The failures of the past have led to the so-called imbalances of the present. The United States, issuer of the world’s most important currency, has become the world’s borrower of last resort. It is the outcome of obvious failures:
• the failure to understand properly the inherent risks of all liberalized financial markets where decisions are made by competing market-oriented institutions;
• the failure to appreciate the greater risks when finances cross frontiers, particularly for fragile emerging market economies;
• the failure of debtor countries to understand the risks inherent in borrowing in foreign currencies and the consequent need for greater fiscal and monetary discipline;
• the failure to understand exchange rate risk both by creditors and debtors;
• more broadly, the failure to understand what it means to live with the exchange rate instability of today’s multicurrency world, instead of the high predictability of the gold standard of the late 19th and early 20th centuries;
• the failure to modernize global institutions in time.
The huge deficits that the United States willingly incurred gave the world breathing space. But that could not last forever. Adjustment in the global balance of payments is now taking place. If it is to occur smoothly, we must move toward a world in which sizable net flows of capital to emerging markets can occur without crisis. Few would dispute that such an outcome is desirable. The question is how best to achieve it.
Many blame the United States’ predicament on the policies of the Federal Reserve and lax regulation of the financial system. These arguments are not without merit, but they are exaggerated. Given the pattern of global savings and investment, the United States emerged naturally—I would argue, inevitably—as the world’s borrower of last resort. That severely constrained the degrees of freedom for Federal Reserve monetary policy, on the plausible presumption that it was loath to permit a sustained recession. Given the scale of the net borrowing by the United States and the lack of corporate demand for outside funding, the aggressive monetary easing, the consequent financial excess, and above all the housing-related excess were almost inevitable.
Thus the United States is at least as much the victim of decisions made by others as the author of its own misfortunes. That is an unpopular view–in the U.S. because it is easier for Americans to accept the view that they are guilty than that they are impotent, and in the rest of the world, because it is far easier for others to accept that the U.S. is guilty than that they themselves are responsible.
Where do we go from here? We need to create a financial and global macroeconomic regime that allows reasonably well-run countries to import at last some capital with a degree of safety that ends reliance on the United States as the borrower and spender of last resort, and that halts the cycle of financial crisis in emerging countries that preceded the ascendance of the United States as borrower of last resort. A different world must now be envisaged, one in which capital flows productively and safely to poor countries.
Excerpted from Fixing Global Finance, © 2008 by Martin Wolf. Reproduced by permission of Johns Hopkins University Press.
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