hands of the central banks of key Asian and oil-exporting economies.
They recognize that the current crisis could not have happened in the absence of an accumulation of credit risk by private financial intermediaries (big banks, broker-dealers and the “vehicles” that operated in the shadows) in the US and Europe. But they also recognize that the accumulation of credit risk by private financial intermediaries would not have been possible if emerging market governments hadn’t been so willing to accumulate exchange rate risk.
Brender and Pisani highlight all the steps in a “global chain of risk taking” that allowed the savings of a Chinese household to be used to finance a US subprime mortgage. But the chain was such that the Chinese household actually never took on all that much risk.
The collapse of private sector intermediation — particularly in the shadow financial system — led to a collapse in lending to households, a collapse in consumer spending, a sharp fall in Asian exports and a global contraction. Rising US household debts no longer support rising Chinese exports (or growing investment in China’s export sector). The system has changed.