Causes: Too Much Debt

Menzie Chinn, one of my favorite bloggers, and Jeffry Frieden have a short and highly readable article up on the causes of the financial crisis. Chinn is not given to ideological ranting and is a great believer in actually looking at data, so I place significant weight in what he says.

Chinn and Frieden place the emphasis on excessive American borrowing, by both the public and private sectors.

This disaster is, in our view, merely the most recent example of a “capital flow cycle,” in which foreign capital floods a country, stimulates an economic boom, encourages financial leveraging and risk taking, and eventually culminates in a crash.

They have little patience for the idea that the financial crisis was the fault of Chinese over-saving:

It is necessary to dispense with the view that all this excess saving from the rest of the world was “forced” upon us. The rest of the world’s capital flowed to us, in part, because we wanted to borrow, and we wanted to borrow because of the Bush administration’s emphasis from 2001 to 2008 on cutting taxes while still spending.

They do endorse as exacerbating factors the low interest rates set by the Federal Reserve earlier this decade, and the growth of a large and unregulated financial sector:

Essentially, the development of an unregulated financial sector has circumvented the entire panoply of banking regulation created in the wake of the Great Depression. This made the financial system vulnerable to traditional “bank panics,” or “runs” on the financial system. The abdication of regulatory oversight (particularly in allowing high leverage) in the presence of too many institutions “too large to fail” meant the buildup of implicit financial liability on the part of the government.

But the overall story is that high borrowing brought in foreign capital; insofar as the borrowing was spent on nontradable goods, such as housing and financial services, necessarily pushing up prices (there is no way for competition from houses in China to keep U.S. housing prices down).

I think it’s hard to argue against the idea that a huge debt-financed bubble was a bad, bad thing. I still think, as you might predict, that the nature of our particular financial system both made the bubble larger than it might otherwise have been, and made its collapse more spectacular than it had to be.

The article is drawn from a book they are working on, which I will be sure to buy.

By James Kwak

74 thoughts on “Causes: Too Much Debt

  1. What are your thoughts on Chinese savings, exchange rate and policy (or at least erstwhile policy) to invest in financial assets?

  2. It’s hard to disagree with the views expressed by the authors but real question is what do we do to avoid another episode of “Who could have seen this coming?”

    It is clear from the very cool reception to Adair Turner’s suggestions regarding a disincentive structure to be put in place to cure a bloated financial services culture, that the financial elite will try their utmost to maintain the status quo.

    Turner’s calls are quite gutsy for an “establishment” figure and should be given more attention than they appear to be getting from folks on the other side of the pond

  3. What I find astounding is that so much of what is happening is being repeated from past experiences. The lesson of the 30’s depression was reduction of personal debt and personal responsibility. Greenspan was a Ayn Rand Ideolog, but Bernanke was supposidly a student of the depression. He was a member of the Fed during the period where the repeal of Glass Seigle had its impact and did not see the incredible risk and fraud taken by the Financial Industry. The gaggle of Economists at the Fed did not do something about the Fraud that was going on through out the system.

    So – looking to the Fed and Bernanke for a solution might be a mistake

  4. Evidence-based economics?

    I dunno, sounds inconvenient, and possibly hard.

    Isn’t there a nice ideology or school out there which will explain why we are all in fact rich without having to get our hands dirty working?

  5. I have little patience for the idea that the financial crisis was not at least in part caused by a global glut of saving. You have $70 trillion of global capital looking for low risk, high-return investments. That demand for low-risk, high-return investment is not the same as the demand for borrowing by consumers looking for mortgages, or even the government looking for people to buy government bonds. The whole reason why MBS blew up so much was partly because there was all this money chasing returns higher than could be bought from the U.S. Treasury.

    And why was the consumer borrowing so much for housing? Stagnant wages lead to an increase in borrowing, aided and abetted by all these foreign funds, to be a substitute for wage gains. That’s why people took out home equity loans and used them as ATMs, it’s why people borrowed so much on credit cards, and why our current savings rate, while something that might have been good 9 years ago, is something that is making our economic problems worse.

    It’s not enough to say the Fed kept monetary policy too loose, or to “dispense with the view that all this excess
    saving from the rest of the world was ‘forced’ upon us.” The economic forces of supply and demand are as inexorable as gravity, and all the more maddening. It is a failure of perspective to deny the demand for higher return investment products ‘forced’ U.S. financiers to become more inventive – just as it is a failure of perspective to deny that American consumers demanded to borrow money out of the equity of their house, so as to keep up their standard of living.

    And it is certainly not good enough to just say that the U.S. cannot rely upon the consumer as the driver of growth. It is that same failure of perspective that does not see that without the consumer as a driver of growth, we are lost. The goal of the administration, of Congress, and all who want the U.S. to get back on the right economic track is to ensure that people are working, that jobs are created, and that people at the bottom rung of the ladder have money to spend. Recovery will only come when those at the bottom are lifted. Otherwise we will have a future of stagnation, low-to-zero growth, and high unemployment. None of that is acceptable.

    We have two choices – we can add additional stimulus funds into the economy to jumpstart the economy, or we can continue to wallow in the Great Recession’s hell. It seems very much like Chinn and Frieden would rather rule in hell than serve in heaven. At the very least, it seems like they believe we must stay in hell. I believe there is a better option.

  6. Engineers are expected to know how big sewer pipes need to be; doctors are expected to know the effects of various drugs, architects are supposed to know how to let people exit safely from a building.
    I expect economists who hold government office to know when there are dangers to the economy.


  7. I am glad to see Chinn putting to bed the notion that Chinese savings is somehow to blame for our credit/debt bubble.

    And from the conclusion of this paper–

    More broadly, though, this also means that the United
    States cannot rely upon the driver of growth that has sustained it over the past three decades—namely consumption. But the consequences extend beyond the nation’s border. The world can no longer rely upon the American consumer. Who will take up this role remains to the next big question.

    The Chinese are trying to shove years of consumption into mere months and guess what? They’re blowing bubbles.

    So, yeah, I wonder who is going to take up the “consumption role.” I suspect that no one will.

  8. thanks for getting the discussion back to that it was done by living human beings who had obligations to their fellow human beings

    – I am sure the US has the slogan “Eigentum verpflichtet” (property/money comes with obligations) also on which whole schools of law are chewing constantly in one way or another

    Even though I would bet on there not having been a single villain nor a conspiracy there was a competition of who is better at “after me the flood” some participants being lobotomized by the mantra of the almighty and unerring market others pretending to be. To me it doesn’t make a difference
    – if I have caused an accident through no matter how understandable an oversight I must still pay for the damage.

  9. This is a great article, James. Thanks for bringing attention to it.

    1) I truly hope that economists work hard to point out the utter disaster that happens when a political party builds an entire economic policy apparently funded by tax cuts – i.e. debt. The GOP’s propensity for spending money it does not have is proven without a doubt – their claims to be “fiscally conservative” are without any foundation whatsoever. (Does not mean I want to race into a tax and spend federal government, but I don’t know how we’ll erase the massive debt acquired since Bush took office without raising taxes.)

    2) As the banking CEOs have discussed in the last year, self-regulation is a whopping failure. I hope economists and policy makers come up with a strong regulatory framework that protects the economy without crippling it. (I was very young when the great inflation crippled the economy in the late 1970s – the post-depression financial regulations, since dismantled in the 1990s, were helpless to prevent that.)

    3) From the article: “…The United States cannot rely on upon the driver of growth that has sustained it over the past three decades – namely consumption.”

    With so many predicting a jobless recovery, it’s clear we’re years away from an healthy economy – particularly since the economy that just crashed was fueled primarily by debt. The recent boom was an unsustainable run of leveraged prosperity, one that we most likely will not be able to afford for a good long while in an economy that is supposedly derived primarily from consumer spending (70 percent was the figure I’ve seen bandied about)…. as the authors of the article point out, it’s not clear who’ll replace the consumer as the growth driver going forward.

  10. I think low growth is acceptable – if we restructure the economy so that we experience it as reduced hours worked per worker rather than as higher unemployment, and redistribute the GDP we do have more evenly so that the working and middle classes see some of the benefits of the last 50 or so years of productivity gains. More leisure time and fewer material goods doesn’t exactly describe a hellish nightmare.

    Raising GDP per capita is a great prescription for the Third World. It’s not at all clear that it is a good one for the U.S. Our problems seem to me to lie mainly in the areas of distribution and the rat race putting too much time pressure on individuals’ lifestyles. A GDP uber alles approach is not going to solve those types of problems.

    Meanwhile, if you’re looking for a source of demand to replace the U.S. consumer – what do the Chinese want to do with all those savings? Find something they want to buy and sell it to them.

  11. I’m with Patrick Earnest on this one. If I read them correctly, Chinn and Frieden are arguing that the crisis was primarily the result of the government running too hot of a macro policy during the Bush years. They also talk about the failure of financial regulation, and that part of the argument makes sense to me. But it is the role of debt and most especically of federal governmnet deficits that they place at the center of their explanation.

    This belies the fact the the Bush expansion was slow in coming and, even after it finally got under way, quite mediocre by post-war standards. But if the macro economy was growing at an unsustainably fast rate, then where was the accelerating rate of inflation? In particular, where was the wage/price spiral that one would expect to see under such circumstances? If fiscal and monetary policy had led to an over-stimulated, over-heated economy, then the crisis should have taken a quite different form than it did.

    I think that Chinn and Frieden are on firmer ground when they stress that, during the Bush era expansion, we used foreign borrowing primarily to invest in non-export competing goods, above all housing and financial services. The U.S. trade deficit was already climbing rapidly at the end of the 90s but it continued to do so straight through the prior recession and all during the Bush expansion, from 1.3% of GDP in 1997 to over 5.7% of GDP in 2005 and 2006, at the peak of the housing bubble.

    In short, it was the nature and shape of the Bush expansion, and not its pace, that probably holds the clues to understanding the eventual collapse.

  12. what do the Chinese want to do with all those savings?

    Save it. There are many many situations in life where a person has to have immense savings just to stay alive.

  13. Having dispensed with the straw man of “this savings was forced upon us” they don’t seem to address the significantly different question: Why did the money actually arrive in the hands of US borrowers?

    People in lots of countries (ones not led by Dubya) would like to borrow huge sums of money too, but they can’t. The money does not flow to them.

    Why not Namibia, Mozambique or Lebanon?

  14. Excellent summation of the crisis!

    I cant help but think that behavioral changes in the US have played a large factor. Among the factors I notice are the following.

    US risk is higher due to a “lack of financial morality”. The world for the better part of a century had a trust in US integrity that always meant money invested in the US had a lower risk.

    Rating Agency actions – Many investors feel their actions were fraudulent in nature.

    Examples from Federal Government, Banks, Trading Institutions, Politicians and on down to the individual seem to have less integrity.

    Based on that view I dont think we have to worry about the Capital Flow Cycle favoring us again in the near future. The new additional risks to capital exposed in this crisis will have to be addressed.

    So I conclude by agreeing with the author and saying that in a macro sense markets do allocate capital on a risk adjusted basis. A recovery may take a couple of years.

  15. I can’t seem to follow the meaning of “not given to ideological ranting” and just “looking at data”. Should I take that to mean that a stoic, ascetically-unemotional living system bearing some resemblance to a human can better interpret data than someone with a severe toothache?

    You of all people should appreciate the value of ideological ranting because I read your blog for that essence. I must have been mistaken.

  16. Just because savers are looking for higher returns doesn’t mean you have to give it to them. You state homeowners borrowed money to maintain standard of living; 1) many actually want to borrow to improve their standard, and 2) many were trying to maintain a standard they couldn’t and shouldn’t afford. Don’t just blame Bush and the Republicans; Clinton and his predecessors, Democrats and liberals are just as culpable in finding ways to spend money to ensure re-election. I don’t agree with your two choices; gov’t is doing a lousy job with the Post Office, VA, Social Security, FDIC, etc. Now you think people who have never run a business can turn around the economy willy-nilly?

  17. I can’t seem to follow the meaning of “not given to ideological ranting” and just “looking at data”

    Believe it or not, most of the time you don’t have to have any basis in fact for anything you say.

  18. Finance has clearly failed. And I mean failed in the engineering sense; it exploded.

    As has been mentioned here many times, a functional finance system would convert savings into productive investment at minimal cost. Clearly, the finance sector does not do this.

    It funneled staggering sums of money into unneeded, unproductive suburban residential construction and commercial real estate in the midst of an oil shock.

    Meanwhile, the most prominent technological innovations are the productivity enhancing miracles of Twitter and Facebook? Or the green tech delusion – totally unsupported by data – that we can run the happy motoring utopia on something other than fossil fuels. I sure hope this is all a cruel joke.

    Please, someone, tell me that there are innovators and entrepreneurs who are working on real things of value that will increase productivity and ultimately create jobs, and all they need is functional finance system to get them started… Please? Anyone?

  19. ANYONE could see this coming! There were personal finance magazines with cover stories of people quitting their jobs to make money flipping homes and condos! Stories of how to borrow against home equity to improve your standard of living! You don’t even need to understand economics to see unsustainable stupidity! (Although stupidity does seem to be rampant.) And Congress (both sides of the aisle) were complicit in the idiocy. MAKING banks lend mortgage money to people without the income to maintain the mortgage because “everyone deserves the dream of owning their own home” and Congress will accuse you of discrimination if you don’t! (But do nothing to hold the voters responsible for learning how to earn a sustainable living and being able to afford the home.) WHY do we have to keep re-living the tulip bulb fiasco??? Because there are always politicians seeking easy re-election from head-in-the-sand voters who want it all without any responsibility. Oops, sorry, guess I just segued into the healthcare debate!

  20. Bush and Republicans were idiots, but not the only ones. I remember teaching high school students in the 70’s the result of continued deficit spending -intentionally – by our government, which was then dominated by the Democrats. Both parties are dominated by people whose only concern is re-election and short-term results. Our country was founded by people who thought long-term. Go ahead and point fingers, just make certain you have enough fingers to go around. If you and I ran our personal finances as Congress (NOT the President) has run our country’s finances for decades, we’d be in jail. Wait! Not true! Instead Congress would be offering us Cash for Clunkers, government-run healthcare at an unsustainable low cost that can ONLY result in rationing and stimulus funds that are only going to keep union teachers employed and consultants fat and sassy. (And I’m having a good day! Normally I’m pretty cynical on these subjects!)

  21. Dave W: “You don’t even need to understand economics to see unsustainable stupidity!”

    Hear, hear! :)

  22. Dave W: “Just because savers are looking for higher returns doesn’t mean you have to give it to them.”

    No, but if you are a con man, excuse me, mortgage broker, it’s easy pickings. ;)

  23. Because our government is the one most likely to be able to not only borrow huge sums of money, but to also raise taxes one way or another on a population that actually is doing pretty well overall. And as long as our country is the one that still provides citizens with the proper environment to start and grow their own businesses with the profit system(capitalism) we will continue to have people who can be taxed at higher rates. To me is the bigger question: what happens when the people who can leverage capitalism to create and grow companies move to other countries? Many Asians who came to the U.S. for an education and/or to succeed in life have gone home because the capitalistic opportunities are greater “at home”. When others stop buying U.S. government securities is when we will know we are doomed.

  24. wally: “I expect economists who hold government office to know when there are dangers to the economy.”

    Economics is not as advanced as plumbing. ;)

    To be fair, many, if not most economists believe that water finds its own level, anyway, in the most efficient manner, and hence that it is better to set it make its own gulleys, than to inefficiently channel it into a pipe. If the gulley erodes the hillside, well, that just makes the remaining land more valuable. Besides, they believe, the landowners are aware of that, and will go around breaking any pipes you put in to prevent erosion.

  25. I am not a believer in the global savings glut as the cause of our problems. However, I would make the following comments on yous introduction to the article:

    1. “Chinn is not given to ideological ranting..” While that may be true, as a regular reader of Econbrowser, I would say that to the extent that he has a political bias , it is to the left.

    2. “…is a great believer in actually looking at data,..” Data is often presented as “the truth”, but more frequently it is used to develop a story to sell a particular point of view.

  26. Patrick, if you are also Patrick Earnest, you must be schizo! Your first post made want to take a metaphorical 2×4 along side your head! Now I want to help you run for Congress – no offense! As to this latest post, we are on the same side of the aisle.

  27. anne: “1) I truly hope that economists work hard to point out the utter disaster that happens when a political party builds an entire economic policy apparently funded by tax cuts – i.e. debt. The GOP’s propensity for spending money it does not have is proven without a doubt – their claims to be “fiscally conservative” are without any foundation whatsoever. (Does not mean I want to race into a tax and spend federal government, but I don’t know how we’ll erase the massive debt acquired since Bush took office without raising taxes.)”

    The Republicans are not a tax and spend party, they are a spend and tax party: spend now, tax later. That may not be their belief, but that is how it works out in practice. (OC, they let the Democrats do the taxing. If we had 20 straight years of Republican administrations, they would self-destruct. Bush nearly pulled that off in only 8 years.)

  28. Demand for higher return investment product leads to the creation of those products. The only thing that was hidden was the risk that these higher returns held.

    As for homeowners, your points, even if true, don’t change the fact that the underlying cause of the borrowing was stagnant wages. Without stagnant wages, you don’t have to borrow to improve your standard of living, and you don’t have to borrow to maintain a standard of living.

    I am blaming Bush and the Republicans for their faults – which over the Bush administration set up many of the economic fundamentals which were the cause of the problem. I blame Clinton and his predecessors for allowing such thoughtless deregulation, allowing the financial sector to get to a point where the fox was guarding the henhouse. But I mentioned neither because criticisms of either administration are beside the larger point that we aren’t doing enough now to stimulate the economy.

    I don’t agree with your premise – government isn’t in charge of the Post Office, the VA is one of the best run parts of the government, Social Security is solvent for many many many years to come, and the FDIC has been well run except for the fact that it is too captured by the financial industry.

    What do you think the government is? It’s the biggest business in our country. And as for running a business, the last President ran several, and he wasn’t able to make the economy work for most people. Running an economy is not the same as running as business, and yes, I do think people who have never run a business can turn the economy around.

  29. Excellent points and I concur. My rules: 1) when someone says they are not idealogical, I KNOW they are and are also dishonest, and 2) data can be presented in almost a infinite number of ways and I don’t trust anyone who says they are objective because they are using data. Anyone who has studied even elementary statistics understands this.

  30. Finance may have failed but in its failure modes there were immense opportunities for profit.

    Hi, let me introduce myself, I am Yakkis, the new type of entrepreneur you speak of. In my revolutionary new book “Profiting from the Failure Modes of Finance” I explain how anyone and their uncle can get rich the American way by exploiting the failures of finance. Look for it at fine bookstores everywhere!

  31. my favourite in this category is “Synergien heben” = lifting synergies
    – which is code word for job loss the more the better
    – I’ve always fantasized a boss-meeting where they would out-trump eachother with the numbers they managed to get rid of at the lowest cost via transferring as much of the cost as possible to the public

  32. “Just because savers are looking for higher returns doesn’t mean you have to give it to them.”

    what an uncharitable thought ….

    “gov’t is doing a lousy job with the Post Office, VA, Social Security, FDIC, etc.”

    didn’t most of those services start as private enterprises? If private enterprise is always so superior, how come that so many end up to be managed by government

  33. I’ve read today that at least of the “too big to fail” banks are even bigger. They have 1 in every 10 dollars. I’d love to know what you and Simon think about what the bailout has done to make them bigger and what we do about it now?

    Also, on housing, I’ve read that many houses have had a price drop so that the house is now worth less than the replacement cost. Any thoughts on what to do about that situation?

  34. who is “anyone”
    – is it my 88 year old neighbour and his wife he having made a living as a carpenter and she as a cleaner – they may have been able to have kept up with the changing world if the changes would have come at an acceptable speed, the way it is now there only protection against getting robbed is to say stubbornly no, no, no to everything
    I am 67, I have been a paralegal most of my life and so should be able to keep up with it all. But to date I can’t figure out what are the altogether monthly/yearly costs if I would get me one of those nice phones where you have net-access everywhere.

    Normally I read the conditions till about the third “except” but by then I am so furious at the sheer audacity with which they shroud their offer in opaquenesses that I throw the pamphlet in the waste-basket where it rightfully belongs
    and I could go on with examples like that without end

    so again who is “anyone” amongst the poor gullibles who should have known better

  35. For every department that the government is doing a lousy job running (Post Office, VA, Social Security) there are others that run remarkably well (NIH, DoD, NASA) that routinely do things that the rest of the world thinks is impossible. The fact is you just can’t tell whether a government run program will work until you see how many Congressmen get their sticky hands on it.

  36. Benjamin Franklin basically gave his (highly profitable) postal service to the government. :)

  37. I keep hearing the argument that Congress was at fault for sticking a gun to the financial sector and forcing them to make loans to all comers regardless of credit risks. However, I have never seen a single shred of evidence provided to support this claim. Remember that it was the GOP in control of Congress when the housing bubble began inflating, so lets stop pointing the finger at Barney Frank! He who is without sin can throw the first stone!

  38. After running through the comments,what in the hell do y’all have against economics and economists? Remember that who signs your salary/commissions cheques wants you to NOT understand the reality of the economy. Your CEOs lie to you and just want you to sing from the same music. Your politicians are lying to you and they are NOT economists. Maybe you can find a way to blame Katrina and
    Iraq on economists.There were many economists (eg: Roubini, Shiller, Hudson…) who over period since 1995 seen it coming and no one cared to stop the music and get off. America is going to suffer for long time.

  39. The “Chinese savings” argument is a nice political way of saying the “Chinese currency policy” (and other similar EM currency policies). Anyone who dismisses this as (at least) a partial cause doesn’t understand the dynamics of these exchange rate regimes and the colossal (and unprecedented) flows of money required to maintain them in the past decade

    So yeah, I completely agree that the US financial system was a big screw up here, doing all kinds of stupid and inefficient things with the piles of cash on their hands. But you also need to understand how China’s exchange rate regime (of selling RMB and buying massive amounts of dollars to keep the value of the RMB down) funnelled huge amounts of cash to the US. Without this financing, the lending bubble in the US couldn’t have gone on as long as it did – it would’ve come to and end much sooner (2005?), and thus the demise would’ve been much less traumatic – we wouldn’t be talking about a historical financial crisis here

  40. @ A
    oh so sorry – I’ll try hard never to let it happen again
    – of course the question who exactly is “anyone” should never ever be asked especially not in a clumsy unsophisticated way.
    After all we do not want those anyones doubting our superior powers of knowledge n’est-ce pas?

  41. It’s still less than a 100-200 billion dollars a year in a 13 trillion a year economy.

  42. There was no glut of saving. Rather, there was an orgy of lending by the US banking system enabled by the Fed. The lending went into speculation, because speculation was profitable just as it has been during the past five months despite all the continued hand wringing about jobs. Bank profits depend upon lending. Securitization off loads the debt onto unsophisticated institutions (like Harvard and public employee pension funds). The bubble continues inflating until collateral values are clearly unsustainable (trees don’t grow to the sky) and then there is a panic by all those holding the paper to exit in the nick of time. Nobody is left to buy it, so now the speculative loans are all called, the hedge fund assets for which a market still exists (commodities and equities) are liquidated, asset values crater and a parade of academic and governmental foozlers takes the floor to campaign for rescue on behalf of selected constituencies for which they have been generally working full time all the while. How can the Chinese be SAVING when 98% of them don’t own anything? How can US consumers be expected to save when their wages don’t cover a humane living standard? What we have here is a middle class hollowed out (and sustained temporarily) by usury, and an upper class inflated (and occasionally blown out) by speculation. The political class (Obama, Frank, Conrad, Pelosi, Hatch, Reid, assorted Republicans whose names I cannot recall) live high in good times and bad times, at all times, by keeping noses to the wind and taking money with both hands. and this is called Democracy and worshipped to the point of outright mania in a good approximation to a nonstop Nineteenth Century revival.

    There will be some kind of recovery and it will be temporary and selective and leave a good many people (most of whom will remain silent) desperate and puzzled about what they possibly could have done differently. When are we going to stop listening respectfully to those who merely sound reasonable and intelligent and massage fraudulent statistics while mobilizing sophistry to insist that institutional conditions are basically sound?

  43. It might be interesting if the moderators of this blog found an expert to write about the Canadian economy and banking industry over the past decade. In contrast to the United states, Canada:

    (1) posted ten budget surpluses (in 2009, Canada posted its first budget deficit in a decade)

    (2) is the only G7 country to pay down its debt

    (2) not one Canadian bank has gone bankrupt due to the 2008 global financial meltdown

    (3) all the banks in Canada are reporting healthy profits for the third quarter 2009

    Some questions are: Why is the Canadian experience in the banking industry so different from that in the United States? What lessons, if any, are there for the United States to learn from Canada in how our banking industry is regulated?

  44. add to above:

    (4) Canada is ranked first in the world (of 134 countries) in terms of “soundness of banks” in 2008-2009 by the World Economic Forum

  45. CG is right. And the yen carry trade was an important aspect as well. (Implicit currency policy replaced outright official intervention in 2004, after the zero interest rate allowed the yen carry trade to depress the yen. But it was the belief that the moneatry officals would not allow “disruptive” yen appreciation that enabled the carry trade.) It is simply nonsense to allege that Asian currency manipulations did not contribute to the U.S. housing bubble. If it was all the fault of Bush’s misplaced fiscal stimulus (which I agree was bad), what happened in the U.K., Ireland, Spain, Australia and Iceland?
    Currency manipulation artificially depresses local consumption and encourages local saving. To say this had no effects abroad is just silly. And the amounts are huge – over $3 trillion in foreign reserves in Japan and China together. What is the excuse for such accumulation, beyond a strategy of export-led growth? Taiwan and South Korea together have more than $500 million (and more than the entire EU). Hong Kong and Singapore each have several times more in foreign reserves thant he U.S.
    In summary, Bernanke had much better insight in this issue than Menzie.

  46. “I have little patience for the idea that the financial crisis was not at least in part caused by a global glut of saving.”

    Is the “global glut of saving” nothing more than wealth/income inequality on a global scale???

  47. Causes:

    1) cheap labor and/or productivity
    2) cheap debt (low interest rates)
    3) wealth/income inequality
    4) a price inflationary attitude from the 1970’s when the fed was really fighting price deflation because of their cheap labor policies (outsourcing, legal immigration, illegal immigration)
    5) bad assumptions about future wage income and/or future asset price gains

    Any more?

  48. Interesting! I have noticed in my neck of the woods (I live within 200 miles of the Canadian border) two new Canadian companies making strong advances in the local market: Tim Horton’s and Irving fuel. South Park was right all along! Blame Canada! LOL.

    Seriously, I hope they’re getting it closer to right, and I’m happy to give them my business. Canada in its current state seems far more down to earth than our economic insanity.

  49. Not just Tim Hortons and Irving Oil. Consider this:

    (1) Canadian banks have started trade missions to China. Which banking system would those famous Chinese savers prefer? Canadian versus American / Swiss / German / British?

    (2) Canadian banks are bringing their American divisions (which are in the red) in line with Canadian regulation.

    (3) Canadian banks have the cash reserves to buy American banks. (A case of foreign take over perhaps?)

  50. Harvard’s endowment investment management team was anything but “unsophisticated”. I think most fund managers would drool to have their returns (averaged over the last 30 years).

  51. Didn’t western europe take the same hit we did? At least Britain, weren’t they run thru the same pressure cooker? and i guess my real question is were they subject to the same influx of foreign capital? or maybe their capital system is subject to different pressures? I am sorry if these questions are wrong or ignorant, i am not a policy wonk and have been reading above my head for some time on all this and am having a hard time connecting the same dots.

  52. I agree here…

    “It is necessary to dispense with the view that all this excess saving from the rest of the world was “forced” upon us.”

    One can blame the “character” of the US consumer, and surely this is part of the story. But the US relied heavily on the theory that markets were self-correcting (and they are, in the long run and in the absence of distortions). While relying on the self-correcting nature of the markets to fix problems that develop over the course of 30 years is always dangerous, it’s particularly foolish when the markets (in this case, the currency market) is being deliberately distorted by a regime with Mercantilist policy goals.

    Jeffrey Frieden has contributed extensively to the literature on “varieties of capitalism” and the adaptation of national economies to policy regimes. He should be highly sensitive to the issues surrounding Chinese currency policy. And frankly, Chinese currency policy was only this problematic because of the complete faith our own economists put in a neo-liberal trade framework (aka, if someone is giving you a massive trade subsidy, including subsidized credit, don’t respond with tariffs, but say thank you!).

  53. StatsGuy: “But the US relied heavily on the theory that markets were self-correcting (and they are, in the long run and in the absence of distortions).”

    Really? Some markets, such as those in time-limited derivatives, are. Others, such as those in theater tickets, do not seem to be. In general, are markets not chaotic? Does the existence of supply and demand curves not indicate that there is nothing to converge (correct) to?

  54. The idea that markets are self-correcting, whether in the long term – in which we are all dead – or the short term (how long is this, btw?) presumes that markets aren’t rigged or regulated. That is, if markets are not rigged and markets are not regulated, then, markets are self-correcting. Or, to state the equivalent, if markets are not self-correcting, then, they’re rigged or if markets are not self-correcting, then they’re regulated. In fact, all markets are rigged or regulated. Therefore,…

    Despite the availability of capital at low cost, if the participants in the markets had made sound investment and lending decisions, the regulators had monitored behavior effectively and enforced the rules, cheap capital wouldn’t have resulted in this outcome.

    I agree with Chinn and Frieden on all counts reported here. I also agree with the reported emphasis on regulatory failure, fed policy and Bush administration tax and spend policy. Democrates are often labeled “tax and spend” Democrats. To be fair, why not label Republicans “borrow and spend” Republicans?

  55. Charles: “The idea that markets are self-correcting, whether in the long term – in which we are all dead – or the short term (how long is this, btw?) presumes that markets aren’t rigged or regulated. That is, if markets are not rigged and markets are not regulated, then, markets are self-correcting.”

    Really? In the short term, perhaps we can hold supply and demand constant, but surely not in the long term. In the long term, does “self-correcting” mean anything?

  56. “…and we wanted to borrow because of the Bush administration’s emphasis from 2001 to 2008 on cutting taxes while still spending.”

    Of course the government has to plan and approve fiscal spending. Bernanke’s Asian Spending Glut Hypothesis is not arguing that Chinese saving forced our Legislative/Executive branch to spend more than the tax revenues. What Bernanke was essentially saying was that there was obviously as much or more demand for our debt than supply because interest rates decreased. The word “forced” refers to the argument that if China kept saving the money they could have been paying their manufacturing employees than America’s unemployment would have increased because Chinese could be more price competitive than the US.

    Thus, in reality, China “forced” America to decide between two choices that COULD have unhappy endings: higher unemployment or more debt. Chinn and Frieden seem to suggest that if America didn’t have this huge fiscal debt, other economic indicators would look similar to what they have looked like since 1997. But of course every dollar that we don’t borrow has consequences just like every dollar we do borrow has consequences.

  57. does “self-correcting” mean anything?

    if markets were completely left to their own devices wouldn’t pirates and brigands take over the rigging and regulating? (but maybe that’s exactly what has happened in finances)

  58. You don’t need an expert to answer that one. Canada seems to be able to continually elect relatively responsible governmental officials. There are just too many right wing nut jobs here in America who prefers a system of government in which the well to do and well connected are allowed to continually rape and pillage the system. After nearly 40 uninterrupted years we got what we deserved!

  59. the causes of the financial breakdown are very simply put:

    1) too much easy money from banks, leading to:

    2) not enough bank lending, leading to:

    3) small businesses closing for lack of operating resources, leading to:

    4) a general and permanent shrink in the global economy.

  60. NO, most of them did NOT start out as private enterprises. VA was begun by the government. FDIC was begun by the government. Social Security was begun by the government; but unlike what the government requires insurers to do the government has done a lousy job of creating and protecting reserves to cover their obligations.

    What is uncharitable about not giving higher interest rates just because savers are looking for them? If you cannot sustain higher rates you cannot in good conscious offer them. Or do you honestly believe if I am looking for a 20% CD interest rate that someone should be “charitable” enough to offer it to me?

    I did NOT say private enterprise is “always so superior”, YOU did. At least private enterprise has competition to encourage innovation and cost-effectiveness. The role of government is to ensure the market stays that way. If the government becomes an active player they will always play unfairly because they do not care about making a profit due to their alternative subsidy called “tax the public”. Private enterprise cannot do that.

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