Many people, including Simon and me, have discussed the similarities between our recent financial crisis and the emerging market crises of the 1990s, so I’ll be brief. The main similarities are excessive optimism that creates an asset price bubble, a sudden collapse of confidence that causes the rapid withdrawal of money and credit, a liquidity crunch, and rapid de-leveraging that threatens solvency. (We have also argued that there are political similarities, but let’s leave that aside for now.) The biggest difference is that instead of being compounded by flight from the affected country’s currency and government debt, in our case the exact opposite happened; investors fled toward the U.S. dollar and Treasuries, making things easier for us than for, say, Thailand. Also, to a partial extent, the parallel requires an analogy between emerging market countries and United States banks; for example, the issue of bailouts and moral hazard arises in the context of the IMF bailing out Indonesia and in the context of the United States government bailing out Citigroup.

Summers’s speech makes a lot of sense, so I’ll just highlight a few points he makes that I think are particularly instructive given our recent experience. I think these are all excellent points. For each one, I’ll quote from Summers, and then comment on its relevance to our situation.

1. Financial crises result from fundamental problems that should be fixed.

“It seems difficult to point to any emerging-market economy that experienced a financial crisis but did not have significant fundamental weaknesses that called into question the sustainability of its policies.”

“Bank runs or their international analogues are not driven by sunspots: their likelihood is driven and determined by the extent of fundamental weaknesses. … Preventing crises is heavily an issue of avoiding situations where the bank-run psychology takes hold, and that will depend heavily on strengthening core institutions and other fundamentals.”

In other words, you can’t blame a crisis entirely on investor psychology; there is something rotten. The panic of September-March was not, as some argued, simply a liquidity crisis; the premise of the liquidity crisis theory is that the fundamentals are sound (institutions are solvent), and Summers doesn’t believe that.

2. The strength of domestic financial systems and institutions matters more than aggregates such as the amount of debt.

“When well-capitalized and supervised banks, effective corporate governance and bankruptcy codes, and credible means of contract enforcement, along with other elements of a strong financial system, are present, significant amounts of debt will be sustainable. In their absence, even very small amounts of debt can be problematic.”**

The fact that U.S. consumers and banks had a lot of debt isn’t itself a cause of anything; if our financial system were effectively governed, debt alone would not have brought it down as spectacularly as it did.

3. Short-term funding is dangerous because it can be difficult to roll over in a crisis.

“Policy biases toward short-term capital need to be avoided.”

“A measure of sound management of short-term flows is implicit in any prudential regulation of banks.”

The U.S. failed on this count. A large portion of the shadow banking system – SIVs and SPVs raising short-term funds and investing them in long-term assets – was entirely dependent on short-term capital. It also turned out that most of the large corporate sector was dependent on commercial paper, which is also short-term. When short-term funding vanished in September, everyone was stuck.

4. Transparency matters.

“If one were writing a history of the American capital market, I think one would conclude that the single most important innovation shaping that market was the idea of generally accepted accounting principles. The transparency implicit in the generally accepted accounting principles (GAAP) promotes efficient market responses to change, and it supports stability. Furthermore, if as Ken Galbraith has observed, conscience is the fear that someone may be watching, it may be the single most effective means of promoting self-regulation.”

I think Summers is right on a historical scale – standard accounting conventions promote transparency. But looking only at the last two decades, I thnk that GAAP did not keep up with the realities of financial innovation, for example in accounting for SIVs. For the beneficial effect cited by Summers to hold – accounting standardization promotes effective self-regulation – the accounting has to accurately reflect the true risk being taken by institutions. If not, the causal chain breaks down.

5. Expectations of bailouts are bad.

“While conditioned, precautionary financial support is constructive in some cases, the risk inherent in systematic availability of unconditional credit to countries can be summarized in two words: moral hazard.”

“It is certain that a healthy financial system cannot be built on the expectation of bailouts.”

Enough said.

6. Rapid intervention in unhealthy institutions is critical.

“Prompt action needs to be taken to maintain financial stability, by moving quickly to support healthy institutions and by intervening in unhealthy institutions. The loss of confidence in the financial system and episodes of bank panics were not caused by early and necessary interventions in insolvent institutions. Rather, these problems were exacerbated by (a) a delay in intervening to address the problem of mounting nonperforming loans; (b) implicit bailout guarantees that led to an attempt to “gamble for redemption”; (c) a system of implicit, rather than explicit and incentive-compatible, deposit guarantees at a time when there was not a credible amount of fiscal resources available to back such guarantees; and (d) political distortions and interferences in the way interventions were carried out.”

Again leaving aside (d), I think our government was guilty of (a), (b), and maybe (c) in the recent crisis. It’s not clear that (a) has yet been satisfactorily addressed (even PPIP seems to be evaporating), especially when it comes to commercial real estate, and we clearly have (b). As for (c), we did move to explicit deposit guarantees, but we still have implicit guarantees on other bank funding (bonds); and though the government probably has a credible amount of fiscal resources, there is still the question of whether Congress or the Fed will come up with the money in a pinch.

So again, I think the Summers of 2000 was basically spot-on. However, I think the Obama Administration – of which Summers, of course, is a central figure – is doing a spotty job of implementing his lessons. Most notably, we have increased the expectation of bailouts by supporting unhealthy institutions, increasing moral hazard; and we have left the problem of toxic assets largely untouched, hoping that economic recovery will make it go away. I think this has been due largely to political realities, not to any failing of Larry Summers to understand his own thinking; the United States government has a lot more power negotiating with itself than an emerging market country has negotiating with the IMF.

The big current question is whether financial regulatory reform will fix the underlying problems that, according to the Summers, are the root of financial crises. For example, according to Summers (2000), we want a regime that discourages dependence on short-term funding, we want more transparency, and we want something that reduces rather than increases expectations of bailouts. Whether we get that – or whether the administration prefers to let regulatory reform fade away in the wake of the health care war – is the remaining test.

* The offiical online home of that paper doesn’t allow free downloads, so I don’t think I should post my copy, although other people may have.

** Citing a paper by Simon, Peter, Alastar Breach, and Eric Friedman!!

By James Kwak

Saturday evening, Nicholas Brady, Secretary of the Treasury from the end of the Reagan administration through the entire Bush I administration, gave a speech at the Institute of International Finance – comparing the current crisis in the United States to an emerging market crisis, only in that case the banks were in the U.S. and the bad assets were in the emerging markets.

There are uncanny parallels between the situation we find ourselves in today and the one the Bush administration confronted a generation ago. . . . First of all there was a serious LDC [Least Developed Country] debt crisis. It’s easy to forget that in 1988 our banking system was in dire straits because the commercial banks held billions of dollars of loans in countries whose economic prospects had ground to a halt.

The solution, according to Brady, was identifying the fundamental problems and forcing all parties to recognize them.

Among the indisputable points we laid out were that new money commitments had dried up in the past 12 months and that many banks were negotiating private sales of LDC paper at steep discounts while maintaining their claim on the countries that the loans were still worth 100 cents on the dollar. There were more, and they were equally sobering. We used these irrefutable facts as a starting point in all subsequent meetings. Our rule was that no suggestions were permitted to be discussed if they didn’t accept the Truth Serum. They were off the table. Goodbye. Don’t waste time. . . . [W]e persuaded the international commercial banks—at first with great difficulty—to write down the stated value of the loans on their books to something close to market value in exchange for that lesser amount of host-country bonds backed by U.S. zero-coupon Treasuries.

Although Brady does not subscribe to the capture thesis that we outline in the Atlantic article, and is generally gentler on bankers than we are, his assessment of the financial industry is similar.

In broad strokes I would say that when I came to Wall Street in 1954, it was a profession, one that financed the building of this country’s industrial capacity and infrastructure. Year by year, however, the industry’s emphasis has moved away from that purpose and toward financial innovation for financial profit’s sake. . . . [T]he U.S. Department of Commerce figures show that from 1980 to 1982, the financial sector accounted for an average of 9.1 percent of U.S. total corporate profits. By 2005 to 2007 that three-year average had more than tripled, to 28.6 percent. . . .

First we should just come out and say it: the financial system that led us to the brink of disaster is broken.

And despite spending his career on Wall Street, and doing a stint as Treasury Secretary, he ultimately argues that banking should be more boring than it is today.

I believe that we need a simpler system centered on deposit-based banks. Under this approach, individual accounts in the depository banks would continue to be protected up to $250,000 and these banks would have access to the country’s central bank. These institutions would not be allowed to participate in markets involving inordinate leverage or equity transactions that would risk their deposit-protecting charter. In contrast to the current mode, when asked what their primary purpose is, the banks’ chief executives wouldn’t talk first about shareholder return. Instead they would stand up and say: “Our institution’s primary purpose is to repay the depositors’ money.” . . .

The highly innovative shadow banking system with its mantra of lower transaction costs, which would continue to introduce new concepts, would fund itself from the money markets and other sources but without federal guarantees and access to America’s central bank. Institutions that currently straddle the two funding markets would have to choose which type of business to pursue.

This reinforces a theme that Simon has been sounding recently: the divide is not between left and right, but between people who want to preserve the current financial system in its basic outlines (a little more regulation, a little more disclosure, exchanges for derivatives, etc.) and people who think it must be dramatically reshaped.

By James Kwak

At the exact same time that we were writing that article, Desmond Lachman – who worked at the IMF for 24 years, and then worked on emerging markets for Salomon Smith Barney for another seven years – was writing an article for the Washington Post saying many of the same things.* Here are the first three paragraphs:

Back in the spring of 1998, when Boris Yeltsin was still at Russia’s helm, I led a group of global investors to Moscow to find out firsthand where the Russian economy was headed. My long career with the International Monetary Fund and on Wall Street had taken me to “emerging markets” throughout Asia, Eastern Europe and Latin America, and I thought I’d seen it all. Yet I still recall the shock I felt at a meeting in Russia’s dingy Ministry of Finance, where I finally realized how a handful of young oligarchs were bringing Russia’s economy to ruin in the pursuit of their own selfish interests, despite the supposed brilliance of Anatoly Chubais, Russia’s economic czar at the time.

At the time, I could not imagine that anything remotely similar could happen in the United States. Indeed, I shared the American conceit that most emerging-market nations had poorly developed institutions and would do well to emulate Washington and Wall Street. These days, though, I’m hardly so confident. Many economists and analysts are worrying that the United States might go the way of Japan, which suffered a “lost decade” after its own real estate market fell apart in the early 1990s. But I’m more concerned that the United States is coming to resemble Argentina, Russia and other so-called emerging markets, both in what led us to the crisis, and in how we’re trying to fix it.

Over the past year, I’ve been getting Russia flashbacks as I witness the AIG debacle as well as the collapse of Bear Sterns and a host of other financial institutions. Much like the oligarchs did in Russia, a small group of traders and executives at onetime venerable institutions have brought the U.S. and global financial systems to their knees with their reckless risk-taking — with other people’s money — for their personal gain.

And here’s the conclusion:

In the twilight of my career, when I am hopefully wiser than before, I have come to regret how the IMF and the U.S. Treasury all too often lectured leaders in emerging markets on how to “get their house in order” — without the slightest thought that the United States might fare no better when facing a major economic crisis. Now, I fear time is running out for our own policymakers to mend their ways and offer real leadership to extricate the United States from its worst economic calamity since the 1930s. If we insist on improvising and not facing our real problems, we might soon lose our status as a country to be emulated and join the ranks of those nations we have patronized for so long.

Enjoy.

* For the record, the Atlantic article was finalized on March 17 and went up on the web on March 26; judging from the URL, it looks like Lachman’s article went up on March 25.

People in finance started making more money,* jobs in finance became more desirable, financial institutions became more influential, and the linkages between the financial sector and the political establishment became stronger. At the same time that our financial sector became more leveraged and more risky, it also became more powerful. The result was a confluence of interests between Wall Street and Washington – one more normally found behind the scenes of emerging market crises, the kind the IMF is called on to resolve.

Simon and I tell this story – and the story of what happened next – in “The Quiet Coup,” an article in the May issue of The Atlantic. (Many thanks to The Atlantic for putting the online copy up as early as they did.) The working title of the article was, “What the IMF Would Tell the United States, If It Could.” Enjoy.

* The data in that chart are from Table 6.6 of the National Income and Product Accounts tables available from the Bureau of Economic Analysis.

Update: Henry Seggerman recently sent us an article he wrote in 2007, comparing the Korean crisis of 2007 to the then-current situation in the United States. He discusses not only the economic similarities, but also some of the political ones.

Update 2: A reader sent us an article about Mark Patterson, formerly Goldman’s chief lobbyist and now Tim Geithner’s chief of staff. Unfortunately, the article was published too late for us to use any of it in our Atlantic article.

By James Kwak

According to the forecast – which factors in only actual policies in place; no assumed miracles allowed – this is not much of a global crisis, particularly for emerging markets (e.g., emerging market growth dips to 3.3% for 2009 and then pops back up to 5% for 2010 in the annual average data; China’s growth will accelerate from now through end of 2010, etc.)  Given that, among other things, the IMF is the point organization for emerging market troubles, the message seems to be a soothing one.

But the IMF also communicates with both its lending to countries in difficulties, and with statements on and around this lending.  Here the news is in striking contrast to the forecast. 

The Fund has plenty of money (or access to the same) – it can currently lend up to $250bn, and has currently disbursed just under $50bn.  Most observers have interpreted this as indicating the IMF does not need additional resources.  But now the IMF begs to differ.  John Lipsky, First Deputy Managing Director (the #2 in the hierachy and #1 carrying a US passport), said at Davos that the Fund would like to double its resources, to $500bn.  Of course, he stressed that this is only as a contingency measure – but do not be misled by this terminology.  The world economy is in serious trouble, this has first order implications for emerging markets, and there will in all likelihood be crises throughout the developing world and perhaps also among some richer countries (think Iceland, but bigger).  The IMF wants you to know this.

The IMF also wants you to know that its major shareholders, including the US, Japan, and large European countries, are in broad agreement with this more negative view.  The Fund would not be floating publicly a scheme for raising this amount of money if it did not already have the richest countries on board, at least in terms of broadly supporting the need for more funding.  The writing on the eurozone wall probably helped – if the IMF is called upon in Western Europe, it needs to have a considerable amount of cash in hand.

The good news is that with the IMF taking matters so seriously, raising $250bn should not be difficult – in fact, Japan has already pledged $100bn.  And the IMF could well move to issue its own bonds – in addition to providing a new source of funding, this would bring the Fund closer to financial markets in ways that will help make the organization more effective.

My reaction is in line with that of Montek Ahluwalia – former senior IMF and World Bank official and now a top economic policymaker in India.  At Davos, he called the plan to raise $250bn, “very modest”.  Other phrases, such as “too small” or ”at least a start” also spring to mind.  In the fall, I predicted that the IMF would need at least $1 trillion in resources to get us through this global crisis.  If anything, I now think that estimate was too low.

I was taking a tour of the world’s news today and came across the following (courtesy of the FT):

• Japanese exports fell 27% year-over-year in November, the largest fall ever; remember, exports were a major reason Japan finally emerged from its decade-long slump a few years ago.
• Thai exports fell 19% year-over-year in November, the first decline since 2002 – and exports make up 70% of GDP. The numbers may have been artificially reduced by political conflict in late November, but political conflict is hardly a good thing in itself.
• China is looking less and less like the big winner of the global recession and more and more like a significant loser. 10 million migrant workers have lost their jobs by the end of November. In response, “the State Council, China’s highest governing body, issued a decree to local governments over the weekend ordering them to create jobs for migrant workers who had returned to their home towns.” Prime Minister Wen Jiabao went as far as saying that a government priority is to “make sure all graduates have somewhere constructive to direct their energy” – somewhere other than social protest, that is.

One of the challenges of an export-driven economy is that when your consumers (Americans and Europeans) stop buying, you have few direct tools to get them buying again. There has been speculation that China could take the opportunity to stimulate domestic consumption and shift its economy away from reliance on exports, but that clearly can’t happen fast enough. Another trick exporters can use is to devalue their currencies, but that will crimp domestic purchasing power and potentially lead to a round of competitive devaluations, with wealthy countries printing money in an effort to stave off deflation and thereby devaluing their own currencies. In the meantime, everyone will be watching the Obama stimulus plan carefully.

The title of the book refers broadly to the recurrence of a need to deal with Depression-style economic threats, a theme that originally (in the 1999 edition) referred to the emerging markets crisis of 1997-98 and and the stagnation in Japan caused by the collapse of their housing bubble at the beginning of the 1990s. More particularly, however, it refers to the problems brought on by a collapse in economic demand – “insufficient private spending to make use of the available productive capacity,” as Krugman puts it. And it seems clear that that’s where we are today. The Case-Shiller index of housing prices reached its peak in real terms sometime in 2006, but the economy continued to grow until the end of 2007, even as housing prices fell significantly. Although the negative wealth effect of falling housing must have had some effect, people still wanted to spend. When the severe phase of the crisis began in September 2008, it was widely described as a credit crunch, meaning that reductions in the supply of credit were making it difficult for borrowers to get the money they needed, either for investment or consumption. Today, however, as Simon has said before, falling demand for credit may be just as big a problem. People just don’t want to borrow money any more, and if that’s the case, then increasing the supply of credit (by funneling cash into banks) will have only a limited effect, as we’ve seen. This is what Krugman finds most worrying about the current situation: the “loss of policy traction,” in which even dramatic moves by the Fed have only a limited impact ont he real economy.

He doesn’t quite come out and say it in so many words, but a lot of Krugman’s story has to do with what might be called psychology. He describes how economic crises may be the product of poor governmental policies and weak economic fundamentals – or they may be entirely the product of panics that have the very real effect of destroying wealth and setting countries back for years. Seen from this perspective, the scale of the current crisis may not have any proportional relationship to the fundamental flaws of our economy (or the global economy). It may simply reflect the fact that the scale, liquidity, and leverage of the global financial system have made it possible for panics to have much greater damage than they did in the past. (I know we’re still not dealing with anything on the scale of the Great Depression, but while the financial system was simpler then, it also had a simpler flaw – the lack of deposit insurance – and a simpler mistake – the failure to expand monetary policy in response to the downturn.)

The fact that you are reading this blog probably means that you would not learn a lot about the current crisis from Krugman’s book (especially if you’ve already read his article in The New York Review of Books), but you might learn something about the crisis of the 1990s, and the dynamics of currency crises. In 1997-98, multiple unrelated emerging market countries suffered panics and currency crises, and the response of “Washington” (the U.S. and the IMF) was to demand fiscal austerity – higher interest rates, lower government spending, higher taxes – in exchange for bailout loans. Now, of course, when large parts of wealthy country economies need to be bailed out, few people are calling for austerity; in the U.S., liberals and (most) conservatives differ only on whether the deficit should be increased through government spending or through tax cuts. Ten years ago, perhaps the austerity argument was defensible: in order for countries to gain credibility (and be able to pay back their loans), they needed to improve their government balance sheets. And at the time, the U.S. could be confident that reduced purchasing power in Thailand, South Korea, and Russia would have little effect on our economy. Today, however, the entire world is facing a steep downturn, and an economic stimulus will be most effective if it is roughly coordinated across countries, including emerging markets. So far the IMF appears to be using a gentler hand than last time, although so far most countries are attempting to steer clear unless absolutely necessary. The fact is that preventing an economic collapse in emerging markets will be an important of our recovery this time, both because of the importance of foreign trade and because of the amount of cross-border investment (think about the massive inflows into international stock funds in the past ten years).

In any case, it’s a quick read, and for those who are nervous about Krugman’s politics they make only a very brief entry near the end.

The general fear was that U.S. indebtedness would lead China to diversify away from U.S. assets, causing the dollar to fall and U.S. interest rates to rise, hurting the U.S. economy and making it harder to finance the national debt. This may yet happen someday. But instead of demand for Treasuries collapsing, it’s been demand for every other type of asset that has fallen. Treasury yields have collapsed and the dollar has appreciated about 20%. Still, despite this increased purchasing power, the fall in U.S. (and global) consumption is having a severe impact on growth of the Chinese economy. Even though the Chinese government has signaled that it will do everything in its power to keep growth above 8% per year (down from 11-12% in the past few years), the slowdown has severely constrained the ability of the urban manufacturing sector to absorb internal migration from the countryside, and there are signs of a reverse migration that is aggravating the problem of rural poverty in China. Although China may seem to have all the cards – high economic growth, large foreign currency reserves – it could yet turn out to be a major loser of the global economic crisis.

This is of course just a brief introduction. For more I recommend Brad Setser, among others: some of his posts are here, here, and here.

• In Ukraine, industrial production in October fell by 7.6% from September (that’s not an annualized rate) and 19.8% from October 2007.
• Russia’s second-largest coal company reported that its Q4 sales would be only one-third the planned level – and that payments from its steelmaker customers since September were only 21% of the value of shipments.
• Credit default swap spreads on Greek sovereign debt are up over 160 bp – higher than at the previous peak in mid-October. (Note that Greece is in both the EU and the Eurozone.)

On the “plus” side, Pakistan and the IMF agreed on a $7.6 billion loan, ensuring economic stability in a particularly important part of the world – at least for a few months. Pakistan’s government says they need a total of $10-15 billion.

(Thanks to Free Exchange for catching this.)

In Argentina, we’ve already seen the government nationalize the private pension system in what many believe to be a naked grab for cash with only a distant relationship to the rule of law.

In Russia, a central government with a war chest of over $500 billion in foreign currency reserves (at least when the crisis started) now has the power to determine which of the billionaire oligarchs will survive and which will be bankrupted. Yesterday the government provided $2 billion (WSJ, subscription required) to the Alfa Group, Mikhail Fridman’s conglomerate, to avoid save him from giving up his 44% stake in a cellular carrier to Deutsche Bank. On Friday, another billionaire will have to come up with $4.5 billion to avoid giving up 25% of the metals company OAO Norilsk Nickel to Western banks including Merrill Lynch and Royal Bank of Scotland, and will likely turn to the government.

Arguably the government’s power in this situation is analogous to the powers the US has granted to the Treasury Department to choose winners in the financial sector. Still, given the other things we know about Russian politics, it is not too far-fetched to see government money used to protect Vladimir Putin’s political allies, impoverish his opponents or nationalize their assets, and keep Russian assets out of Western hands. (Whether the government will have enough money for the job is another question.)

Another likely reaction of governments faced by financial and economic crisis is a return to (or, in many cases, an increase in) protectionism. Richard Baldwin describes how the current state of global trade agreements makes this not only possible but likely, further hurting the global economy.

Finally, there’s (still) Zimbabwe, forgotten by the world, where power-sharing talks are still going nowhere.

That aside, it seems more and more likely that we are witnessing a repeat of 1997-98, just on a grander scale. Credit default swaps on Russian sovereign debt are trading at over 1,000 basis points, which essentially means that investors think the country is more likely to default than not – this just months after the high price of oil seemed to make Russia a dominant regional economic power, and just weeks after Russia was negotiating to lend money to Iceland (as of a couple days ago, it was still possible that Russia would participate in the IMF bailout of Iceland). Argentina, as Simon pointed out earlier, has the honor of being the first country to expropriate private property under the cover of the financial crisis. The Economist published a chart showing CDS spreads on sovereign debt across Eastern Europe showing that Ukraine, the Baltics, Hungary, Romania, and Bulgaria are all at risk. (Many of those spreads are already much higher than in the chart: Ukraine at 2617 bp, Russia at 1038, Turkey at 775, the Baltics between 650 and 1000.) Hungary in particular is showing eerie echoes of 1997-98, as the government takes emergency steps, including increasing interests rates by three full percentage points, to combat speculators betting that the currency will fall – a battle that few countries were able to win a decade ago.

I won’t go into more details; you can read the news yourself. Perhaps the starkest sign of the emerging markets crisis is what Bjorn Malmquist, an Icelandic reporter, said to Planet Money: “Everybody is wondering when the IMF is going to come and help us” – this after widespread speculation that the IMF had become just one among many sources of money in times of crisis.

For those wondering what is going on: The basic dynamic is that nervous lenders are refusing to roll over loans to countries seen at risk of default (or companies in those countries), which can become self-fulfilling. Even where governments built up foreign currency reserves to prevent precisely this problem, like in Russia, they have been undermined by private sectors that gorged themselves on foreign debt. It’s similar to the crisis of confidence that hit banks in the wealthy countries, with the added twist of floating currencies. When creditors fear that, say, Hungary will default on its foreign debts, demand for forints dries up, because the only place you can invest forints is in Hungary; when demand dries up, the forint loses value, which means that from the perspective of Hungary, all of those debts get bigger and even harder to pay off. As a side effect, this means that currency speculators can make money by betting on which country will come under pressure next, as happened in serial fashion in 1997-98. Which country comes under attack at a given time can therefore be somewhat arbitrary and not necessarily correlated with the underlying solvency of the banking sector or the government.

As Simon and Peter said in their op-ed, the risk is that the global economy degenerates into financial war, where countries look out for their own economies at the expense of others. Within the developed world, coordination has been pretty good, after a rocky start. However, Brad Setser points to one disturbing thing. In granting unlimited swap lines with central banks in the UK, the Eurozone, Switzerland, and Japan, did the Federal Reserve unwittingly create a split between haves and have-nots in the global economy? As G7 become more attractive places to put your money, emerging markets become relatively less attractive, exacerbating the problem.

Emerging market countries can probably be protected through sufficient application of financial force, in the form of loans from the IMF, the ECB, or other sovereign governments (just like shoveling cash into a bank perceived as risky can make it seem less risky). But the IMF doesn’t have enough money for the scale of the problem, and bailing out emerging markets hasn’t made it to the top of the G7 agenda (understandably). Establishing the mechanisms to combat such crises in the future will need to be one topic for the international summits that will occur during and after this crisis.

One more thought: Americans may ask why we should care, given all of our domestic problems. In my previous post I pointed to the case of Pakistan, where financial crisis may create even more political instability. More broadly, though, I think it’s a certainty that we will be blamed for any economic misery that occurs in the wake of this crisis, since the conventional wisdom is that we exported it to the rest of the world. That’s one more thing our national reputation needs.

Argentina does produce and export a lot of commodities, and these prices are falling, so this creates a potential difficulty for government finances.  Still the government’s proposed response is a stunner: President Cristina Fernandez de Kirchner announced Tuesday that she plans to take over (i.e., nationalize) 10 private pension funds (the Argentine Congress would have to approve this; we’ll know soon how that will go).  The pension funds hold a great deal of government debt, so grabbing them would presumably get the government off the hook for that debt.  But what about people’s pensions?!?

Most importantly, does this indicate that governments around the world feel they can break contracts and expropriate property freely just because all economies have encountered some sort of trouble and many industrialized countries are “recapitalizing” something?  If the global crisis is becoming a smokescreen for confiscation, then our problems just got a lot worse.