Monday, January 27, 2014

Global Dollar-Based Financial Fragility in the 2000s (Part I)

"Yves here. It’s been frustrating to see orthodox economists continue to invoke the Bernanke “saving glut hypothesis” as a significant driver of the crisis. That view was rebutted in gory detail in a 2010 paper by Claudio Borio and Piti Disyatat of the BIS, “Global imbalances and the financial crisis: Link or no link?” (see Andrew Dittmer’s summary here). Not surprisingly, the orthodoxy has chosen to ignore this paper (which also includes an important discussion about another bit of wrong-headed thinking, the failure to distinguish between the “natural” rate of interest and market rates of interest). The “savings glut” is still routinely mentioned in op-eds and papers by Serious Economists.
A new working paper by Junji Tokunaga and Gerald Epstein, “The Endogenous Finance of Global Dollar-Based Financial Fragility in the 2000s: A Minskian Approach,” builds on the perspective of the Borio/Disyatat paper and they are recapping it in a four-part series. Readers should find this to be a straightforward, persuasive discussion of an important topic.
By Junji Tokunaga, Associate Professor in the Department of Economics and Management, Wako University, Tokyo and Gerald Epstein, Professor in the Department of Economics, University of Massachusetts-Amherst, and Co-Director of the Political Economy Research Institute (PERI)
Global financing patterns have been at the center of debates on the global financial crisis in recent years. The global imbalance view, a prominent hypothesis, attributes the financial crisis to excess saving over investment in emerging market countries which have run current account surplus since the end of the 1990s. The excess saving flowed into advanced countries running current account deficits, particularly the U.S., thus depressing long-term interest rates and fueling a credit boom there in the 2000s.
According to this view, the financial crisis was triggered by an external and exogenous shock that resulted from excess saving in emerging market countries, not the shadow banking system in advanced countries which was the epicenter of the financial crisis. Instead, we argue that a key cause of the global financial crisis was the dynamic expansion of balance sheets at large complex financial institutions (LCFIs) (Borio and Disyatat [2011] and Shin [2012]), driven by the endogenously elastic finance of global dollar funding in the global shadow banking system.
The endogenously elastic finance of the global dollar contributed to the buildup of global financial fragility that led to the global financial crisis. Importantly, the supreme position of U.S. dollar as debt-financing currency, underpinned by the dominant role of the dollar in the development of new financial innovations and instruments, and was a driving force in this endogenously dynamic and ultimately destructive process..."


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