Credit crisis…a symptom, not the cause of global imbalances

What is often considered to be an American-led banking crisis should really be considered just a symptom of global imbalances (and not the cause of them).   Rather than seeing this credit crisis (turned banking crisis, turned global economic crisis) as the result of US financial greed, innovation or stupidity…its more accurate to look at this recent crisis as just one of a string of bubbles that burst as a RESULT of global imbalances in international finance.

The global imbalance that I’m talking about is the role that the US has been forced to assume as the absorber of surpluses from many exporting countries (especially emerging economies of China, east Asian nations, and oil exporters).

Remember, if one country (or a bloc of nations) runs a current account surplus, then some other country by definition, must be running a deficit.  But when countries such as China, Japan, South Korea, Taiwan, etc make it their policy to control their exchange rates vs. the US dollar, and to drive their economies with export-driven growth, then by definition, there must be some other country running a surplus.

The lessons of the 80´s – 90´s taught most emerging nations the dangers of running current account deficits.  They learned mostly through experience the brutal dangers of accepting capital from foreigners (Mexico in 94, SE Asia in 97-98, Russia in 98, Brazil in 99, Argentina 2001-02).   So, as a result of learning these lessons the hard way, almost every emerging economy chose to build up `reserves´ of US dollars, and to run surpluses rather than deficits.


China and others purposely decided to ´smoke but not inhale` from global finance.  They would do everything in their power to recycle the incoming dollars, and send them back outside of the country.  This process of dollar recycling guaranteed that the money earned from exports would be sent back out of the country as US treasury purchases.

The more China exported, the more they were forced to purchase US treasuries to keep their undervalued currency undervalued, so that the machine could continue.  But, the more they exported capital, the more that global finance became flooded with cheap credit and easy money.  This should have fueled inflation, but cheap Chinese products and labor kept a lid consumer products and drove down labor costs around the globe.  In this new world, the central bankers in the US and Europe were able to keep interest  rates at all time lows without running the risk of inflation.

The only problem was the (string of) asset bubbles that followed…

A series of bubbles…

In response to a flood of cheap credit on tap from Asia, China, and oil exporters…we saw a series of bubbles build up in assets starting in the late 1990´s.  First was the internet bubble,then Telecom bubble, then real estate bubble, then commodities bubble…all the while there was a credit-bubble building and building and then finally popped.

Each of these asset bubbles built up as a direct result of cheap credit on tap from countries that were unwilling (or unable) to absorb incoming capital from global finance, and instead chose to force that capital back on the only country willing and able to absorb excess savings abroad: the USA.

The key question now that the credit bubble burst is:  what´s next?  If you assume that the credit bubble was just the result of American´s choosing to spend more than their income (and poor regulation in the USA), then you might be inclined to believe that this would be over once the credit crisis were over.  But, if you believe (like I do), that this credit crisis was just a symptom rather than the root cause of the recent pain…then you would have to wonder like I do: what´s next?

Note: Morgan Stanley highlights the fact that there will likely be another bubble in their recent article A New Global Liquidity Cycle, where they say `It’s time to get ready for the new global liquidity cycle.`

The only way that this series of crises will end is for the underlying imbalances in global finance to be corrected.  In order for this to happen, then countries like China (Japan, S Korea, Taiwan,etc) will need to stop targeting undervalued exchange rates by selling local currency and buying US dollars.  The only way out is for global finance to be restructured in a way that emerging markets would not be afraid of accepting capital from developed economies, and would be willing to run deficits without the fear of punishing deficit and currency crises.

In an ideal world (or one that makes sense), capital would flow from the rich developed nations to the rapidly developing ones (where opportunities to invest that capital was greater).

For now, we live in a strange world in which money flows on a massive scale from the worlds poor developing nations to the developed rich ones.  And, as a result of this perverse capial flow, we will continue witnessing bubbles that will continue bursting until we fix the underlying causes of these problems.

Originally published at Globotrends and reproduced here with the author’s permission.