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Thesis & Antithesis

A critical perspective on energy, international politics & current affairs

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Location: Washington, D.C.

greekdefaultwatch@gmail.com Natural gas consultant by day, blogger on the Greek economy by night. Trained as an economist and political scientist. I believe in common sense and in data, and my aim is to offer insight written in language that is clear and convincing.

25 November 2008

From crisis to crisis

Crisis begets crisis. In the 1970s, high oil prices helped create stagflation, and the cure for stagflation – the Fed raising interest rates – sent Latin America into default. Then with widening US current account and budget deficits, the Plaza Accord helped to devalue the dollar, but the near-term result –monetary easing in other countries – created a stock market bubble in Japan, whose burst triggered an economic crisis.

Now is no different. From the Asian financial crisis, developing countries learned it is better to hoard reserves in good times than to beg the IMF in bad ones. And to deal with the prickled dotcom bubble, the Fed let money loose, and while it celebrated the “great moderation” of low inflation, a housing bubble grew, one snubbed by the Fed since asset bubbles, it claimed, were not for the monetarist to deflate.

There were other problems too: high oil prices transferred wealth from those who had it to those that were not sure what to do with it; China thought it easier to lend money to Americans to buy Chinese goods than to help its own people to buy them; there were American wars and tax cuts to finance as savings were low and household debt up; and Wall Street went into a another collective daydream thinking that if you package assets broadly enough and sell them widely enough, risk will go away. What could go wrong?

It is actually a wonder that this crisis took so long to come. For the past four years it has been “imminent.” The US current account has been unsustainable and the dollar has been about to collapse; housing prices have been about to fall all over the OECD; high oil and commodity prices have been about to create inflation; and the “twin engine” global economy running on US and China has been about to “run out of steam” unless aided by sickly Europe and Japan.

Much as Wall Street is to blame, this was an economic crisis before it was a financial crisis. Now it is a political crisis. How a crisis is solved is as important as solving it. The short-term task is to restore confidence in banking, restore demand, and manage the inevitable downward adjustment of housing prices. And there are absurdities to prevent such as writing trillions in bilaterally traded credit default swaps that appear nowhere in balance sheets, or packaging assets and liabilities in a way that no one understands what is the underlying risk or value.

The longer term challenge, however, is to find a way to arrest the crisis beforehand. For years, the world knew it was on an unsustainable economic path. Save a meagre revaluation of the Yuan, little was done to change course. That reveals a great deal about the growing gap between the reality of the global economy and the adequacy of the institutions to manage it. Without those institutions this crisis will soon beget another.