As already noted here, FT economics columnist Martin Wolf has a new book out called Fixing Global Finance. It’s not really about the current crisis, but it is about the giant imbalances in global capital flows that Wolf thinks were the biggest cause of the current crisis. I went to a breakfast with Wolf on Thursday, and he explained with characteristic Wolfian clarity that what set it all off was the Asian financial and economic crisis that began with the collapse of the Thai baht in the summer of 1997.
As local currencies tanked all over Southeast and East Asia, corporations and banks that had borrowed in dollars suddenly stood no chance of repaying their loans. The lesson that these countries–and China, which survived the 1997-98 scare but only just barely–drew from the experience was not just to stop borrowing in dollars but to stop borrowing from the rest of the world, period.
“These were the world’s natural capital recipients,” Wolf said. “Instead, they started to export capital in a big way.” Add that to perennial capital exporters Japan and Germany, and oil-exporting countries that were getting ever flusher as crude prices rose, and you had a vast, sloshing wave of money that ended up flowing to the countries with the most “elastic” banking systems–the U.S., the U.K., Australia, Spain–and financing spectacularly unsustainable house-price booms. (And there are people who want to blame this whole thing on the Community Reinvestment Act?!?)
What needs to happen in the coming years, Wolf says, is for emerging-market nations to become net borrowers again–just not in dollars or euros or any other currency but their own. “We’ve got to have local-currency bond markets where the risks are shifted to investors,” he argues, adding that we also need a much bigger and richer International Monetary Fund that could reassure emerging-market governments that it will help them out when markets turn against them.
Wolf has of course been talking about this stuff for years, and hardly anybody outside the small circle of current-account-imbalance obsessives paid any attention. I know I didn’t. I have a copy of a book called G7 Current Account Imbalances that Menzie Chinn gave me last year sitting on my desk. I haven’t read a page of it. “I got sort of disheartened writing about it,” Wolf says. Now everybody’s paying attention, but “it’s now too late.” (Although not too late to buy his book, I feel compelled to add.)
On a happier note–for the U.S. at least–Wolf says the dollar appears likely to maintain its role as the world’s lead currency, meaning we can shove much of the cost of our financial system semi-collapse onto other countries through devaluation of the dollar. The Asian countries hit by the crisis in 1997 and 1998 spent an average of 35% of GDP recapitalizing their banking systems. In the U.S., he says, the cost is likely to be around 10% of GDP.
Finally, Wolf echoes what a lot of people have been saying lately, although he gives it a more global perspective than one usually hears around these parts: “A long era which began with the elections of Reagan and Thatcher–and, more important–the rise of Deng Xiaoping … is clearly coming to an end.”
Wolf lived in Washington D.C. in the 1970s, and remembers the strong sense both there and in London in those days that “governments just weren’t working.”
We’ve lived through 30 years of that idea, which I to some extent shared, and as with most ideas people eventually took it too far. It led to the idea that there wasn’t anything government could do well except fight wars. … This great pendulum is now going to swing back.