Global imbalances and the financial crisis: Link or no link? By Claudio Borio and Piti Disyatat, Bank for International Settlements Working Papers
One explanation for the financial crisis favoured by Western economists, in particular by the US Federal Reserve chief Ben Bernanke, is the theory of the global savings glut. The hypothesis says that emerging nations save more than needed and they park these excess savings in the West, particularly the US, driving down interest rates there and leading to a credit boom, which in time leads to a crash. This theory thus lays the blame on countries like China, with large current account surpluses, as being at least indirectly responsible for the crisis. According to this view of global imbalances, the US had no alternative but to run huge current account deficits to offset the surpluses in countries like China.
This BIS (Bank for International Settlements) paper rubbishes the global savings glut view. The authors point out that the data doesn’t agree with the hypothesis. For starters, it doubts the link between current account balances and long-term interest rates. The US dollar long-term interest rates tended to increase between 2005 and 2007 with no apparent reduction in the US current account deficit. Next, if the US assets were indeed so attractive for emerging market governments, how is it that the US dollar has steadily declined in value over the past decade? Further, while the US current account deficit began its deterioration in the early 1990s, the world savings rate actually trended downwards to the end of 2003. The authors argue that “the stabilization and reductions in the US current account deficits since 2006 have occurred against the backdrop of a continued upward drift in emerging market saving rates”. Also, real world long-term interest rates have trended downwards sincethe early 1990s, irrespective of developments in the global savings rate. And if global savings have been rising, that should have depressed aggregate demand, yet the world economy enjoyed a long boom between 2003 and 2007.
Also read | Manas Chakravarty’s earlier column
The point, say Claudio Borio and Piti Disyatat, is to look at gross capital flows instead of current account deficits and surpluses. Gross flows rose from around 5% of the world gross domestic product in 1998 to over 20% in 2007, with the bulk of them being between advanced economies. What’s more, since 2000, the outstanding stock of banks’ foreign claims grew from $10 trillion to a peak of around $34 trillion by end-2007. In short, the paper says that the focus on global current account imbalances misses the excessive risk-taking by banks and, in particular, the role of European banks in supporting the boom in the US housing credit.
The financial crisis, say the authors, is a crisis of the financial system and it doesn’t help to look at real economy indicators such as current account balances to find its origins. Instead, the paper says the main macroeconomic cause of the financial crisis was not “excess saving”, but the “excess elasticity” of the monetary and financial regimes in place. By excess elasticity, the authors mean that the financial system lacks the tools to prevent credit and asset price booms on the back of excessive risk-taking.
The policy imperative, therefore, is clear: It’s necessary for regulators to curb excessive risk-taking. The Basel III rules for banks are based on that principle. It’s time for the West to take a cold hard look at its brand of financial capitalism instead of pointing fingers elsewhere.
Illustration by Jayachandran/Mint
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