Americans are from Italy, Europeans are from Japan

Many people believe that America will try to play “the Italian card”: inflating away its public debt and devaluing the currency in order to maintain international competitiveness. Europe, meanwhile, also faces skyrocketing public debt, but the strengthening euro makes inflation impossible, making Japanese-style stagnation a serious risk.

MUNICH – The American business model has collapsed. During recent years, the United States borrowed gigantic sums of money from the rest of the word. Net capital imports exceeded $800 billion in 2008 alone. The money came largely from selling mortgage-backed securities and collateralized debt obligations, claims against claims against American homeowners (or to be precise, only against the homes themselves, as the owners were protected by the non-recourse nature of loans).

The market for such securities has now vanished. While the volume of new issues in 2006 was $1.9 trillion, the likely volume in 2009 will be just $50 billion, according to the most recent IMF estimates. The market declined by 97%. No number reveals the true catastrophe of the American financial system more than this one.

As the flow of funds from the world to US homeowners was disrupted, house prices collapsed by 30%, and construction of new homes by more than 70%. The recession was inevitable. Laid-off construction workers tightened their belts, as did homeowners. Some did so because they felt poorer. Others did so because the banks, shocked by the collapse of the securitization business, stopped giving them home-equity loans for consumption purposes.

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