Tuesday, February 24, 2009

"The Great Crash, 2008: A Geopolitical Setback for the West"

Source: Roger C. Altman, Foreign Affairs, January/February 2009.

Summary: The financial crisis has called into serious question the credibility of western governments and may precipitate an eastward shift of power.

ROGER C. ALTMAN is Chair and CEO of Evercore Partners. He was U.S. Deputy Treasury Secretary in 1993-94.

This seems an excellent summary of the causes and likely repercussions of the current global economic crisis. I quote:
Conventional wisdom attributes the crisis to the collapse of housing prices and the subprime mortgage market in the United States. This is not correct; these were themselves the consequence of another problem. The crisis' underlying cause was the (invariably lethal) combination of very low interest rates and unprecedented levels of liquidity. The low interest rates reflected the U.S. government's overly accommodating monetary policy after 9/11. (The U.S. Federal Reserve lowered the federal funds rate to nearly one percent in late 2001 and maintained it near that very low level for three years.) The liquidity reflected, among other factors, what Federal Reserve Chair Ben Bernanke has called "the global savings glut": the enormous financial surpluses realized by certain countries, particularly China, Singapore, and the oil-producing states of the Persian Gulf. Until the mid-1990s, most emerging economies ran balance-of-payments deficits as they imported capital to finance their growth. But the Asian financial crisis of 1997-98, among other things, changed this in much of Asia. After that, surpluses grew throughout the region and then were consistently recycled back to the West in the form of portfolio investments.

Facing low yields, this mountain of liquidity naturally sought higher ones. One basic law of finance is that yields on loans are inversely proportional to credit quality: the stronger the borrower, the lower the yield, and vice versa. Huge amounts of capital thus flowed into the subprime mortgage sector and toward weak borrowers of all types in the United States, in Europe, and, to a lesser extent, around the world. For example, the annual volume of U.S. subprime and other securitized mortgages rose from a long-term average of approximately $100 billion to over $600 billion in 2005 and 2006. As with all financial bubbles, the lessons of history, including about long-term default rates on such poor credits, were ignored.
Comment: The article also indicates that the crisis will reduce the confidence in the free market ideology as advocated by Bush 43, and perhaps that advocated by several previous administrations in Anglo-Saxon nations. There have been competing economic ideologies. Those of Chavez in Venezuela, Putin in Rusia, Morales in Bolivia have looked good in times of high energy prices, but may suffer when their energy export income goes down. The economic ideology of the Chinese government may fair better in evolving global public opinion.

I am glad to see Obama discussing ways to cut the deficit in the long run even as he is increasing it in the short run. We need to balance immediate efforts to break the downward cycle, and long run efforts to deal with the underlying problems. JAD

No comments: