A lost decade for the global economy?
Commentators have been speculating on the effects of the credit crisis in the U.S. on global markets for months but it seems that we are truly on the edge of a catastrophic banking crisis in the U.S. on an order not seen since the stock market crash of the 1930s. The Toronto Stock Exchange has lost 10% of its value since June, the Russian stock market has ceased trading after losing $700 billion worth of value and American regulators are expected to have spent $1000 billion on bail-outs to major banks and investment firms by time everything is said and done.
While we live in an age of unprecedented prosperity we also live in the age of recurrent financial crises. For the most part, the worst effects of financial crises have been contained to the developing world. When it comes to financial crises the worst effects are usually determined by the extent that an economy is plugged into the global economy and whether or not there are “circuit breakers” in place to mitigate the effects of financial crisis contagion when things go bad. Developing countries have usually lacked these “circuit breakers” which explains why they have been hit so hard.
It will be interesting to see how a banking crisis in the U.S. would play out considering that they have been the staunchest advocates against the use of capital controls – one of the most common forms of “circuit breakers” against financial crisis. Developing countries that have resorted to capital controls in times of crises have generally weathered the storm much better than those that haven’t. Capital controls are not generally believed to benefit economic efficiency in the long-run, but can be important tools to stop outflows of capital when investor confidence has been shaken.
There are many important differences between the experience of the U.S. during crises and developing countries. First, the U.S. economy is at the centre of the global financial architecture. A large decrease in the wealth of the U.S. means a decrease in the wealth of much of the rest of the world given the role that American consumption plays for many economies. Furthermore, it has usually been up to the U.S. to intervene in financial crises given their pivotal role in the IMF. Some countries have been hung out to dry during financial crises at the whim of the U.S. while others have received generous bail-out packages from the IMF, largely at the advice and interest of U.S. policymakers.
While regulators are scrambling to head off a collapse of the entire global financial architecture it seems to me that the U.S. may be added to the list of countries that have experienced a “lost decade.” The globalization of finance has led to vast wealth but has also been the source of trillions of dollars in lost GDP growth. Japan suffered a lost decade in the 1990s after the collapse of the property bubble. In essence they lost an entire decade worth of economic growth because of a bubble in the economy. The current financial crises occurring in the U.S. may prove to result in a lost decade for the entire global economy as a result of the collapse of the credit bubble.
While regulators in Washington are gaining control over some of the largest investment firms and banks on Wall Street this may be part of the problem. The current crisis appears to be to be a result of too much intervention where it is not needed and not enough in crucial sectors of finance. America believes in a complete laissez-faire approach to regulating finance but if there is one thing we have learned from the financial crises of the past it is that the economically efficient level of regulation is certainly not zero.
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