Introduction
Dr Linda Yueh is an economist and commentator on global economic and business issues. She is a fellow in economics at the University of Oxford, a visiting professor at the London Business School, and an associate of the Centre for Economic Performance at the London School of Economics and Political Science. Previously, she worked as a corporate lawyer internationally, based in New York, Hong Kong and Beijing. Recent books include Macroeconomics (co-authored with Graeme Chamberlin), Globalisation and Economic Growth in China (co-edited with Yang Yao), The Law and Economics of Globalisation: New Challenges for a World in Flux (editor), and The Future of Asian Trade and Growth: Economic Development with the Emergence of China (editor). Dr Yueh is editor of the Economic Development and Growth book series published by World Scientific Publishing, and serves as an adviser to the World Economic Forum in Davos, Switzerland, and the UK government. She is a frequent commentator for the media, including the BBC, CNBC, CNN and the Guardian.
The Financial Crisis
Although it is certainly true that excessive risk-taking by financiers and inadequate regulatory supervision are to blame for the global financial crisis, international macroeconomic forces should not be overlooked as a contributing factor. This is particularly the case as any lasting resolution must address the causes as well as the wider context of the most significant global economic crisis in recent memory.
The economic crisis of 2008 has its roots in the last recession. Ever since the US central bank used loose monetary policy to stave off a technical recession in 2001, after the dot-com bubble burst, low interest rates in developed economies became the norm as economic growth continued to be strong. Cutting interest rates to stimulate the economy during a downturn is the usual use of monetary policy, but the extent of globalization in a fundamentally changed global economy of the 2000s altered its effects.
The mispriced risk, which was at the heart of the US subprime mortgage crisis, is a result of low interest rates and excess liquidity. Credit was cheap and plentiful, which is peculiar in a country with a low rate of saving as well as a high level of consumer debt and highly leveraged firms. Normally, with a savings deficit, borrowing would be more expensive given the low supply of funds.
The liquidity did not cause inflation. This is due to globalization and the global appetite for US debt, which kept down prices and the cost of borrowing. The US Federal Reserve then missed the signal that money was too cheap and lenders continued to seek borrowers, even if they were sub-prime ones.
This strong demand for US treasuries stemmed from the trade surpluses in the Middle East (due to oil exports) and China and elsewhere in Asia (due to cheap manufactured goods). When combined with a high savings rate, particularly in Asia, large foreign exchange reserve holdings accumulated in their coffers. As a result of the fixed exchange rates operated by these countries, purchases of US treasuries were necessary even if the American interest rate, and therefore returns, were low.
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