2008 November 13 Thursday
Hank Paulson On Imbalances As Economic Crisis Causes

US Treasury Secretary Hank Paulson discusses some ways to fix the financial system but also addresses imbalances that led to the crisis.

And to adequately reform our system, we must make sure we fully understand the nature of the problem which will not be possible until we are confident it is behind us. Of course, it is already clear that we must address a number of significant issues, such as improving risk management practices, compensation practices, oversight of mortgage origination and the securitization process, credit rating agencies, OTC derivative market infrastructure and regulatory policies, practices and regimes in our respective countries. And we recognize that our financial institutions and our markets are global, but our regulatory regimes are national, so we will examine how best to improve cooperation and information sharing to foster global financial system stability.

Paulson says global imbalances caused the capital market distortions that led to our unfolding financial disaster.

But let us not forget one fundamental issue which lies at the heart of our problems. Over a period of years, persistent and growing global imbalances fueled a dramatic increase in capital flows, low interest rates, excessive risk taking and a global search for return. Those excesses cannot be attributed to any single nation. There is no doubt that low U.S. savings are a significant factor, but the lack of consumption and accumulation of reserves in Asia and oil-exporting countries and structural issues in Europe have also fed the imbalances.

But why did the US savings rate plummet? My take: Low US savings are in large part a result of high Asian savings. The mechanisms that Asian governments used to reduce domestic consumption and to accumulate US debt caused distortions in the US monetary system and economy. The Asians - especially China - effectively kept US consumer prices down by buying US debt and keeping their currencies weak against the US Dollar. The Federal Reserve was therefore able to pursue an overly expansionary monetary policy without the warning flag of consumer price inflation. Instead the excess expansion of the US monetary supply expressed itself in asset price inflation.

Paulson wants to address the global imbalances. But governments of some other nations might continue to resist US efforts to close the US trade deficit.

If we only address particular regulatory issues as critical as they are without addressing the global imbalances that fueled recent excesses, we will have missed an opportunity to dramatically improve the foundation for global markets and economic vitality going forward. The pressure from global imbalances will simply build up again until it finds another outlet.

I expect the pressures from the global imbalances to build up again because so far I hear little from the bulk of our elites that indicate they understand the importance of fixing the causes of the problem. In fact, the priority in Washington DC is to reflate the bubble as quickly as possible. They seek to curtail the short term pain and help people who can't afford the houses to keep those houses. Yet we need prices to fall from their bubble levels.

As long as the housing price-to-rent remains above historical norms and the ratio of housing prices to income remains above historical norms we haven't reached sustainable prices in the real estate market. We should not reflate housing prices when housing prices are clearly distorted by reckless and destructive lending practices.

Share |      By Randall Parker at 2008 November 13 11:14 PM  Economics Credit


Comments
dchamil said at November 14, 2008 5:56 AM:

If we want Americans to save more, we might try paying them higher interest rates to do so. Simple, no?

Randall Parker said at November 14, 2008 7:18 AM:

dchamil,

When the Chinese government buys US bonds it lowers US interest rates and discourages savings. Those lower interest rates helped fuel the real estate boom.

Bobo the clown said at November 14, 2008 8:11 AM:

So, help me understand this.

The Chinese government (their elites) are evil because they helped the American people have an extended good time?

Isn't there a little matter of future time orientation, or lack thereof, here?

Randall Parker said at November 14, 2008 8:33 AM:

Bobo the clown,

Your question is hard to parse. What are you trying to say?

James Bowery said at November 14, 2008 2:17 PM:

Bobo, I don't think you can call the era to which you refer as a good time for the American people anymore than you can refer to a bunch of sex slaves hooked on heroin as having a "good time". The American people were fed cultural heroin and enslaved by an alien "leadership" that has had pretty much run of the West for several decades.

Bobo the clown said at November 14, 2008 6:16 PM:

"Bobo, I don't think you can call the era to which you refer as a good time for the American people anymore than you can refer to a bunch of sex slaves hooked on heroin as having a "good time". The American people were fed cultural heroin and enslaved by an alien "leadership" that has had pretty much run of the West for several decades."

That's kind of appropriate, don't you think, considering the Opium Wars :-)

JerseyBrett said at November 14, 2008 8:26 PM:

I agree with James Bowery. Western society is simply delusional. Delusional in the sense that its citizens think you can live any lifestyle you want without any economic, social or political consequences. When has any society prospered when its smartest citizens fully embrace the "creative" lifestyle, its middle class citizens indulge in beer pong every night and its lower classes give birth to millions of illegitimate children. Hahahaha. If you stop and think about it, its absurd that we even made it this far from the "Great Disruption" of the 1960s. Also, how on Earth can anyone claim that it was a good idea to import vast amounts of unskilled foreigners into Western countries? I just read a pretty amusing article in the Economist about how Sarkozy considers himself a Socialist now. Hahahahaha. How does he expect to keep a society running on massive unfunded entitlements, retirements at age 55, 35 hour work weeks, below replacement rate fertility levels, enormous legacy costs and an expanding, unemployable African population? Hahahahaha. Westerners are so delusional. John Derbyshire was spot on when he once said, "The West seems to be in the grip of some sort of collective insanity." Man, Asia is going to eat us for lunch....

James Bowery said at November 15, 2008 10:56 AM:

Bobo writes: That's kind of appropriate, don't you think, considering the Opium Wars :-)

Not if the same "leadership" was responsible for both the opium trade that harmed the Chinese people AND the cultural heroin trade that harmed the US people.

Bobo the clown said at November 15, 2008 12:30 PM:

"Not if the same "leadership" was responsible for both the opium trade that harmed the Chinese people AND the cultural heroin trade that harmed the US people."

The Ming Dynasty is gone so you can only be referring to the International Capital Collusion!

miles said at November 15, 2008 3:59 PM:

Randall Parker wrote:

"As long as the housing price-to-rent remains above historical norms and the ratio of housing prices to income remains above historical norms we haven't reached sustainable prices in the real estate market. We should not reflate housing prices when housing prices are clearly distorted by reckless and destructive lending practices."


..........Amen to that. Thats the key to so much, but people just dont see it.

James Bowery said at November 15, 2008 11:42 PM:

And what Parker doesn't see is the cost of reproduction as more fundamental to being "sustainable". And, no, I'm not talking about the cost of reproduction to a Mexican Catholic.

Randall Parker said at November 16, 2008 8:51 AM:

Cost of reproduction: Obscure references are so cool. One can pose as knowing more and no one can challenge you because there's security in obscurity.


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