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Financial Crises and Economic Crises

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Thursday, 29 August 2013 05:22

Robert Samuelson wrote about the recent downturn in financial markets in several major developing countries in response to the rise in long-term interest rates in the United States. While he notes that this is not likely to lead to a larger crisis given the current circumstances in the developing world, he concludes his piece by telling readers:

"Every major financial crisis of the past 20 years has begun with some relatively minor event whose significance seemed isolated: weakness of the Thai baht in the summer of 1997; trouble in the market for “subprime” U.S. mortgages in 2007; Greece’s misreporting of its budget deficit in 2009. Could this be 'deja vu all over again'?"

It is worth making an important distinction between these crises. The subprime mortgage market was a small part of a much larger story, a serious bubble in the U.S. housing market that was driving the economy. For some bizarre reason, the Fed and most other economists did not recognize this situation even as the bubble was already rapidly deflating. (Many do not understand it even today.) The Greek situation was a story of serious imbalances in the euro zone with the southern countries running massive current account deficits that could not be corrected because of the common currency.

By contrast, the East Asian situation was largely a case of a crisis of confidence that was aggravated into something much bigger through mismanagement by the I.M.F. and folks at Treasury like Larry Summers. The current situation looks much more like the East Asian situation.

There is no inherent problem with capital flowing from rich countries to the more rapidly growing developing countries, that is what the textbooks say is supposed to happen. The real problem will be if the I.M.F.-Summers mistakes of the past are repeated.

 

Comments (7)Add Comment
...
written by JSeydl, August 29, 2013 7:28
There is no inherent problem with capital flowing from rich countries to the more rapidly growing developing countries, that is what the textbooks say is supposed to happen. The real problem will be if the I.M.F.-Summers mistakes of the past are repeated.


The IMF may be irrelevant this time around since these countries have massive amounts of reserves. It could be somewhat problematic, though, if the recent shift in capital flows disrupts the longer-term correction that needs to happen. I have no idea why the Fed would want to send the signal that interest rates in the US should be higher. If the goal is to reduce the current account deficit over the long term, this is not a good policy.
Samuelson Hasn't a Clue, So He Guesses Because Everyone Else Does Too
written by Last Mover, August 29, 2013 7:34
"Every major financial crisis of the past 20 years has begun with some relatively minor event whose significance seemed isolated ...


But that's the whole point of depending on those who understand what's going on versus depending on someone like Samuelson.

For example Dean Baker kept pointing to bellweather factors like housing starts and rental vacancies that were out of synch as the bubble was building, not an obscure isolated event at all. Where was Samuelson then?

Samuelson the scatterbrain wants you to think it's some kind of mystery no more predictable with expertise in macro economics than it is with fortune telling, which keeps columnists like himself in the business of selling guesses as news.
Could this be “deja vu all over again”?
written by Ellen1910, August 29, 2013 10:14
A good title to this entry, because there are differences between financial and economic crises.

Warnings of future financial crises come typically from the relatively sudden recognition of previously unrecognized linkages and previously underestimated leverage ratios. They are precipitated by the errors of the lenders of last resort -- the central banks, international organizations, etc.

For example, the failure of the two Bear Sterns hedge funds in June 2007 was the warning that the soundness of banks might be unknowable, because the financial integrity of the big banks was dependent upon the financial integrity of an unregulated shadow banking system of off-balance-sheet entities whose financial integrity could not be evaluated.

The Fed papered over the coming crisis when it bailed out Bear Sterns in March 2008; it precipitated the crisis when it allowed Lehman to go to the wall.

The question today is how exposed are the banks to problems in the debt of emerging markets. Or to ask the question differently, how much of the "money" the Fed has paid the banks for QE3 assets has been loaned to speculators who have bought emerging market debt.

Do we know? Anymore than we knew the extent and quality of the banks' off-balance-sheet investments in September 2008?
oops dejavu is here
written by pete, August 29, 2013 10:46
own/rent is about where it was in 2002, 6 years into the previous housing bubble, when drs baker and shiller were crying that we were in a housing bubble! Only shiller is calling the alarm now, while the regulators are being pushed to loosen lending standards...that is indeed the James Johnson replay. Shillers PE is way over historic norms in the stock market. Note in 2002, when the very serious folks (baker shiller) said there was a bubble, Krugman was joking (apparently) about the need for a bubble (in the midst of a bubble, not realizing it).
"pete" drags the conversation down
written by Peter K., August 29, 2013 3:47
into the mud. Why? Why must we suffer these people on the Internet?

Why would Krugman want a bubble? People who denied the bubble obviously didn't say they WANTED ONE as Krugman did.
WHat's your problem, troll?
bubblicious
written by Peter K., August 29, 2013 3:52
2002-2006 there was rampant fraud and excessive optimism. Not now. Plus there was Countrywide Financial, etc. They're all gone. Fannie was nationalized.
...
written by Philip F., August 29, 2013 5:45
It seems like maybe the relative collapse of the commercial paper market in early 2007 was the real harbinger of of the Great Recession that went unnoticed by many?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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