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Identifying And Fixing The Global Economy's Woes

The roots of the global economic meltdown are far deeper and more complex than most people think, and recovery will require far bolder actions than are being taken now.

That’s the sobering message delivered by Martin Wolf, associate editor and chief economics commentator for the Financial Times. Wolf, one of the world’s most influential financial journalists, also holds positions at the University of Oxford and the University of Nottingham in England and the Ben-Gurion University of the Negev in Israel.

In a recent interview, Wolf discussed what went wrong with the global economy and how to fix it:

1. The economic crisis is a result of a worldwide expansion of credit since 1980. “Over the past three decades, there has been an extraordinary expansion in credit. That led to an extraordinary amount of bad lending,” Wolf said, characterizing recent events as the result of the bursting of “an enormous credit bubble.”

The credit bubble actually began to form in the 1970s, Wolf said, when runaway inflation left the world financial system with an anemic balance sheet and many corporations and individuals starved for credit. In the early 1980s, inflation receded and developed countries began lending more in response to pent-up demand.

But consumers became ever more dependent on easy money. By the mid-2000s, U.S. savings rates had turned negative for the first time, and in 2005 and 2006, Americans outspent their incomes by an unprecedented 5% and 6%, respectively. “That was, of course, all fueled by debt. U.S. households were borrowing more than ever before, and the country’s debt-to-disposable-income ratio doubled,” Wolf said.

Also beginning in the 1970s, developed countries began transferring excess capital and credit to emerging economies. That led to a series of 80 financial crises during the 1980s and 1990s, as developing countries borrowed their way into boom periods that inevitably went bust. Each time, foreign lenders ultimately fled, leaving the country’s currency to collapse and precipitating a massive economic crash.

To head off these cycles, developing countries began purchasing foreign assets, particularly those of the U.S. “They take their trade surpluses and park the money back in the U.S., where it becomes lendable,” Wolf said, noting that this excess liquidity helped push U.S. interest rates to extremely low levels, which further inflated the credit bubble. U.S. lenders began giving money to many people who couldn’t afford to pay it back.

2. The U.S. stimulus plan will help but will not cure the problem. “There still seems to be a lot of thinking in the U.S. that you can have a short-term stimulus that pump-primes the economy and then everything goes back to normal,” Wolf said. “I think that is nonsense. We are in a world in which, at least for the moment, private spending is collapsing.”

While the government should try to sustain demand in the economy, the U.S. stimulus plan is too small to do the trick, Wolf said, noting that it calls for $400 billion in spending in 2009 and $400 billion in 2010. That’s only 3% of the U.S.’s $14 trillion economy in each year. “In the context of a massive downshift in private spending, which is the main reason for the fiscal deficit today, a 3%-a-year stimulus is going to be an inadequate offset,” he said.

3. President Obama must abandon his ambitious domestic agenda and concentrate on resolving the global economic crisis. The stimulus package “seems to rest on the view that what went wrong here was that the banks went overboard on a very specific subclass of bad assets,” Wolf said. “We’re going to find, as this recession unfolds, bad debt emerging everywhere. You can’t simply find a class of toxic assets, take them off the balance sheet and everything will be fine.”

Obama needs to shift his thinking and realize that the roots of the global economic crisis involve the basic structure of the world’s trade and finance systems, Wolf said. A major part of the solution will involve restructuring the system to encourage more spending by consumers in developing countries, since consumers in developed countries have resumed saving and cut back on spending.

“We should now be thinking about how emerging countries can avoid a massive cut in spending because of their foreign currency problems. It’s really incredibly important for everyone to understand we are in a global economic system and we are all affected by what other countries do,” Wolf said.


This article was written by a professional financial journalist for Legend Financial Advisors, Inc. and is not intended as legal or investment advice.

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