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.