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In a ground-breaking article, The Global Crash we could have avoided (Australian Literary Review, 6/5/09), Dr John Edwards suggested that the global financial crisis (GFC) could have been prevented because it was simply due to the large sub-prime losses that heavily-indebted US banks incurred as the result of commercial irresponsibility and defective regulation.
Though it is possible to quibble about details of his case, the path out of the GFC that Dr Edwards has suggested as a consequence of that simplifying conclusion (ie addressing one part of the global problem at a time and starting with reform of US institutions) is plausible and attractive.
None-the-less it will be suggested below that more than reform of US institutions is required to reduce the risk of ongoing global crises because:
|The Need to Do More||
The Need to Do More than Reform US Institutions
The article, The Global Crash We Could have Avoided, did not only suggest a simple explanation of, and remedy for, the GFC (related to better banking practices and regulation in the US). It also outlined and argued against many broader theories about GFC causes (eg high debt levels / a credit boom / low interest rates / an asset bubble / international financial imbalances).
For example, the article commented on many of the views expressed about causes of the GFC by Australia's Prime Minister (Mr Rudd) in a paper ('The Global Financial Crisis, The Monthly, February 2009). It endorsed his view that "the main problem in the US was [poor] financial regulation and political attitudes towards it", but rejected his suggestions (and similar claims by many other observers) that broader issues are also at stake.
Can Other Factors Be Ignored?
However, while Mr Rudd's main conclusion seems overstated (ie that a heavily interventionist system of political economy is now needed because the 'neo-liberal' paradigm of the last few decades failed - see A Social Democratic Alternative to 'Neo-Liberalism'?), there is a need to consider the other possibly-significant causes that he (and others) suggested. Unless these are addressed, as well as the relatively-easily-corrected defects that Dr Edward's article nominated, the GFC is likely to have more severe and longer-lasting consequences than he implied.
Two particular facts suggest that his article has not addressed all aspects of the problem:
Simple Causes in Complex Systems?
An even more fundamental question involves the adequacy of simple causes (such as irresponsible bankers and defective regulation) in explaining outcomes in complex systems. A lightening-strike does not necessarily cause a bush-fire. What happens depends on the environment in which it occurs (ie a bushfire may result in a in a tinder-dry environment, but seldom during a thunderstorm). The assassination of Archduke Franz Ferdinand of Austria has often been identified as the 'cause' of World War I. But there have been many assassinations that did not lead to world wars. Other environmental circumstances (eg international political stresses) also had to be right for that particular assassination to have such severe consequences.
Thus one can't conclude (as the article suggested) that factors that did not lead to a financial crisis elsewhere could not have contributed to one in the US. Moreover:
Dr Edward's article was probably premature to conclude that, because booms in sharemarket and property values did not lead to financial crises in (say) Australia, they could not have done so in the US - a quite different environment.
Context to the GFC
The US, unlike Australia, was apparently engaged in very risky unilateral endeavours to promote global economic development in the basis of democratic capitalist practices - presumably as a legacy of the Cold War against Communism.
The US clearly based its monetary policy (which had been the main tool for macroeconomic management since the 1970s) on maintaining global growth in the face of the demand deficits implicit in East Asia's export-led industrialization strategies (see Structural Incompatibility Puts Global Growth at Risk, 2003). For example Alan Greenspan (as Federal Reserve Chairnan) often noted the need to guard against deflation as the reason for the low interest rates that inadvertently encouraged asset inflation in the US - yet deflation was a risk that Japan faced because of features of its economic model (but the US itself didn't). Mr Greenspan, at the same time, expressed hope that market forces would eventually force a reduction in the global financial imbalances that resulted from this.
The East Asian export led industrialization strategies that Japan pioneered were macroeconomically unbalanced (ie they had to contain a large demand deficit, because of the way production was organised). They were thus unsustainable within themselves (ie they depended critically on other's willingness and ability to run large and perpetual current account deficits) - see Are East Asian Economic Models Sustainable?, The US was able to take this responsibility for counter-balancing these demand deficits for many years because: (a) the $US was the global reserve currency; (b) it had a strong financial system; (c) the development of macroeconomic management methods (ie boosting liquidity to counter financial reversals) appeared to allow long term sustained growth; and (d) rapid escalation in asset values in recent years allowed high rates of household spending and government tax collections. However because of the scale that economies operating on East Asian economic models acquired, they ultimately had the effect of making global growth unsustainable, long before US sub-prime mortgages emerged to trigger a crisis in 2007 (op cit).
A financial crisis of some sort could probably not have been avoided just by smarter bankers and better regulation just in the US. A tinder-dry economic environment had been created, and was likely to be ignited by something. If the US had not had the aggressive banks and loose regulatory / monetary arrangements needed to sustain large financial imbalances, a different sort of crisis would have occurred at another time.
The Problem with a Narrow Focus
Dr Edward's hopeful vision of the future had much appeal. However it may not be achieved without practical action to address more of the diverse factors that have led to the current situation, Structural Indicators of Ongoing Recession / Depression speculates about what else could go wrong, for example, that:
US adherence to 'world standards' for financial regulation on its own would merely expose East Asia (which is now economically significant to Australia) to the financial crises that have always been implicit in the region's economic models. The adjustment to market forces that would occur in a few years would probably be catastrophic rather than incremental.
Getting Australia's House in Order
On the assumption that the problem may be quite complex and thus not quickly resolved, some suggestions about Australia's response are in Managing Australia's Economic Crisis. This refers (for example) to: developing more realistic machinery of government; and boosting the supply capacity of the economy.