Asia's Fault?

Now that the sub prime crisis has spread to practically every other kind of borrowing, Paul Krugman wants to know why, and thinks he has found the answer in the writing of then economics prof Ben Bernanke.

The speech, titled “The Global Saving Glut and the U.S. Current Account Deficit,” offered a novel explanation for the rapid rise of the U.S. trade deficit in the early 21st century. The causes, argued Mr. Bernanke, lay not in America but in Asia.

In the mid-1990s, he pointed out, the emerging economies of Asia had been major importers of capital, borrowing abroad to finance their development. But after the Asian financial crisis of 1997-98 (which seemed like a big deal at the time but looks trivial compared with what’s happening now), these countries began protecting themselves by amassing huge war chests of foreign assets, in effect exporting capital to the rest of the world.

The result was a world awash in cheap money, looking for somewhere to go.

Where it went was mostly to the US. Why?

Mr. Bernanke cited “the depth and sophistication of the country’s financial markets (which, among other things, have allowed households easy access to housing wealth).” Depth, yes. But sophistication? Well, you could say that American bankers, empowered by a quarter-century of deregulatory zeal, led the world in finding sophisticated ways to enrich themselves by hiding risk and fooling investors.

And wide-open, loosely regulated financial systems characterized many of the other recipients of large capital inflows. This may explain the almost eerie correlation between conservative praise two or three years ago and economic disaster today. “Reforms have made Iceland a Nordic tiger,” declared a paper from the Cato Institute. “How Ireland Became the Celtic Tiger” was the title of one Heritage Foundation article; “The Estonian Economic Miracle” was the title of another. All three nations are in deep crisis now.

There is something odd and counterintuitive the fact that the money so often went where it could do the most damage. Why did it go for McMansions, war and HDTVs instead of, say, scientific research and new schools?

In any case, the mercantilist economic policies that produced the glut are still at work, and continue to damage both seller and buyer.

So that’s how we got into this mess. And we’re still looking for the way out.