BACKGROUND & CONTEXT
Since August 2007, what originally started as a housing bubble in the USA and Britain quickly became a widespread credit crunch; was followed in 2008 by an unprecedented crisis of
confidence in world's banks, central banks and the governments behind them; was later succeeded by sovereign debt worries for European countries previously thought to be prosperous and dependable ; unveiled shortly after persistent frictions on the setting of global exchange rates and the adequacy of bank capitalizations; and is now increasingly looking like it will lead to trade conflicts which can inevitably alter the rules of globalization.
In recent memory no other economic crisis managed to confound so many economists, bankers, businessmen and government leaders, in so many countries, so much and for so long. This one hasn't just caused massive global financial instability, but it will also be remembered for laying the foundation for the emergence of a new world economic order.
Seven years after the crisis, all of the G7 countries representing the advanced economies of the world are unmistakably flirting with deflation. Even Germany, which best weathered the shock among the G7, is now facing economic stagnation courtesy of unfavorable currency fluctuations combined with deteriorating demand in its own home turf of Europe.
Yet, a lot has happened since March 2009 -- the low-point of the Great Recession -- when $30 trillions of global wealth vanished inexplicably. Since then most stock markets worldwide have bounced back from their historic drops, and some like the in the US or UK have even reached record highs.
Alas, appearances can be deceiving. Historically strong stock markets have always been associated with strong economies. To suggest that this time is different has to pass scrutiny, especially for two key assumptions sustaining the excitement: the lowest interest rates in generations are expected to deliver real economic growth worldwide and, investor hopes of oversized financial returns from equities, when compared to alternatives, are warranted.
Both of these assumptions invite natural skepticism. What if the exceptionally daring monetary experiments by central banks in the US and the EU were not able to deliver the longed-for recoveries in the rich countries of the world? What if the flirtation with deflation was not a fantasy, but a new adversity to prick the stock-market bubbles back into reality? After all, Japan is a living proof for both of these misplaced hopes for over 20 years now.
Inconsistent explanations behind the wreckage
In the weeks following Lehman's bankruptcy, when the US government was perceived as struggling to regain financial stability while still experimenting with how not to violate the moral principles of capitalism, investors everywhere ran for the exits: with assets prices dropping precipitously, over $12 trillion of world's financial wealth disappeared quickly.
By March 2009, six months after Lehman's bankruptcy, the financial damage was simply devastating. What had started as the US sub-prime mortgage crisis, originally estimated to cause about a $1 trillion of asset impairment to a number of careless lenders, had gradually evolved into recent history's largest and most brutal financial asset destruction story: at that low point, as much as 30% of world's GDP went temporarily missing.
Yet reactions and explanations were everything but consistent. Pinning the problem on the U.S. subprime mortgages – which was the first media reaction – failed to explain the severity and reach of this global contraction, which ended up all the way in Russia. After all, the latter had apparently no banks exposed to subprime or to other toxic paper.
The "mispricing of risk" argument proposed by former Fed chairman, Alan Greenspan, did not address the dangerous role that the "shadow banking" system — the non-bank financial institutions that defined deregulated American finance — played in this debacle. They, more than commercial banks with tight lending practices, are behind the $7 trillion excessive debt which ballooned in the U.S. financial sector in the decade preceding 2007.
"The failure of laissez-faire U.S. capitalism", suggested by the former E.U. President Sarkozy, did not illuminate how Europe's largest universal banks have been even more devastated. It is now widely acknowledged that, beyond U.S. investment banks and financial giants, the practice of reckless overleveraging was alive and well on both sides of the Atlantic. Those so-called European "universal banks" like UBS, Deutsche Bank, RBS and Barclays, to name a few, were surely keeping rival banking conglomerates like Citigroup and Bank of America in ravenous company.
The Great Crisis of 2008 has had devastating consequences worldwide. But its impact on America has been brutal, comparable only to the economic damage of the Great Depression. Although a global consensus on the causes behind the Great Recession has been particularly difficult to reach, three factors appear to create convergence everywhere: excessive household debt, overleveraged financial sector and breakdown in accountability (both in the supervisory regulations and the corporate governance of big financial firms) to control an "overdose" condition in the previous two.
All three factors were present to varying degrees on both sides of the Atlantic. The question of "to what extent has lax monetary policy also contributed to stimulate the presence of all three?" is, rather remarkably, still unanswered.
Against this backdrop, there still remains however a few questions of major consequence. Attempting to answer some of them could provide valuable lessons for the future:
- When bubbles stemming from lax credit burst, as in 2007, who gets hurt the most?
- Why free-flow Global Finance, a once hailed concept, hasn't averted the recession?
- Why is global deleveraging, a post-recession imperative, still very much deferred?
- Can monetary policy geared to currency debasement deliver economic growth?
- Why are all the rich economies of the world struggling with growth renewal?
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