Once in a while, separate thinkers reach strikingly similar conclusion. It gets even more interesting when their observations come to light in a compressed timeframe.
Yesterday, Willem Buiter pointed out a major difference in perspective between US and foreign economists. Americans are wedded to the idea of doing whatever it takes to forestall a recession, no matter how costly it proves in the long term; many foreign economists think the US needs to wean itself off its debt habit, which will inevitably lead to a period of painful readjustment.
Harvard economist Kenneth Rogoff sings from the same hymnal today in a Project Syndicate article (hat tip Mark Thoma), but manages to avoid directly criticizing his professional colleagues. He instead points out that Americans need to listen to experts in developing countries that have survived the very sort of crises that the US is now facing.
No matter how astute and fact based Rogoff’s observations are (he earlier released a persuasive and troubling analysis with his colleague Carmen Reinhart), no policy maker in America will accept the idea either that our economy has anything in common with that of the developing world or that it is in danger of banana-republic type troubles. There is therefore no chance his eminently sensible proposal will be taken seriously.
The political and economic leadership of this country has difficulty even learning lessons from other advanced economies. Exceptionalism is a deeply-rooted notion in the American psyche, and that plus prideful inability to recognize how rapidly our standing is slipping will almost certainly prevent us from learning invaluable lessons from those who have been down the painful path we are on.
As the United States’ epic financial crisis continues to unfold, one can only wish that US policymakers were half as good at listening to advice from developing countries as they are at giving it. Americans don’t seem to realize that their subprime mortgage meltdown has much in common with many previous post-1945 banking crises throughout the world.
The silver lining is that there are many highly distinguished current and former policymakers out there, particularly from emerging market countries, who have seen this movie before. If US policymakers would only listen, they might get an idea or two about how to deal with financial crises from experts who have come out safely on the other side.
Unfortunately, the parallel between today’s US crisis and previous financial crises is not mere hyperbole. The qualitative parallels are obvious: banks using off-balance loans to finance highly risky ventures, exotic new financial instruments, and excessive exuberance over the promise of new markets.
But there are strong quantitative parallels as well. Professor Carmen Reinhart of the University of Maryland and I systematically compared the run-up to the US subprime crisis with the run-up to the 19 worst financial crises in the industrialized world over the past 60 years. These include epic crises in the Scandinavian countries, Spain, and Japan, along with lesser events such as the US savings and loan crises of the 1980s.
Across virtually all the major indicators – including equity and housing price runs-ups, trade balance deficits, surges in government and household indebtedness, and pre-crisis growth trajectories – red lights are blinking for the US. Simply put, surging capital flows into the US artificially held down interest rates and inflated asset prices, leading to laxity in banking and regulatory standards and, ultimately, to a meltdown.
When Asia and Latin America had their financial meltdowns in the 1990s and early 2000s, they took advice not only from the International Monetary Fund, but also from a number of small panels composed of eminent people representing diverse backgrounds and experiences. The US should do the same. The head of the IMF, Frenchman Dominique Strauss-Kahn, could easily select a superb panel from any range of former crisis countries, including Mexico, Brazil, Korea, Turkey, Japan, and Sweden, not to mention Argentina, Russia, Chile, and many others.
Admittedly, the IMF’s panel would have to look past America’s current hypocrisy. The US Treasury strongly encouraged Asia to tighten fiscal policy during its 1990s crisis. But today the US Congress and president are tripping over themselves to adopt an ill-advised giant fiscal stimulus package, whose main effects will be to tie the hands of the next president in simplifying the US tax code and closing the budget deficit.
Americans firmly told Japan that the only way to clean up its economy was to purge insolvent banks and regenerate the financial system through Schumpeterian “creative destruction.” Today, US authorities appear willing to contemplate any measure, no matter how inflationary, to insure that none of its major banks and investment houses fails.
For years, foreign governments complained about American hedge funds, arguing that their non-transparent behavior posed unacceptable risks to stability. Now, many US politicians are complaining about the transparency of sovereign wealth funds (big government investors mainly from Asia and the Middle East), which are taking shares in trophy American assets such as Citibank and Merrill Lynch.
In fact, having countries like Russia and China more vested in the well-being of the US economy would not be a bad thing. Yes, the IMF ought to develop a voluntary code of conduct for sovereign wealth funds, but it should not be used as a weapon to enforce financial protectionism.
For years, I, along with many others, have complained that emerging markets need greater representation in global financial governance. Today, the issue goes far beyond symbolism. The US economy is in trouble, and the problems it spins off are unlikely to stop at the US border. Experts from emerging markets and elsewhere have much to say about dealing with financial crises. America should start to listen before it is too late.