There has been some discussion that the US economic crisis closely resembles many of the emerging market crises of recent decades. Simon Johnson makes the argument quite well in this article in The Atlantic.
In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.
But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.
Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better—in a “buck stops somewhere else” sort of way—on the flow of savings out of China. Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing efforts to promote broader homeownership. And, of course, it is axiomatic to everyone that the regulators responsible for “safety and soundness” were fast asleep at the wheel.
But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they allbenefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector’s profits—such as Brooksley Born’s now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998—were ignored or swept aside.
It is quite hard to argue with that assessment and I really don’t. I also don’t expect that the mutally beneficial relationship between large business and government will end anytime soon. We may change the letters after the names of the politicians in charge, but money talks and Democrats are just as susceptible to it as Republicans. Much of the deregulation that is currently decried by Democrats in fact started under Carter and continued through administrations of both parties.
And because I don’t expect the relationship to end, I expect the government to solve this as many other banana republics have in the past – through inflation. Most economists seem to think that as the economy recovers and inflation emerges, the Fed will be able to remove the new money from the system in time to prevent a large inflation rate, but I have my doubts. First of all, if the Fed missed the dot com bubble, the housing bubble and now the deflation of the last 6 months, what makes anyone think they will be any better at recognizing emerging inflation? I sure don’t. Second, inflation has nothing to do with growth; it is a monetary phenomenon and can emerge regardless of growth rates (remember the 70s!).
Johnson also believes inflation could emerge quite quickly (via Base Line Scenario):
As we explained in our Washington Post article yesterday, we strongly support what Ben Bernanke is doing – there is a lot of uncertainty and the alternatives are much worse. But we don’t accept the premise that the Fed’s actions today cannot cause inflation quite soon. Arguing more about this, here and elsewhere, should help us think about how to manage the consequences and minimize the costs.
Excessive inflation is a typical outcome in oligarchic situations when a weak (or pliant) government is unable to force the most powerful to take their losses – high inflation is, in many ways, an inefficient and regressive tax but it’s also often a transfer from poor to rich.
As I’ve pointed out before, there are two variables which correlate well with high levels of inequality: inflation and corruption. They go hand in hand and the US has plenty of both. Yes, we are a lot like an emerging economy and destined to become more so.
