Friday, August 28, 2009

The Real Cause of the Financial Crisis

No doubt the cause of the financial crisis that began last fall will be discussed and debated for years. Future PhD's will make their names drawing conclusions from it. But as we approach the anniversary of the collapse of Lehman Brothers, the casting about for a root cause will intensify. To date, I have read no better explanation than this one at Econbrowser, co-authored by Menzie Chinn, a professor at the UW Madison:

[W]e view the current episode as a replay of past debt crises, driven by profligate fiscal policies, but made much more virulent by a combination of high leverage, financial innovation, and regulatory disarmament. In this environment, speculation and outright criminal activities thrived; but those are exacerbating, rather than causal, factors....

We are now witnessing the unwinding of this process of debt accumulation....

In some sense, this process of retrenchment is necessary. For many years, the United States consumed more than it produced. We borrowed and for a while thought that the old rules had been suspended. But now it turns out that we do have to pay back what we have borrowed. The attendant higher saving rate and lower investment rate will lead to a substantial improvement in the current account balance, or in other words, the paying off of our debt.
We borrowed and spent like there was no tomorrow. Well, welcome to tomorrow.

I just listened to a fascinating discussion of Orwell with Christopher Hitchens. He describes how Orwell recognized one of his own strengths was his "power of facing unpleasant facts."

Certainly Chinn's analysis above includes some unpleasant facts. Our power of facing with regard to these facts is not immediately apparent; but one can hope that we yet have the power to become a bit more Orwellian. Which in this sense would be a good thing.

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