Interesting new paper here by Heleen Mees of ERIM. She theorizes that China actually caused the entire financial crisis. It’s essentially the global savings glut story which I am not entirely sold on. China accumulates reserves because the USA likes to buy cheaper goods and services. It’s not just a desire to save in dollars. It’s a demand function as well. China just so happens to be the primary place of cheap production. So they end up with the dollars as a matter of necessity. Anyhow, it’s an interesting perspective and I’d be interested in readers views here:
“At the onset of the financial crisis, in 2007 and 2008, the main worry among commentators and economists was the growing purchasing power of sovereign wealth funds of authoritarian states like China and the United Arab Emirates. In a column in NRC Handelsblad in July 2007 I reckoned that, if China would keep accumulating foreign reserves the way it did, within 10 years China would be able to acquire all publicly listed companies in Europe. In June 2008 Laurence Kotlikoff predicted that ChinaHs foreign reserves, which amounted already to $2 trillion at the time, would multiply within a matter of years. But Kotlikoff had a very benign view of ChinaHs hoarding. He predicted that, by becoming the world’s saver, China would also become the developed world’s savoir, with respect to its long-run supply of capital and long-run general equilibrium prospects (Kotlikoff et al., 2005). Ben Bernanke, who was Fed Governor at the time, had an equally sanguine reading of the global saving glut. In his by now infamous 2005 Sandridge lecture, Bernanke boasted about the “depth and sophistication of U.S. financial markets, which (U ) allowed households easy access to housing wealth.”
In September 2008 it all started to unravel quickly. Government sponsored enterprises Fannie Mae
and Freddie Mac, created in 1938 and 1970 in order to promote homeownership, were placed into
conservatorship by the U.S. federal government, and little more than a week later the investment bank
Lehman Brothers collapsed. In order to prevent a full domino effect, the U.S. Treasury bailed out insurance behemoth AIG a few days after that. As stock markets tanked, the Dow Jones dropped more than 500 points on September 15, U.S. Congress consented to the Troubled Asset Relief Program (TARP) that authorized expenditures in the order of $700 billion for the purchase of assets and equity from financial institutions to strengthen the financial sector. Images of foreclosed properties and displaced homeowners flooded the TV screens. Before that faithful September month, most people had never heard of credit default swaps, collateralized debt obligations or subprime mortgages.
So it may not come as a surprise that Wall Street has been singled out as the villain in the prevalent
narrative of the financial crisis and the ensuing Great Recession. I show, however, that there were even larger forces at work. The build-up of savings in China and oil-exporting nations, which were heavily skewed towards fixed income assets, depressed interest rates worldwide from 2004 on. By the time the Federal Reserve (Fed) wanted to put the brakes on the economy and started to raise its policy rate again in July 2004, it was too late. Long-term interest rates in the United States remained stubbornly low, in spite of the Fed raising the fed funds rate from 1 percent in July 2004 to 5.25 percent in June 2006, adding further fuel to the housing bubble. While the subprime mortgages with exotic features did not help either, my research shows that long-term interest rates are the most important factor driving housing demand (Chapter 2).”
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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