29th February 2012
The paper's author, Homi Kharas, a research analyst with the Brookings Institution in Washington, begins from the premise that so far, global consumer demand has been concentrated in the rich economies of the OECD. One of the main drivers of global imbalance, and certainly one of the prime underlying causes of the global financial crash of 2008, was the disproportionate reliance on exports by emerging market economies, particularly China.
The argument by now is a very familiar one. The massive trade surpluses built up through strong exports and weak domestic consumer demand created vast capital flows back into US dollar assets. These drove down yield and created a "hunt for yield", pushing investors generally away from the near zero yields of risk free bonds and into risk assets like property and equities.
Credit soared while the cost of credit fell, boosting levels of personal and government indebtedness. Lightly regulated markets in the US and the UK particularly, responded with innovative financial engineering which disguised both risk and the extent to which risk was being leveraged, and ultimately spread contagion throughout the financial system.
On this argument, none of this would have happened if emerging markets had had strong domestic consumer growth so that wealth fed back into local economies through increased consumer demand. There are any number of other "interventions" that could have and should have been made, but the absence of a well developed consumer base in emerging market economies was key to the shape of the trade and capital flows in the pre crash period, giving form to the boom that led to the bust.
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