What happened to the global economy and what we can do about it
with 21 comments
By Simon Johnson
The next financial boom seems likely to be centered on lending to emerging markets. Sam Finkelstein, head of emerging markets debt at Goldman Sachs Asset Management, summed up the prevailing market view – and no doubt talked up his own positions – with a prominent quote in Monday’s Financial Times (p.13, front of the Companies and Markets section):
“Debt-to-GDP ratios in the developed world are about double those in emerging markets and they’re growing. This makes emerging markets interesting because you’re pick up incremental spread [higher interest rates compared with developed world rates], and in return you’re actually taking less macroeconomic risk.”
This is a dangerous view for three reasons.
First, against all historical evidence, it assumes that the only macroeconomic risks we should worry about – in general or for emerging markets – are related to standard measures of government fiscal policy. “Less risk” and “more yield” was exactly what securitized subprime mortgages and their derivatives were purported to offer; this combination typically proves illusory.
Second, emerging markets got into serious trouble through private sector overborrowing both in the 1970s (Latin America, communist Poland and Romania) and in the 1990s (many parts of Asia). In some crises, the government stepped in and ended up holding a great deal of debt – but this does not change the fact that the exuberance was all about private sector banks (in the US and Europe) lending to private sector corporations (financial and nonfinancial) in a mispricing of risk that started out at modest levels but grew over the cycle.
Third, when your ability to borrow depends in part on the value of your collateral – see the academic work of Ben Bernanke and the experience of Japan in the late 1980s (e.g., the classic Hoshi-Kashyap volume) – then rising asset prices enable you to borrow more. This does not necessarily have to go bad in a macroeconomic sense, but experience over the last 30 years is not encouraging. Global moral hazard – the idea that someone will provide a bailout – does not mix well with free capital flows and this kind of financial accelerator.
Goldman Sachs knows all this, of course. But, as they will tell you correctly, reforming incentives or even discouraging this kind of cycle is definitely not their job. Their role is to make money, pure and pretty simple given their market share.
It’s the responsibility of government to make the world financial system less dangerous. Judging from the G20 summit (see my comments on the communique) this weekend, we are making no progress at all in that direction.
Written by Simon Johnson
June 29, 2010 at 6:16 am
Posted in Commentary
Tagged with goldman sachs
“Goldman Sachs knows all this, of course. But, as they will tell you correctly, reforming incentives or even discouraging this kind of cycle is definitely not their job. Their role is to make money, pure and pretty simple given their market share.” ================================================
Goldman Sachs discourages “reforming incentives” and encourages “this kind of cycle”.
Goldman is also fully aware that “It's the responsibility of government to make the world financial system less dangerous”.
Which is why Goldman owns the politicians who are in a position to discourage this type of cycle.
LarryP
June 29, 2010 at 7:57 am
Why would GS let a little thing like risky loans, that may never be paid, interfere with their ability to make a profit? Uncle Sam will always bail them out.
ella
June 29, 2010 at 9:18 am
Thus, you will have an ‘overspill’ of the Citigroup -type, unless something is done about it All these G-20 and so forth ‘institutions’ are loaded with references to systemic risks, systemic institutions. Then your President walks in the room, with a Fin-reg reform ( let’s hope it gets blocked in the voting ), with systemic risk alive and well to quote Yves Smith, what are the people representing the emerging markets or ‘countries’to think ?
Maybe the FSB task forces should read your book before the matter rolls back on the conference table in Korea
charles
June 29, 2010 at 9:43 am
Reducing the debt to GDP ratio (or at least leveling it’s trajectory) is not dangerous – trying to pull forward more demand on credit is dangerous.
Wilma
June 29, 2010 at 10:03 am
A president for the people is what Americans believed they were electing. Instead, we have a president who choses his people from Wall Street, supports Wall Street, the big banks and Goldman Sachs and believes in the government controlling everything. We still have 10% unemployment in this country and I do not believe Americans will forget the campaign promises that were made that have not been kept. Intelligent, but unable to get a grip on what’s important to Americans at this stage in the game!
Robbie Griffin
June 29, 2010 at 10:20 am
A small contradiction here, Robbie? If “we have a president who choses his people from Wall Street, supports Wall Street, the big banks and Goldman Sachs” how could it be said that he “believes in the government controlling everything”? From the behavior, all we see is an absence of government control. Excoriate this weasily maggot all you wish – no argument there – but not on this account.
Kliment Voroshilov
June 29, 2010 at 3:45 pm
Anyone serious will tell you that the 10% figure is as phony as the current President. Why don’t we redo the census so that that we can claim unemployment is declining? The actual figure is near 17% and rising.
Tyrone
June 29, 2010 at 4:19 pm
Obscene, isn’t it? And this prevaricating little eel has done zilch to address the problem and won’t until the streets of Washington are filled with a sea of angry faces.
Kliment Voroshilov
June 29, 2010 at 4:31 pm
I think I have to side with GS on this one, mostly – the key risk to lending in the 70s was US inflation. LatAm borrowed in dollars, thinking future dollars would be cheap to buy, then Volker happened.
Many factors are different here – LatAm has less structural debt than we do (reverse of 70s), we’re already at low/negative inflation (so dollars are already pretty expensive), the population hourglass favors LatAm this time (the Boomers starting hitting the work force and the housing market in the 80s in force).
US 30 years are under 4% today… That’s a lot of macro risk if the US starts to face a sovereign debt crisis. LatAm’s biggest risk is probably structural export dependency, but they’ve done a decent job of developing internal markets (unlike China).
IMHO, the biggest risk to LatAm debt is that GS is advocating it.
StatsGuy
June 29, 2010 at 10:43 am
The biggest problem with large capital inflows is that they get misallocated due to loose governance (or outright corruption) — a situation that GS seems to always be able to sniff out like a bloodhound.
Read Full Article »