Much of the popular, and scholarly, analysis of the crisis has focused
on its financial aspects: the breakdown of financial markets, the malfunction
of financial innovations, the failure of financial regulation. …
… This attention is certainly warranted. The descent into panic that started in 2007 began in the American market for asset-backed securities and their derivatives, and was transmitted throughout the world largely through financial channels.
Yet this approach to the crisis misses its broader and deeper causes. This was,
quite simply, a foreign debt crisis, the result of a classic capital flow cycle. It
demonstrates remarkable similarities with previous instances of capital flow
cycles, and of debt crises, from Latin America in the 1980s and Mexico in 1994 to East Asia in 1997-1998 to other occurrences in Turkey, Russia, Argentina — not to mention Germany in the early 1930s or the United States many times in the nineteenth century.
Between 2001 and 2007 the United States borrowed from abroad between
half a trillion and a trillion dollars every year. The aggregate amounts are hard
to calculate, but probably come close to five trillion dollars and averaged about
five percent of GDP per year – roughly similar to the percentages common in
developing-country borrowing sprees. As capital flowed into the country, the
American economy went down the well-worn path of other massive capital
inflows. Large portions of the borrowed funds were spent on tradable goods,
leading to a burgeoning of the country’s trade deficit, which roughly doubled. The
remainder went to nontradable goods and services, leading to a substantial
increase in their prices. Housing was only the most prominent nontradable
that experienced this effect, but the phenomenon was much broader. Between
2002 and 2007, in fact, durable goods prices declined 13 percent in the United
States, while services prices rose by 25 percent. Whatever may have been
happening with the nominal exchange rate, this was the functional equivalent of a real appreciation, as relative prices shifted in favor of nontradables producers
and against tradables producers.
Foreign borrowing allowed Americans to consume more than they produced,
and to invest more than they saved. It allowed the U.S. government
to spend more than it took in in taxes. It fueled a debt-financed expansion
of consumption – of importables and of nontradables. The expansion became
a boom, the boom became a bubble, and the bubble eventually burst.
These themes are more fully developed in our forthcoming book, Lost Decades: The Making of America’s Debt Crisis and the Long Recovery (W.W. Norton), as well as this published chapter. In the article, Frieden, also notes the intellectual challenges posed by the crisis:
…I am sure that future scholarship will help us understand better the
mix of opaque financial innovations, agency problems in financial institutions, regulatory laxity and capture, and other components of the dynamic that contributed to the depth and breadth of the crisis. But the macroeconomic sources
themselves also suggest some major analytical questions of direct relevance to those interested in political economy — none of which, to my knowledge, have been addressed convincingly by scholars. Herewith a simple catalogue:
1. What explains the division of the world into surplus and deficit countries?
This was not a typical flow of capital from rich to poor nations: much of the
capital flowed from poor to rich nations. Nor is it fully explained by demographic
factors driving different savings rates, for in many instances the surplus savings of
many surplus-saving countries are themselves the result of national policy. The
same puzzles suggest themselves about the major borrowers: why did the United States and the United Kingdom shift so quickly from net creditors to net debtors?
2. What drove the striking macroeconomic and financial developments of the post-1995 period? To what mix of electoral, economic, technological, and special-interest constraints and opportunities were policymakers and financiers responding?
3. What was the relationship between purely financial developments and macroeconomic trends? Did finance drive macroeconomic policy, by enabling easy borrowing (and lending)? Did macroeconomic policies enable financial expansions? Or did some third set of factors drive both macroeconomics and finance?
4. Why was it so difficult for governments of the booming economies to
begin adjustment before the crisis hit? From at least 2003, there was continual
academic and policy discussion of the global imbalances, with a broad consensus
that they were unsustainable and that they would cause serious problems. Yet
virtually no government acted upon these warnings. General enjoyment of the good times is not a particularly convincing explanation, for there is ample evidence that politicians that preside over serious crises pay a major price. And yet a failure to adjust in time during a borrowing boom is the rule, not the exception.
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