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Friday, January 18, 2008

Paul Krugman: Don’t Cry for Me, America

How did we end up with problems usually associated with third-world economies?:

Don’t Cry for Me, America, by Paul Krugman, Commentary, NY Times: Mexico. Brazil. Argentina. Mexico, again. Thailand. Indonesia. Argentina, again. And now, the United States.

The story has played itself out time and time again... Global investors, disappointed with the returns they’re getting, search for alternatives. They think they’ve found what they’re looking for in some country or other, and money rushes in.

But eventually it becomes clear that the investment opportunity wasn’t all it seemed to be, and the money rushes out again, with nasty consequences... That’s the story of multiple financial crises in Latin America and Asia. And it’s also the story of the U.S. combined housing and credit bubble. These days, we’re playing the role usually assigned to third-world economies. ...

The global origins of our current mess were ... laid out by ... Ben Bernanke ... in 2005... Mr. Bernanke asked a good question: “Why is the United States, with the world’s largest economy, borrowing heavily on international capital markets — rather than lending, as would seem more natural?”

His answer was that ... third world economies ... were shaken by a series of financial crises beginning in 1997. As a result,... their governments began accumulating huge precautionary hoards of overseas assets.

The result, said Mr. Bernanke, was a “global saving glut”... In the end, most of that money went to the United States. Why? Because, said Mr. Bernanke, of the “depth and sophistication of the country’s financial markets.”

All of this was right, except for one thing: U.S. financial markets ... were ... not, in fact, uniquely well-suited to make use of the world’s surplus funds. It was, instead, a place where large sums could be and were invested very badly. Directly or indirectly, capital flowing into America ... ended up financing a housing-and-credit bubble that has now burst, with painful consequences. ...

[T]hese consequences probably won’t be as bad as the devastating recessions that racked third-world victims.... The saving grace ... is that our foreign debts are in our own currency. This means that we won’t have the kind of financial death spiral Argentina experienced, in which a falling peso caused the country’s debts, which were in dollars, to balloon in value...

But even without those currency effects, the next year or two could be quite unpleasant.

What should have been done differently? Some critics say that the Fed helped inflate the housing bubble with low interest rates. But those rates were low for a good reason: although the last recession officially ended in November 2001, it was another two years before the U.S. economy began delivering convincing job growth, and the Fed was rightly concerned about the possibility of Japanese-style prolonged economic stagnation.

The real sin, both of the Fed and of the Bush administration, was the failure to exercise adult supervision over markets running wild.

It wasn’t just Alan Greenspan’s unwillingness to admit that there was anything more than a bit of “froth” in housing markets, or his refusal to do anything about subprime abuses. The fact is that as America’s financial system has grown ever more complex, it has also outgrown the framework of banking regulations that used to protect us — yet instead of an attempt to update that framework, all we got were paeans to the wonders of free markets.

Right now, Mr. Bernanke is in crisis-management mode, trying to deal with the mess his predecessor left behind. ... I suspect that it’s already too late to prevent a recession.

But let’s hope that when the dust settles a bit, Mr. Bernanke takes the lead in talking about what needs to be done to fix a financial system gone very, very wrong.

    Posted by on Friday, January 18, 2008 at 12:31 AM in Economics, International Finance | Permalink  TrackBack (0)  Comments (96)

          

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