“This financial crisis is a direct result of the greed and irresponsibility that has dominated Washington and Wall Street for years,” said Barack Obama yesterday. The American worker, John McCain explained last month, has been “betrayed by a casino on Wall Street of greedy, corrupt excess.” These explanations are extraordinarily superficial, even by the standards of American presidential campaigns. “Wall Street” has been “greedy” for hundreds of years. So why is the global financial system in crisis now?
It’s time for the candidates to learn some elemental economic principles and even a little history. The fundamental cause of today’s financial crisis is excess liquidity in the United States. When lenders have too much to lend, they have strong incentives to throw money at questionable borrowers. The resulting economic imbalances are unwound either through financial crises or war.
American lenders have had too much money at their disposal in recent years because China has lent staggering sums to America, especially the U.S. Treasury, Fannie, and Freddie. Beijing has done that because the United States is the place where most excess cash in the world goes. The Chinese have excess cash because they have excess savings. They have excess savings because the government depresses internal consumption and creates massive trade surpluses-like last year’s US$262.2 billion (all of which but $5.9 billion related to sales to the United States). Beijing runs up massive trade surpluses because it manipulates the value of its currency to provide a cost advantage, provides below-market credit to producers, depresses the cost of labor, and subsidizes crucial manufacturing inputs like energy and water. When a country engineers excess savings, it has no choice but to lend funds abroad.
The path to a sounder financial system in the world, therefore, is to get the Chinese to adopt market-economy principles. If Beijing cannot do that-which it undoubtedly cannot due to its authoritarian political system-then we need to examine our trade and other relations with China. It is simply not possible to maintain a sustainable international financial system when one large country continues to game all the others with a non-market economy.
What should the United States do? The answer is not so clear, but we obviously need to start holding China to the promises it made to join the World Trade Organization. Of course, that’s only a start.
Yet one thing is obvious: we’re not going to get where we need to be if we let the presidential candidates avoid the real issues by blaming the greed of Wall Street’s financial intermediaries.