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Globaloney 2.0 argues that the institutional structure of the global economy needs to change fundamentally if we are to avoid a repeat of the boom-bust cycle. If this is true, then the news from Bretton Woods, where many of the world’s economic leaders are meeting to try to rethink the way we think about economic globalization, is very disappointing.
Click on the image of the Mt. Washington Hotel to see an interesting Financial Times report by Gillian Tett and Martin Wolf.
One of the arguments that I make in Globaloney 2.0 is that the risks of international finance were systematically ignored or “misunerestimated” as a former President might have said. I call the false belief that international finance is fundamentally safe and sound “Financial Globaloney.”
When you take even relatively safe domestic investment patterns and add to them the instabilities and uncertainties of international currency markets, I argue, the risks rise exponentially. When those investment are highly leveraged, as they usually are, the risk profile explodes.
The good folks at the Financial Times have produced an excellent brief presentation that explains the “carry trade” (which my students will recognize as an example of “naked interest arbitrage”), showing both why this investment pattern would seem “safe as houses” and why it can go so badly wrong.
Click here to go to the FT carry trade site. (Note: you will need to register — it’s free — to view the article.)
The bad news is that the carry trade, which unwound during the bust, is leveraging up, with the U.S. as the low-interest source of funds. That’s why the dollar keeps falling — investors borrow dollars and sell them to get currencies that earn higher interest. That’s why it has been so difficult to talk the dollar back up — you’d need to raise U.S. interest rates or bring down foreign rates to lessen carry trade flows.
The carry trade collapses during a crisis. Everyone rushes to cash out and bring their money home. That’s why a surge in the dollar would be bad news for the global economy — it would probably be associated with another seismic financial shock.
Matthew Rose has a fun article in today’s Wall Street Journal titled “The Devil’s Dictionary — Financial Edition.” It is an amusing account of how certain financial terms have taken on a new meaning in this post-crash world. Here’s a sample.
SUBPRIME, adj. A measure of diminished intellectual capacity and increased financial mendacity.
TOXIC ASSETS, n. 1. A collection of bad loans and other botched financial bets that caused big losses for banks, prompted a credit crunch and sank the economy (Sept. 2008 to May 2009). 2. Long-term investments that will pay handsomely when the housing market recovers (June 2009 onward).
I’d like to offer up an addition to the dictionary:
FINANCIAL GLOBALONEY n. The persistent but misguided belief that global financial markets are “safe as houses” despite repeated evidence to the contrary. Also the rhetoric used to support this belief and to sell it to investors, policy-makers, etc. See Veseth, Globaloney 2.0.
Paul Krugman has a very interesting piece in today’s Sunday New York Times magazine on How Did Economists Get it So Wrong? Click on the link to read it.
Krugman comes to many of the same conclusion I do in Globaloney 2.0 regarding what I call Financial Globaloney, although he focuses much more than I do on the internal debate within the economics profession (I am a bit more interested in how the ideas were sold to and bought by investors, officials and the general public).
The discussion of Freshwater versus Saltwater economists is a good introduction for non-economists to the debate within the profession. I have mixed emotions about his discussion of “ketchup economics;” his point about research methods is well taken, but relative prices, which are at the heart of the ketchup metaphor, really do matter more than they seem to here.
Krugman successfully walks a fine line here between criticizing the ideas that have been proven wrong and attacking the personalities behind them. I prefer to keep the personalities out of the critique when I can, but I appreciate that Krugman’s position is different from mine.
The article is a good read (and a good introduction to his most recent book, The Return of Depression Economics). A highly recommended antidote to the Globaloney influenza.
One of the most important points I make in Globaloney 2.0 is that the risks of globalization have been ignored relative to the gains. I spend two chapters explaining how and why the financial risks in particular were ignored and what the dire consequences of this have been.
In the final chapter I outline the necessary conditions for a globalization that is economically feasible and politically sustainable. One of those conditions, naturally, is that the risks of globalization need to be explicitly considered, both by the millions of men and women who work in the global economy but also by those who design its policy architecture.
It is good to know that I am not alone in this concern over globalization risk. A column by Gillian Tett in today’s Financial Times strikes much the same note. “Welcome to the new world of risk-aware globalisation” identifies risk in both the financial sector and throughout complicated global supply chains. It’s a good read — click on the link above to see the article.
You should also check out this report cited in Tett’s column: Global Risks Report 2008, by World Economic Forum, Citigroup, Marsh & McLennan, Swiss Re, Wharton and Zurich Financial Services http://www.weforum.org/pdf/globalrisk/report2008.pdf