Noodling on Global Imbalances

I’m going to mostly think out loud here if you don’t mind. At the moment, there’s a common view of the relationship between “global imbalances” of financial flows and the bubble in the United States that relies on the idea of a “global savings glut.” Too much money was being saved in Asia, and it had to go somewhere. So it poured into the US and helped generate our bubble. Ezra Klein says maybe it’s the other way around:

I just had a conversation with Steve Pearlstein that’s making me somewhat reconsider the point. The causality, he argued, isn’t as clear as all that. It may be that we developed these exotic financial instruments as a response to the river of money being pumped into our system. Or it may go the opposite way: That money was pumped into our system because we concocted abnormally attractive investments that caught the eye of foreign investors.

This is a slightly different spin on the same argument: In this telling, the current account deficit was still the problem. But it grew so large not because of foreign investors but because of Wall Street’s decisions. Without the development of seemingly safe, high-return assets, that money would have been left to low-yield treasuries, and because those wouldn’t have delivered sufficient returns, the money would have ended up going elsewhere. If that’s true, then it may be that sufficient regulation of the financial sector actually could do quite a bit to ease our current account problems.

I think that all depends on what you think the “problem” is exactly. After all, we’re talking about a period of time in which average people’s earnings were flat or falling. The current account imbalance allowed people to skirt that problem via debt-financed borrowing, thus allowing consumption and apparent living standards to continue growing. If you regulated the (apparently) high-yield, (apparently) low-risk investment opportunities out of existence, the money would have flowed elsewhere — to Ireland, Spain, Iceland, Lithuania, the UK wherever else people were willing to offer an (apparent) free lunch to savers. It’s hard to imagine American politicians actually doing that. The crux of the matter is that foreign capital flows into the United States weren’t a “problem,” they were a solution to the problem of stagnating income. Our problem today is that those flows were unsustainable, so now everyone’s in trouble. But it seems to me that what’s really needed is a solution to the problem of wages and income. And the tragedy of the bubble years is that for all the money that flowed into the country, what we have to show for it is stuff that’s of little enduring utility — houses that are now vacant, or more-or-less frivolous consumption goods. In principle that money could have funded the kind of investments in infrastructure and education that would pay off in terms of faster growth and higher incomes down the road. Instead, it basically all went into depreciating assets.