Today’s ongoing financial market turmoil comes as no surprise to those who have been warning about the risks to the world economy from the end of the housing market bubble in the United States. Back in January, the United Nations’ outlook for the global economy raised concerns about the economic pain this might impose on heavily indebted US households. It also emphasized how weakly regulated, closely interconnected global financial markets, together with persistent global macroeconomic imbalances, jeopardize growth and development prospects in the world economy, including poorer countries.
The US current account deficit has been the most widely discussed indicator of global imbalances. For the past five years, the US has been sucking in more than $2 billion a day of other countries’ savings, as the easy provision of domestic credit on an unprecedented scale has allowed households to spend more than they earn. Such borrowing was especially attractive as asset (housing and equity) prices kept rising, interest rates remained low, and succeeding generations of financial market innovators could convince investors that they had mastered the exigencies of risk. Thus, further lending, even against over-valued collateral, was “sold” as a sign of good times ahead.
Warnings about irrational market exuberance were largely ignored, especially as US consumer spending helped fuel strong growth across the global economy. Robust exports from Japan and Europe supported economic recovery and steadied investor confidence, providing, in turn, further export opportunities for newly industrializing countries, most notably China.
Meanwhile, heightened international competition kept the lid on inflation, and interest rates remained low, giving a further boost to consumer spending and completing what looked like a virtuous growth circle. Even many of the poorest countries seemed, at long last, to be joining in, posting strong growth on the back of rising energy and raw material prices, renewed mining investments from abroad, and increasing fiscal revenues.