The Very Important and of Course Blacklisted BIS Paper About the Crisis

Admittedly, my RSS reader is hardly a definitive check, but it does cover a pretty large number of financial and economics websites, including those of academics. And from what I can tell, an extremely important paper by Claudio Borio and Piti Disyatat of the BIS, “Global imbalances and the financial crisis: Link or no link?” has been relegated to the netherworld. The Economist’s blog (not the magazine) mentioned it in passing, and a VoxEU post on the article then led the WSJ economics blog to take notice. But from the major economics blogs and publications, silence.

Why would that be? One might surmise that this is a case of censorship. Borio has been a long-standing critic of the Greenspan and later Bernanke thesis that central banks should ignore asset and credit bubbles if prices are stable. He and William White went public (as public as you can go in the BIS) in 2003 with their contention that an international housing bubble was underway and action was warranted. Greenspan and virtually all other right-thinking economists ignored the bubble and other signs of trouble (like a sustained near zero consumer savings rate in the US) and drank the Great Moderation Kool-Aid instead.

Despite the overwhelming evidence of their colossal pre-crisis screw-up, most academic economists are unwilling to admit much if any error. And they are generally respectful towards Bernanke (the fact that the Fed is the biggest single source of funding for academic research no doubt contributes to the deference shown to the central bank).

The paper is important for a second reason: it seeks to address the limited and imprecise thinking about the relationship between the financial markets and the real economy. I cover some of this ground in ECONNED. The shortcomings of prevailing macro models include: an equilibrium assumption (by contrast, financial markets, which impact the real economy, have no propensity to equilibrium), no role for credit, banks, or even money (except sometimes in error terms).

In addition to its heretical views, another reason the Borio/Disyatat paper has gotten less attention than it warrants is that it is written densely and defensively, perhaps a response to the way the clear and well documented White/Borio papers on the housing bubble were dismissed as having no theoretical foundation. I read it early in the summer, and have dragged my feet in posting on it because it would be difficult to do it justice in a single piece. It should have occurred to me sooner to write about it over two or three posts.

However, I may simply not have been up to the task of making it accessible. Our Andrew Dittmer (a Harvard Phd in mathematics who among other things, has taught group theory to seventh graders) has converted the paper into Layspeak:

The May 2011 Bank of International Settlements paper by Claudio Borio and Piti Disyatat is quite important It suffers, however, from one defect: it is not written in English, but in economese. I have therefore taken the liberty of poetically translating it into our language (and adding occasional remarks here and there). All numbers below are references to page numbers in the original paper.

* * * * *

The global financial crisis led to widespread dislocations and misery. However, another set of victims, hitherto overlooked, were central banking authorities and professors of economics who had staked their names on the thesis that the current configuration of the global financial system (which they had helped to engineer) was generally wonderful. These unfortunate souls were forced to come up with an explanation for the crisis on short notice, and it had to be an explanation in which they themselves played no role.

Ben Bernanke et al. rose brilliantly to the challenge. They remembered that many Asian countries had stocked up on foreign currency reserves in the hopes of never again being at the mercy of the IMF (26, note). Obviously, trying to resist the IMF was wrong and deserved criticism. Moreover, saying bad things about the Chinese would inevitably be welcomed in foreign policy circles eager to talk about the coming “bipolar confrontation” between America and China.

This “savings glut” theory argued that savings by Asian (and Middle Eastern) countries had washed like a tidal wave onto US financial markets, effectively forcing US money managers to invest imprudently in the course of their attempts to cope. For instance, these “excess savings” were widely assumed to have reduced long-term interest rates, thereby making credit cheaper.

There were some obvious problems with the global imbalances theory. Before the crisis exploded, many of the same economists had pointed to the same imbalances as a happy coincidence of needs, leading to better results for all (23). According to the sort of economic theory that was used in these explanations, if “global imbalances” were causing long-term interest rates to fall, that was simply a natural market outcome that should be contributing to equilibrium (23).

Consistency is the hobgoblin of little minds, and the “excess savings” theory was duly welcomed. It was even paid the supreme compliment of being accepted by Goldman Sachs’ lobbying division (see Effective Regulation, part 1, page 1).

Despite the consensus of these eminent authorities, we have decided to take a second look at the theory. Unfortunately, we have found further problems.

The idea of “national savings” or “current account surplus” refers to the total amount of exports sold minus the total amount of imports sold (more or less). The “excess savings” theory holds that this excess had to have been financed somehow, and so presumably by countries in surplus, like China.

However, for the US in 2010, the total amount of financial flows into the US was at least 60 times the current account deficit (9), counting only securities transactions. If this number were correct, then inflows would be 61 times the current account deficit, and outflows would be 60 times the current account deficit. The current account deficit is a drop in the bucket. Why would anyone assume it had anything to do with the picture at all?

Moreover, if the “savings glut” theory was correct, we would expect there to be certain historical correlations between the following variables: (a) current account deficits of the US, (b) US and world long-term interest rates, (c) value of the US dollar, (d) the global savings rate, (e) world GDP. There aren’t (4-6, see graphs).

You would also expect credit crises to occur mainly in countries with current account deficits. They don’t (6).

Suppose we look at a more reasonable variables: gross capital flows (13-14). What do we learn about the causes of the crisis?

Financial flows exploded from 1998 to 2007, expanding by a factor of four RELATIVE to world GDP (13), and then fell by 75% in 2008 (15). The most important source of financial flows was Europe, dwarfing the contributions of Asia and the Middle East (15). The bulk of inflows originated in the private sector (15).

If we look instead at foreign holdings of US securities (15-16), Europe is still dominant, but China and Japan are a little more prominent due to their large accumulations of foreign exchange reserves (15). Still, the Caribbean financial centers alone account for roughly the same proportion as either China or Japan (16). Other statistics provide a similar picture (17-19).

So what caused the crisis? Clearly, the shadow banking system (mainly based around US and European financial institutions) succeeding in generating huge amounts of leverage and financing all by itself (24, 28). Banks can expand credit independently of their reserve requirements (30) – the central bank’s role is limited to setting short-term interest rates (30). European banks deliberately levered themselves up so they could take advantage of opportunities to use ABS in strategies (11), many of which were ultimately aimed at looting these same banks for the benefit of bank employees. These activities pushed long-term interest rates down. Short-term rates remained low because the Fed didn’t raise them as long as inflation didn’t appear to be an issue (25, 27).

The Asian countries played a small role as well. They didn’t want US/European-driven asset price inflation to spill over into distortions in their economies, and so they protected themselves by accumulating foreign exchange reserves (26 and 26 note). That was mean of them. If they had allowed more spillover, then the costs of the shadow banking system would have been partly borne by them, and that would have made the credit crisis less severe in the advanced countries (26). As things stand, instead, the advanced countries are suffering, while Asian countries have bounced back strongly (26).

What should we do? Well, we have suggestions for theory and practice. Let’s start with the practical suggestions.

Countries should do a better job of restraining their financial sectors (24). However, that will probably not be enough (24). Countries should also work together to share the burden of consequences of further crises (27). Unfortunately, countries are irrational and political and so are often unwilling to cooperate in ways we consider wise (27).

Since we can’t count on other countries doing the right thing, we will have to count on the Fed instead. If there is another boom in asset prices, the Fed should cool it off by raising interest rates and so inducing deflation in the rest of the economy. The balance of views in the international community has been shifting in this direction (27).

As for the theory, maybe you are wondering what was wrong with economics that led people to believe in the “savings glut” theory. We have a few ideas.

First, most present day macroeconomic analysis proceeds by imagining that people only trade physical objects with each other. They don’t use money, and they certainly don’t make loans or go bankrupt. Even though the people that make these analyses know that in the real world money and loans and bankruptcy DO exist, they think that is useful to pretend that they don’t and then arrive at authoritative conclusions. We would like to beg them humbly to reconsider this blind spot (2, 12, 21, 27-31).

Second, current analyses of interest rates make a distinction between the “market” interest rate and the “natural” interest rate. The distinction between these two rates is very subtle, so we’ll explain it carefully.

The “market” interest rate refers to the interest rates people pay on various kinds of loans. The “natural” interest rates is an unobservable variable that is equal to whatever economists decide the interest rate really ought to be for the purpose of some model. Usually, this imaginary interest rate is calculated in such a way that whatever the Fed and banks and hedge funds do, it can never change. It only depends on what physical goods are bought and sold in the economy (1-2, 20-23, 29).

In the past, economists have decided to use the imaginary interest rate instead of the actual interest rate. We don’t want to be disrespectful, but is there any chance they might be willing to change their minds?

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  1. Linus Huber

    I am no economist but often when I mention that we have too much debt in the system, some well educated guy will reply that I have no clue as debt equals savings.

    It is exactly the point that seems to be missed that debt MUST remain serviceable and be repayable within a reasonable period of time. Default is not part of their thinking and the creative destruction as tought by Schumpeter is not acceptable anymore. This led to the present statism that tries to maintain the status quo with all means available which in itself is an unsustainable proposition.

    Anyway that is the way I see it. Comments are welcome.

    Thanks for translating the paper, Yves. Makes life a lot easier.

    1. sgt_doom

      Please tell “some well educated guy” that hundreds of trillions of worthless (IMHO) credit derivatives, i.e., securitized debt, equals savings (as in profits) ONLY to those debt-financed billionaires peddling it.

      And tell him to go read David Graeber’s Debt: the first 5,000 years.

    2. Marshall Auerback


      You are over simplifying. The idea is that PUBLIC debt equals private savings. You are conflating two distinct concepts when you group private and public debt together. That’s where you make a crucial mistake. For households and businesses, paying back debt means they have to sacrifice current consumption (spending), as you rightly note. For the government, no such financial constraint is imposed operationally (although there are clearly LEGAL constraints, as the recent debt ceiling fiasco demonstrated). But operationally speaking, the government’s ability to spend now is independent of how much debt it holds and what it spent yesterday.

  2. Fraud Guy

    Since I can’t read poetic economese, but can guess, the shorter version is:

    A) Euro and American banks created huge piles of money out of whole cloth.

    This was meant to transfer the benefits of those funds to employees (I’m guessing the ones who already had access to good compensation).

    B) Asian countries saw this, and held onto some of that spun money to protect themselves when the rest disappeared like fairy gold with the morning sun. Since they saved that money, they can now safely use it to recover.

    To stop this from happening again:

    1. Don’t let banks and bank employees loot the world economy.

    2. Hope that the fed will step in to slap down the next attempt at global fraud.

    3. Economists (private and public) need to let their theories get applied as opposed to locked away in pristine settings that have little to do with the real world.

  3. CB

    I just hopped over to the pdf and the first thing that struck me was that it’s in English. Is it my mis-impression or are Americans, with the notable exception of bi-lingual Spanish-English speakers, hicks about other languages? Honestly, we take pride in not speaking other languages and I write that as someone who doesn’t speak another language but wouldn’t brag on it.

    I worked for a German based company for two years and the international population of upper management didn’t have any Americans that I knew of. Americans seemed to disappear above the higher reaches of middle management. I discussed this with several (American) colleagues and they had noticed the same. We assumed it was the provincialism of so many Americans that shut them out of upper management: they only speak English, they’re decidedly uncosmopolitan, they don’t have a comfortable familiarity with other cultures and social milieus. Most of the identifiable upper management that wasn’t German was upper class Asian, well traveled, multi-lingual, well educated, socially sophisticated.

    1. Yves Smith Post author

      BIS papers are in English. In addition, the US is the dominant player in graduate economics programs (no joke, something like 90% of the well regarded econ grad schools in the world are here). So those are the big reasons for the heavy use of English.

      1. Aldi

        Economy, like psychology, are largely american creation as modern academic “study”. The biggest and oldest university departments is all American. It’s very much late enlightenment british thing. The rest of the learned world was into marxism as an explanation of capital and history during the 20th century.

        With the creation of huge supercomputer, I don’t think economy as an art of trying to find BS explanation will survive. market condition, production rate, and flow of money would be generated and explained via machine print out. (do economist even have explanation how the shadow banks operate, its huge size and its effect on world capital flow? I doubt it.)

    2. Paul Tioxon

      I have also noted a shift in the language requirements for a PhD. Especially in the sciences. I guess I was delusional thinking German might be critical for Physics or Chemistry. Anyway, when I asked about the dominance of English in research from a friend who was preparing his umteenth grant, he said at all the conferences, only English was used to present and from researchers all over the world. We are the lingua Franca now. In so many fields.

      Of course, it didn’t hurt that when we took over the world, we got it from the British Empire who nicely spread their language along with them. I guess people still have a hard time with the Pax Americana hegemony talk. We do, completely dominate the world. 700 military bases on foreign soil says so. You can provide the amount of Euro/Petro/Narco/etc-dollars around the world that completes the domination.

      1. BetaSheep

        German is required for a PhD in Classical Languages and Literature. So many arcane papers on arcane subjects in the field were written by Germans and nobody bothered to translate them because so few people read them.

  4. RebelEconomist

    The natural rate of interest may be difficult to observe, but I don’t think that should stop economists from trying, because it (or more realistically a term structure) is a key economic parameter. In particular, if the natural rate is negative, then a central bank policy rate of 1% may represent tight monetary policy. I imagine that deriving an estimate of the natural rate by observation would involve something like surveying the rates of return that people are expecting on all kinds of real projects (eg Adam Smith’s “rate of mercantile profit”). Unfortunately, that kind of forensic work does not seem to be given much prestige by the economic establishment, so not enough of it gets done.

    1. JustAnObserver

      An unobservable natural rate of interest would seem to play the same role for economic “instability deniers” that hidden variables do for those trying to deny the non-locality of quantum mechanics … strange for an academic subject so dominated by physics-envy … although the physics they are so envious of is the pre-Plank, pre-Einstein, pre-Poincare version.

  5. dearieme

    “the US is the dominant player in graduate economics programs”: mm. If well regarded physics is done in many places but well regarded economics effectively only in the US, you’d have to wonder about the merits of the discipline, or the nature of being well regarded.

  6. Richard Kline

    What? Imaginary numbers? (Well, it worked for the mathematicians, and economists are pseudo-mathematicians, so . . . .)

    Caribbean shadow pools exceeded Chinese capital? Quick, get the Bank of Sweden Prize[Fools] on the line!: It’s just a geography problem, the formulas can be salvaged!! Seriously, find a macroeconomist who had that figured in accurately, and you’ve got the next Prize Fool tipped.

    The decision by Euro-American monetary and securities authorities in the last twenty years to allow any old speculator with a modem and a silly piece of paper to go into business as a bank, completely unregulated, leveraged 30x or more, was the most immoderate act of folly in modern (post-1600) history. Well, ‘bank;’ these were called funds, or ‘investment firms,’ or any old name, but using an asset base of securities (not backstopped by any lender of last resort) they were permitted to ‘lend’ into the capital markets effectively like banks. Creating ‘money.’ Not a few of them were much larger than the financial powers of the smaller sovereign governments. Since they didn’t actually own anything but shelves of derivatives and various government and corporate bonds, they weren’t ‘productive’ [got that right], and weren’t actors who registered in real economic models [real, as in ‘reality’ TV]. And those unregulated, unconstrained, unproductive actors _completely swamped any actual economic production_ as far as their financial impact, and continue to do so. To the utter detriment of any actual economic activity.

    The world’s economic activity is quite capable of becoming unstable or systemically constrained without these ‘shady banks,’ but the non-bank banks have been an uncontained cancer by themselves. Once they’ve killed the economy, they’ll kill the money, and then, maybe, finally kill each other off. Unless we just cut to the endgame first. Unregulated money-issuers have no purpose or right to exist, and they are an uncontrolled threat to everybody not profiting from them as of now.

    1. kievite


      The decision by Euro-American monetary and securities authorities in the last twenty years to allow any old speculator with a modem and a silly piece of paper to go into business as a bank, completely unregulated, leveraged 30x or more, was the most immoderate act of folly in modern (post-1600) history.

      It’s more complex then that. Conversion to “casino capitalism” is the natural logic of development of capitalism. So replacement of industrial capitalism with financial capitalism was immanent. And this conversion did not happen due to lack of oversight or as a folly. It was nurtured and encouraged by a series of government decisions for the last 50 years.

      So what we are experiencing is a the completion of the transformation of one type of capitalism to another. It happened in stages:

      — Computers brought innovations into financial markets

      — Globalization kicked in

      — Due to globalization the sheer size of the financial markets increased to the extent that they started to represent a different, new phenomena allowing new types of redistribution of wealth to be practiced.

      — Commercial banks turned into investment banks to exploit this opportunity.

      — Shift to bank “self-regulation” created huge shadow banking system which dwarf “official” under the smoke screen of “free-market” propaganda and engaged in pursuit of short term profits and self-enrichment of top brass which became new elite partially displacing the old one.

      — as financial speculation proved to be much more profitable to other activities deindustialization kicked in the USA as the financial center of the world.

      — Growth of inequality, job insecurity, as well as frequency of financial crises were natural consequences of financization of the economy.

      — Debt expansion which led to overconsumption within the industrial economies, made financial expansion to take the form of a competition for spheres of influence, which we see in post USSR space, Iraq, Libya and elsewhere. And central banks play critical role in financing wars. After all Banks of England was created with this exact purpose.

      I think by now transformation is by-and-large is complete. In short we are not living in a new politico-economic system in which financial capital won victory over both labor and industrial capital.

      1. Joe Rebholz

        “– Computers brought innovations into financial markets”

        Computers are hardly ever mentioned. Yet our present system could not exist without them. Imagine CDO’s, tranches, MERS, high speed trading, even now regular trading, having to be done by clerks. Impossible. Computers have allowed incomprehensible complexity. No wonder our money-economic systems, like computers themselves, crash now and then, perhaps even randomly.

        1. sgt_doom

          Exactly! Thievery, larceny and slavery never existed pre-computers.

          Why, I wonder what all those Mongols and Vikings were watching on TV to ever motivate them in all that raping and pillaging???

        2. Rex

          Joe, I agree with your observations about computers. I spent most of my life working on and around computers, starting with the big ones used by corporations and banks in the 60’s and 70’s, then to the wide distribution of PC’s that put computing power everywhere.

          I’ve always felt that the computers were a net benefit to society. Clearly we wouldn’t have the internet and this blog without them. We use them all the time to solve problems that would not be possible with paper and slide rules (weather and climate comes to mind).

          But, lately I see many instances, like those Joe mentioned, where computers seem to be pushing things to instability or otherwise having a negative impact. As an engineer, many of our social and financial systems can be thought of as closed-loop feedback systems. Computers are become an integral part of the feedback and add gain (amplification) to the loop. This can be optimized by inserting damping (an appropriate attenuation or control) to avoid instabilities that come from too much gain in the feedback loop. A simple example of to much gain and instability in a feedback system is the loud howling sound in a PA system from a microphone picking up gain from the speakers without proper damping.

          So I am mostly proud of my role in the propagation of computers into peoples hands, but am seeing many cases where, like Frankenstein’s monster, computers are being used in ways that are providing too much gain in undamped systems and contributing to instability.

          The gain from computers is not bad by itself but the trend to remove all controls or attenuations while adding this gain is bound to cause instability. HFT seems to me one of the more obvious and stupid examples.

      2. sgt_doom

        “It’s more complex then that. Conversion to “casino capitalism” is the natural logic of development of capitalism.”

        You’ve got things turned around and convoluted horribly.

        So-called “casino capitalism” wasn’t a natural development of any kind; securitization in share form (mortgage pool certificates, etc.) occurred in the 1920s leading up to the Great Crash, and was ended in 1933.

        Securitization this time around, in bond form, has yet to be ended, only more institutionalized, unfortunately, and was brought about by a most concerted effort by JPMorgan Chase, the Group of Thirty, the Wall Street Investment houses (Derivatives Policy Group in the late ’90s to “lobby” — i.e., to legally bribe) along with the Private Securities Litigation Reform Act of 1996, the Gramm-Leach-Bliley Act of 1999, and the Commodity Futures Modernization Act of 2000, coupled with that most convenient bankruptcy act against the lower two-thirds — just before the meltdown — and the Depository Institutions Deregulation and Monetary Control Act of 1980 (to kill all federal usury laws), the pattern was most definite, and nothing natural about it at all…..

        1. kievite


          Three suggestions:

          1. Try to understand the meaning of French proverb ““Appetite comes with eating” and how it is applicable to banks.

          2. Read the book Casino Capitalism by Susan Strange

          3. Get the vote record of Commodity Futures Modernization Act of 2000

    2. Rex

      Richard said, “Well, ‘bank;’ these were called funds, or ‘investment firms,’ or any old name, but using an asset base of securities (not backstopped by any lender of last resort) they were permitted to ‘lend’ into the capital markets effectively like banks. Creating ‘money.’ ”

      After the 2008 crash, I started reading about things economic and financial to try to find an answer to my simple question, “Where did all the money go.” I was quite naive but it was pretty clear to me that it wasn’t like a poker game where the money was shifted from one (or many) to another. Seemed that most of it, that had been reflected in stock prices and home values had just evaporated.

      My reading included Econned and led me to this blog which I have followed since. Now I think I know a bit more than I did in 2008. Richard’s paragraph, that includes the sentence above, seems to be one of the most succinct answers to my question that I have seen.

  7. Keating Willcox

    excellent article…excellent discussion. Does the increased speed with which transactions can happen (I keep thinking of all those ads for e-trade with the baby trader) give the illusion that you can have more risk because you can escape faster? Does the internet really have a lot to do with all this? You can set up a bank with a web site. Not necessary to have a big old granite building somewhere. What will we say has happened when China has the biggest bubble of all? When you are building entire, empty cities, does that count as a bubble?

    1. walt

      “… the illusion that you can have more risk because you can escape faster?” DeLong recounted a anecdote recently that at a dinner just about everyone was long Treasuries and thought they could bail when they turned down because of inflation.

      I am in the same situation with Vanguard’s GNMA fund.

  8. cook

    super article. translation from economese should be standard equipment on academic publications.
    “… the Fed is the biggest single source of funding for academic research…”; 3rd paragraph.
    this factoid is news to me. do you mean all research, or only economic?
    do you have the source of this readily at hand?

    1. Knut

      I think she means Macroeconomic research, which is probably the case. Some of the Fed Banks (Minneapolis in particular, but St Louis not far behind) are little more than propaganda mills for right-wing macroeconomics.

    2. Yves Smith Post author

      I’ve been told the Fed funds a full 1/4 of all grad school econ research. I can’t confirm that but it was from a credible source.

  9. Ignacio

    Amongst the solutions proposed they apparently forgot to mention the role of fiscal heavens and the potential benefits if those dissapared.

  10. Philip Pilkington

    Borio is a very good economist. He has independently come to many of the same conclusions as to the working of the banking system and the money supply as the MMTers.

  11. craazyman

    Never understood how you could have a savings glut when the 800 million savers live on 2 grains of rice a day and sh*t in their sinks or in the streets ‘cuse the Kant afford a bathroom.

    Anyway, I guess being a PdH economist means never having to say your wrong.

    it goes like this

    “OK, I admit I was wrahh iiii teeeeeee. I was wroihghghghgh IIItttttt. I was wraghghghghahhhheyeyeyeyettttt tttttttt. I was wrouuuuunghaaaaaaaaaaahhhhhkkkkkhhhhaaaeyeyeyeyeyeTTTTTTT.

    It just keeps going.

    That’s the think Even 7th graders can understand group theory. If it’s explained well. That’s pretty much the way it is with almost anything. Almost. Most things are really so simple that almost anyone can understand. But it takes a really smart person to know how to explain things well, so that almost anyone can understand.

    1. Moopheus

      Being able to clearly explain a complex topic to nonspecialists is really a function of how well the explainer understands the topic him/herself. Which means, at last as far as finance and politics go, if someone can’t explain, then either they lack the necessary understanding, or they are hiding something. Or both.

  12. chad

    “Since we can’t count on other countries doing the right thing, we will have to count on the Fed instead. If there is another boom in asset prices, the Fed should cool it off by raising interest rates and so inducing deflation in the rest of the economy. The balance of views in the international community has been shifting in this direction (27).”

    I thought “taking away the punch bowl” was a fundamental function of the Fed already.

    1. Jim Haygood

      From mid-2004 to mid-2006, the dynamic duo of Greenspan and Bernanke tried the ‘hide the punchbowl’ routine, taking the Fed Funds rate from 1.00% to 5.25% (a record percentage increase) in thirteen quarter-point baby steps. By the time they finished, the US housing market had begun to crumble, and financial markets followed a year later.

      Greenspan’s baby steps were a mistake, I’d say. If you’re gonna hike, hike big. Take it up a point, monitor the response, then take it up another point if need be. Don’t baby the banksters — they’re big boys.

      This Wednesday afternoon, the mirror image of ‘hide the punchbowl’ will be on display. With Fed Funds pegged at zero for ‘the functional equivalent of forever,’ young Bennie is going to try to assert his bald-pated sway over the entire yield curve.

      Mumbling academics told him this will affect ‘expectations.’ Quite the opposite of his intention, my expectation is that what Banzai Bennie will likely achieve in practice is to definitively break the back of the 30-year secular bull market in bonds.

      Seeking to suppress near-invisible long rates, at a time when the money-supply M’s are mushrooming higher, is exactly the sort of sophomoric goofball stunt that one would expect from a bunch of purblind PhDs who wear Hush Puppy loafers cuz they don’t know how to tie shoelaces.

      Watch Operation Twist blow up in their fool faces, like Wile E. Coyote touching off a box of Acme explosives in a Roadrunner cartoon.

      Beep, beep!

  13. John Hall

    I read this article when it came out and thought it was very good. I even sent a note to Borio commenting on how good I thought it was. The summary is also very good.

    However, I think it’s a bit dramatic to say that it was “blacklisted” or “censored” by the blogosphere. That’s rubbish.

    1. Yves Smith Post author

      This is a fundamentally important paper and no one has taken note of it. Try putting “Borio” into a search field, say at the FT. His previous papers got noted in the paper proper. Ditto if you do a web search. His earlier papers got picked up in the MSM to at least some degree. This is now four months out from the pub date, so the ripple through from the initial release is well over.

      This is VERY similar to what happened to the now widely cited paper by Akerlof and Romer on looting. It too was ignored on its initial release basically because ti was too heinous to consider that looting was a widespread activity. It collided with the “if you deregulate, what’s there to worry about, the incentive to make money assures everyone will be responsible.”

      It should be no surprise that a paper offensive to orthodox thinking that also has the nerve to point out, no matter how politely, that hordes of economists have missed very basic issues would be ignored. The fact that it is a de facto blacklisted paper as opposed to a formally blacklisted paper does not change the outcome.

  14. Paul Tioxon

    It seems that this paper is pointing out, that the problem requires a unit of analysis greater than a discrete national economy. The international system of states, as anchors of regulation, reining in overly elastic credit, reducing the inflation of asset prices across asset classes, sectors and national boundaries in addition to transnational regulation of finance and trade, may be the analytical framework for controlling the problems of mean people with too much money and time on their hands.

    The imbalances caused by too much credit, derives, in my estimation, from causes previous to the process of credit creation. The problem of surplus profits, with no place to go and nothing to do but be lent out. This is not a strictly mechanical production model of money turning into profits and profits building up lending or the basis for credit extension. It is the political problem of making sure that markets serve the international state systems and NOT a transnational, stateless system of commerce based credit creation.

    What ever tweeks the financial economists seem to come up with, the global system of commerce seems to find a work around. The two front nature of financial regulation has to be in each state as an anchor of the social order with laws and restraints of too much credit creation. This begins with, limiting the charters of banking corporations, by means of restrictive covenants, in their state based incorporation process. The transnational nature of global business plays the discrete sovereignty of each nation state off against each other. A global authority would assume elements of sovereignty, superior to each and all nation states in order to rein in credit creation from stretching beyond its boundaries, causing imbalances in countries that did not set up precautions to ring fence themselves from this problems, like the East Asian and other economies. Have done.

    As the authors point out. Political considerations are harder at work, than the mechanics of capital flows, credit creation or meaningful reform to stop imbalances.

  15. Eric L. Prentis

    Andrew Dittmer says, “Consistency is the hobgoblin of little minds.” Please, I am tired of correcting this misconception. Emerson’s quote is, “A foolish consistency is the hobgoblin of little minds.” It takes a major intellect, long academic study and vast experience to construct a mathematical model that consistently matches the complexity of reality. We revile economists because they assume away all the problems to justify their preconceived conclusions or the dogmas of those paying them. It is impossible to get an economist to see the truth based on empirical evidence. The financial elite have purchased economists to spout academic hocus-pocus to justify Wall Street’s thievery.

    1. ECON

      Eric has made a point glanced over regarding economists and in fact observed in other fields including the sciences.
      Economists on Wall St and financial firms must sing from the corporate book of platitudes or forever be denied sustinence in the financial sector. Who pays you determines the song.

  16. Captool

    I have been looking and looking, is there a paper that points out the cost to the economy in expected earnings on savings, by the fed keeping rates this low. as in every point below x my older clients have to draw on reserves to make ends meet when they expected to have more interest earnings. I hate seeing riskier instruments pushed on these folks, and i know its hurting them, and I don’t quite understand how the fed seems to think this is a no cost policy.

  17. Susan the other

    Why did Dittmer sound so hilarious? I must be totally perverted. This was the funniest things I’ve found on NC since the parody of Timmy and the bottle opener. I guess I managed to miss the point entirely because I got lost in the irony. I may have come away with one point: It is now naughty to save and that is why there will be imposed on you a negative interest rate. I mean, how can any of us forget that Greenspan appeared before the Finance Committee and confessed that he had found an error in one of his models? All I can do is stay tuned because I don’t understand anything that is happening. I’m puzzled that anyone can comment on Dittmer with a straight face.

    1. Yves Smith Post author

      He did intend to be tongue in cheek. I’m sure he will be glad to learn that SOMEONE got his humor.

    2. Pwelder

      Sorry I missed the one about Timmy and the bottle opener. If it’s in the same league as the Dittmers “translation” it must be a helluva piece. Anybody have a link handy?

      More seriously, it would be really helpful to know if the authors of the original paper have expressed any opinion – formally, informally, winks, nods, wig-wags – as to whether Dittmers got them pretty much right.

      1. Susan the other

        Timmy and the bottle opener was a comment in conjunction with an article about Elizabeth Warren and a clip showing her grill Timmy in a congressional hearing (I think). And Timmy prevaricated shamelessly. It was a good month ago.

  18. RSDallas

    It appears to be an interesting article. I could only make it through about 1/3 of the article. It amazes me how much intellectual brainpower has gone into coming up with a reason why the financial system crashed and the credit bubble burst.

    The truth be told, it was that some very stupid people made some very stupid decisions as to who should be entrusted with borrowed money. Come on folks, we have serious problems when someone’s pet is issued a credit card and when someone earning $900.00 a month is granted a 1 million dollar home mortgage and when people are given loans without the lending institution even calling to see if the applicant has a job, let alone how much they make.

    I think that is what the authors of this article were eluding to in the limited reading I conducted. With this said, “What in the world makes this a compelling paper?”

    Our leaders, both politically and financially should be tried for treason and every single borrower who falsified any loan information should loose their homes. Probably more so the Fed and Treasury. There is no way in hell that this much fraud and corruption, on the part of both the borrowers and lenders could transpire without the main (TBTF) financial institutions knowing that they would be protected by the government if things got bad. Which it did and they were.

    The one piece of the puzzle that I can’t wrap my arms around though is “Why were the financial institutions allowed not to fail?” Is it safe to say that these same individuals would be found guilty of treason if we knew who they were. Somebody has to authorize a loan officer to approve a loan without calling and verifying the applicants qualifications. Somebody had to authorize a poor quality loan to be included in a mix of good quality loans and then securitized with a AAA rating. Someone has to grant their approval of a borrower borrowing 125% of the appraised value of a property. Somebody had to approve the commercial construction loan with no down payment and again for 125% of the appraised value. Are you telling me that the CEO’s of JP Morgan, Wells Fargo, Bank of America and Citi Group did not know that their employees were approving these loans?

    Who initiated this? Where did the directive to engage in this type of lending originate?

    Today, the Wall Street Journal reports that Citi Bank has recently sent out some 340 million advertising pieces for credit cards. I wonder how many pets were on the mailing list?

    1. Joe Rebholz

      “Somebody has to authorize …”

      I agree with many of your points. But maybe the somebody was a computer. Still somebody designed and used the computer programs. The fraud and lawlessness needs to be fixed, but we need more; the system must be changed. Even if there had been no fraud or lawlessness there still would have been a crash, only later than 2007, because the system even without fraud, etc. causes bubbles which can only crash.

    2. sgt_doom

      “The truth be told, it was that some very stupid people made some very stupid decisions as to who should be entrusted with borrowed money.”

      Geez, I hope you’re not really in Texas, as it seems like someone from that unfortunate state is forever bringing up the talking points.

      Do a little arithmetic, please: $1.5 trillion in subprime loans written between 2003 – 2007, then $14 trillion in mortgage backed securities and CDOs written (leveraged) based upon said loans, then the most conservative estimate is they were leveraged at the minimum of ten times to $140 trillion, and a 4% mortgage default rate — something which normally shouldn’t affect the American economy, let alone necessitate a global meltdown — cascades across all that leveraging to at least equal to $5.6 trillion, with further unemployment thanks to the banksters causing it to increase to trillions more (thanks to all that leveraging).

      And that doesn’t even account for the fact that the subprime market wasn’t even a drop in the bucket compared to all the leveraging and ultra-leveraging enabled by the peddling of securitized debt globally and nationally by the bankster class!

      And BTW, the upper 5/6ths recipients of those subprime loans were corporate RE speculators, and wealthy individual RE speculators, and corporate house-flippers, and wealthy individual house-flippers, it was only the bottom 1/6th which were residential (individual and family) home buyers.

      Live and learn, buddy, live and learn…..

    3. Fiver

      Have a look at Exhibit 4 in this 2009 report clearly illustrating who was and who was not, responsible for taking on the great bulk of the debt during the bubble from 2000 through 2007. It ought then to be immediately clear why the reason there has been virtually no traction for a robust political/regulatory/law enforcement response is that Bernanke didn’t just bail out insolvent banks with his criminal stupidity, he bailed out the top 2 income quintiles who owe the bulk of the stupendous sums of bubble debt owed to those banks. And as anyone following markets for the last couple years knows, he will do whatever it takes, legal and visible or illegal and hidden, no matter how much damage is inflicted on the lower 3 quints in the US or whole nations, even groups of nations elsewhere, to keep that unearned income flowing into banks.

  19. Hugh

    It is good to see any attention paid to the paper economy and the consequences that it has for the real economy. Because the paper economy is so much larger than the real economy, it has a constant distorting effect on the real economy. It can loot the real economy, blow bubbles in it, and then magnify the damage of those bubbles. Equilibrium is a central article of faith of charlatan economics. But what is important to realize about the paper economy is that, over and above the normal disequilibrium of markets, the paper economy is profoundly destabilizing. The tendency of the paper economy doesn’t create blips or spikes in the real economy. It sends it over the cliff.

    The paper economy is a product of the wealth inequality of kleptocracy. Looted wealth has to go somewhere. But it is also a tool for further looting and so greater wealth inequality.

    1. chas


      Seems to me we have a real economy which produces all the stuff we need & want – food, clothing, shelter, transportation, energy, health care, electronics, entertainment, etc. We happen to need money to exchange all of this between producers & consumers who are most of the times also producers. And who produces the money? This RIGHT was given to commercial banks & the central bank who oversees them.

      The real economy is humming along at less than capacity but the money producers are doing a miserable job. Mostly all of guvment’s efforts are directed at fixing the broken money producers. Why don’t we just get rid of these pathetic, failed money producers & let the Free Market produce the money. They’re doing a great job of producing all our stuff.

    1. Valissa

      Agreed! More of Andrew Dittmer’s colorful economic re-interpretations would be very welcome. I’ve always thought the savings glut theory was bullshit… so enjoyed the great snarky takedown of that!

  20. Fiver

    Good piece.

    I’ve thought since the first time I heard the claim years ago that there was a “savings glut” that such patently self-serving stupidity would soon blow away with the rest of the debris – never underestimate the ability of the best and brightest to lay on the BS so thick they convince themselves up is down. On par with constant accusations of Chinese perfidy in pegging to the dollar (as if it was wrong to try to blunt the effects of action taken by the world reserve currency Central Bank that has for decades used its position as a sledge hammer whenever deemed necessary) rather than craft a trade policy response that recognized an historically-speaking virtually instant arrival on the scene of hundreds of millions of very smart, very well educated, very hard working, and very low paid employees.

    I’m quite certain that in 2030, when half the planet is in chaos and/or ruin, there will still be economists and policy-makers barking into their wrist-phone implants on “secure” channels that Globalization, while having hit a bit of a “rough patch” remains both inevitable and desirable, in fact the best of all possible worlds.

    When I was a kid, I simply assumed, a la Star Trek, that a one-world system was the only sensible path for humanity. Well, given we aren’t going to the stars any time soon, if at all, and given there are 7 billion of us on a planet that can sustain only 1 billion at average US consumption levels over time, the “One Big System” approach is suicidal. How about an economics that acknowledges some rather basic limitations to “growth” at all?

  21. Chazz Michael Michaels

    I see why you might declare this censorship by the academic community. But it doesn’t seem like it’s news to say that the crisis was caused by bankers looting the global economy. Wasn’t that the point of Inside Job?

  22. JustAnObserver

    Not to in any way derate this piece (it made me laugh out loud) or the original research paper but I seem to recall very early on in the GFC someone doing a numbers based takedown of the “its all down to the Chinese savers” bollocks. This too was just ignored.

    Can’t remember who but I have a vague feeling it was FT related – William Buiter (in his Mavrecon days) ? Martin Wolf ? AlphaVille ?

  23. zebulon

    he who gets to borrow all the money and then declare bankruptcy is he who wins.

    bankruptcy lets people WIN. they get a fresh start.

    the banks can go bankrupt and their former owners win because the loss is never repaid. they keep their personal wealths due to the corporate veil of limited liability protecting their assets by way of a court system that makes ‘piercing the veil’ such a prolonged process that even when successful, it is ultimately useless because justice delayed is justice decayed .

    the only rational solution is to expropriate the wealth of ALL people who received value from the banks. that is NOT going to be limited to their ceo’s and chairpeople, but also counterparties including hedge funds and other people in the u.s.. —-it is a complex web that wall street weaved.
    and while i WOULD trust the people of the u.s. to go after their wealth, i wouldn’t trust the government to implement such a program.

    i favor a new privatised bearacracy called “citizens wall street reverse bailout fund” , and it is to be headed by former goldman sachs people tasked with getting bonuses based on how many of their old bosses and other people’s money they can ‘steal back’ in the name of the government.
    also, every former goldman employee hired, but first pass an recruiting exam in which they give up their old bosses. it’s easy, these greedy fucks are going to jump at the chance to take each others’ money because they will be so scared that if they don’t , it will be their money being taken.

    turn the pirhanna on themselves, throw them a bone,—this will provide some money for recapitalizing the governmnetn and the new nationalized bank system, as well as ensuring that former bankers are never in a place to victimize the public again.

    of course, this is all fantasy. world war iii would sooner happen than this scenario.

  24. joebhed

    While completely and finally shelving the system imbalances – gross savings hypothesis, hopefully once and for all, the strength of he BIS study is in its Conclusion.

    Calling for reforms to the monetary system to provide the financial stability that is elusive under the pro-cyclical, or excessively-elastic in paper-speak, banking, financial and monetary system we now have.

    From the paper – Conclusion
    “” Analytically, this paper is a plea for a more systematic inclusion of monetary and financial factors in current macroeconomic paradigms. The distinguishing characteristic of our economies is that they are monetary economies, in which credit creation plays a fundamental role.””

    This is great because it is as close as modern monetary economists can come to saying there is something wrong with the money system.

    Unfortunately, they remain incapable of understanding the rudimentary structure of a debt-based money system, along with the implications of compounding interest in such a system.

    Were they to understand the work of Dr. Bernd Senf, of the University of Berlin, they would agree that “The Deeper Roots of the World Financial Crisis” is the debt-money system.

    At that point, perhaps they would welcome the analysis of Dr. Kaoru Yamaguchi of a transition to a debt-free monetary system under control of the national government.
    On the Workings of a Public Money System……

    The really good thing is that if you follow the thinking to the end, it’s the money system.

  25. allis

    Thank you, Andrew Dittmer. Perhaps mainstream economics can be laughed out of existence.
    A question: why do so many intelligent people have faith in orthodox economics, and how did such nonsense ever come to be promulgated and accepted?
    One hypothesis, put forth by Mason Gaffney in “The Corruption of Economics” (1994) is that in the late 19th and early 20th century “Neo-Classical Economics [was developed as] a Stratagem against Henry George.” Is this hypothesis generally known? Is there any validity to it?
    Gaffney gives an interesting quote by the Henry George antagonist and influential economist, Richard Ely ,(1938): “Perhaps I am a college professor and the steel-car magnate whose rapacity I am called upon to help hold in check has endowed the chair which I occupy. Is it strange that many of us who are called upon to control others should simply refuse to do it?”

    1. joebhed

      Great stuff.
      That quote should have been used in the “Inside Job” movie when they were trotting out all the academia-econs to justify “the way things are”.
      That great movie ended without closing the loop from the bankcorporations funding to the university endowment funds – which would have made things a lot clearer.

      1. allis

        The Gaffney book has pages of information about the capture of academia by the enemies of Henry George. One of the worst was Cornell, but also Columbia, Johns Hopkins, and, of course, University of Chicago

  26. Francisco from Brussels

    I fully agree that the Borio/Disyatat BIS paper which I read a few weeks ago thanks to the Vox EU post is an excellent piece of work and I am delighted that it is discussed in this blog which I read on a daily basis and I consider as my favorite one even on the other side of the ponf here in Brussels. More recently I read an oustanding post on ‘Macroeconomic Resilience’ blog on distorsionary and distributional macro effects of mainstream Central Bank policy which I believe is an excellent complement to the Borio/Distayit analysis: ‘Bagehot’s Rule, Central Bank Incentives and Macroeconomic Resiliencede Macroeconomic Resilience,

    Cheers and best regards from Brussels

  27. Aquifer

    “most present day macroeconomic analysis proceeds by imagining that people only trade physical objects with each other. They don’t use money, and they certainly don’t make loans or go bankrupt. Even though the people that make these analyses know that in the real world money and loans and bankruptcy DO exist, they think that is useful to pretend that they don’t and then arrive at authoritative conclusions.”

    Classic example of Whitehead’s Fallacy of Misplaced Concreteness – never mind those pesky little “details” that don’t fit neatly into our model ….

  28. tgm

    Very important paper. Note however, that there are no references to Keynes, even though the paper is repeating Keynes critique of neoclassical theory. Minsky is not mentioned either, although he certainly pointed out much of this way back. — The link to the recent Brooking paper is important, as that report reflects the mainstream’s dissatisfaction with the prevailing IT paradigm. But the reception of Borio’s excellent paper show that it will still be some time before the mainstream is willing to embrace the real world.

  29. coutney d

    I for one have always seen capitalism as means by which competion and market conditions ie supply and demand, facilitate growth and validity in a field,product,commdity or whatever one’s heart desires. the most frustrating and disheartning thing about the economic crisis is just how far from capitalism we have come. Gone are the days when a person could save up money for a house or education or transportation. Now all these life changing benefits must be aquired through credit from a “monopoly” of lenders who all lobby for less regulation so they can play high stakes poker with the money which “seems” to have disapeared.Fiat currency is dangerous. Loss of meaningful wealth is dangerous.Lack of savings is dangerous, And yet the worlds overwhelming population of middle and working class people are now so entrenched with rags to riches myths they cant even see the fleece over there eyes.This is not rocket science nor is it triganomics. This my freinds is what happens when you privatize profit and then socialize loss

  30. Raj Thamotheram

    Great article. Great debate. I work in the investment world, on corporate governance and responsible investment/ESG. What’s really interesting to me is that your very active debate is largely unknown to my community and another project that I am involved with – the Network for Sustainable Financial Markets – has many academics but few economists.

    Similarly, I see UNCTAD mention CSR quite seriously in their 2011 report but the section on investment seems to me to be rather weak and largely misses the point about how mainstream investment could be a bigger part of the solution (impact investing is all very nice but not a game changer).

    Shouldn’t we put more effort into connecting enlightened economists with enlightened investors? And what would be an agenda of mutual interest?

    1. courtney d

      The reason I believe our talk on this website is unknown to a corporate governance body is this. Any one with the desire for an outside opinion or a fresh point of view is most likely discouraged by the keepers of the “business as usual crowd”. In my humble opinion the economic change which must manifest itself to bring about the financial stability we all so desire will at first be traumatic as well as destructive. The systematic change was averted in 2008 with T.A.R.P. and other bail outs. A wise man once said “the most painful experience one can have is trying to avoid pain in the first place.The advent of the industrial age along with the discovery of cheap energy and an ever increasing human population,compounded with an insatiable desire for a better lifestyle, higher profit, with hands off maintenance is beginning to catch up to us. I admire this discussion and I find it fascinating that a member of the investment community would join it with such an open mind.Although I have to reiterate my somewhat pessimistic view. This global economy is designed to uphold the gains of private institutions. While depleting the resources from society. I don’t believe in socialism, but I know greed when I see it. When we as a people find a way to maintain a sustainable degree of profit gain that is available to all those who are compelled to participate we will see true change.

  31. coutney d

    Does anyone have an opinion on the Brooksley Bourne incident with Alan Greenspan during the Clinton years. Do you think it was ignorance or arrogance? Also does anyone think that economic crises could have been avoided if the sale of over the counter derivatives was regulated. Last question, does the O.T.C. derivatives market still remain unregulated and does it represent capitalism or a cowardly investment tool for investors. thanks

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