Thursday, September 18, 2008

The Great Rebalancing

Steven Pearlstein has a good article in the Post this morning that presents a big-picture view of the financial crisis. He presents a very stark case - that this crisis is nothing less than the rebalancing of the global imbalances that have persistently defied economic gravity for at least the last two decades.

For years we have been willing recipients of a flood of cheap cash from abroad - mostly East Asia, but elsewhere as well. We didn't get this cash by exporting - we got it by borrowing it. The government borrowed it, corporations borrowed it, and through banks and credit card corporations, families borrowed it from places like Japan, Taiwan, and now China. That flood of money pushed up prices everywhere - price increases in real estate allowed the average American family to live a life of luxury they had never known before. Tuitions sky-rocketed, but record rates of college attendance were still attained because of the availability of student loans. Our government was able to wage indefensible and unconscionable wars because it didn't have to ask the American people for any kind of sacrifice. Why would they bother asking for that kind of sacrifice? The Chinese were more than willing to finance the invasion of sovereign nations!

In other words, for the last two decades bubbles have been percolating throughout America. Bubbles in housing. Bubbles in tech stocks. Bubbles in ALL stocks. Buyers were readily available to get a piece of the pie which seemed to magically keep increasing as East Asia pumped more and more cash into our economy. Then one bubble burst - housing. And another - investment banking. Now with the precarious state of the newly nationalized AIG, banks that American families interact with on a daily basis look more unstable.

Pearlstein uses scary language:

"You know you're in a heap of trouble when the lender of last resort suddenly runs out of money."

"What we are witnessing may be the greatest destruction of financial wealth that the world has ever seen -- paper losses measured in the trillions of dollars." (when he says "paper losses" here it sounds rather trivial... but remember how many jobs were created by those "paper gains").

"But more than psychology is involved here. What is really going on, at the most fundamental level, is that the United States is in the process of being forced by its foreign creditors to begin living within its means. "

I've talked at length about the danger of "global imbalances" in the past. Everybody that's written about them has prayed for a "smooth landing". And who knows - maybe we'll get a relatively smooth landing and this is just a really bad business cycle. Maybe by 2010 or so, foreigners will still want to lend to us... just less than they did before. I hope so.

One thing is for sure - with the events of the last three days, 2008 will enter the history books next to 1981, 1929, and 1873. It will be a doozy people - and unlike '81 and more like '29 and '73, '08 is likely to completely redraw the economic and power map in the United States and the world - we will spend differently, we will have different national priorities, we will interact differently with the rest of the world, and we will look at ourselves differently afterwards.

No comments: