BEIJING – Before July 2007, most economists agreed that global imbalances were the most important threat to global growth. It was argued that the United States’ rising net foreign debt-to-GDP ratio – the result of chronic current-account deficits – would put a sharp brake on capital inflows, in turn weakening the dollar, driving up interest rates, and plunging the US economy into crisis.
But this scenario failed to materialize. Instead, the crisis stemmed from the US sub-prime debacle, which quickly dragged the global economy into its deepest recession since the 1930’s.
Most economists failed to foresee the economic dynamics that actually led to the crisis, because they failed to pay enough attention to the rapid increase in US total debt. Instead, they focused exclusively on US foreign debt, ignoring household debt (mortgage and consumer debt), public debt, business debt, and financial debt.
In particular, they should have paid greater attention to the sustainability of US mortgage and consumer debt. In 2007, the mortgage and consumer debt-to-GDP ratio was more than 90%, compared to 24% for net foreign debt.