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nothing new? February 14, 2008

Posted by Bradley in : Uncategorized , trackback

Yesterday, Dominique Strauss-Kahn, the Managing Director of the IMF gave a speech in which he focused on the current world financial problems:

The challenges that the Fund and its members face … have changed. In its early years, the crises that our members faced were mostly current account crises. Large scale capital movements between countries were relatively rare, and financial institutions tended to be national rather than international. And transmission of problems from the national to the global level was relatively slow. Obviously that is no longer the case.
..If we look now at the current financial crisis from this perspective we can see that what began as a problem in a single sector in a single economy–the housing market in the United States–has become a global problem. And what was first manifested as a problem for financial institutions is now becoming a problem for economies. This is obviously the case in the United States. I believe that the effects will be felt increasingly in Europe. And I do not think the emerging economies are immune from this crisis.
.. The lesson I draw from this is that we have to look for both the causes and the cures of crises in the interaction of national and global developments and in the interaction of economic and financial market developments.
.. Let me be more specific. The present crisis is the result of a perfect storm: a macroeconomic environment with a prolonged period of low interest rates, high liquidity and low volatility, which led financial institutions to underestimate risks, a breakdown of credit and risk management practices in many financial institutions, and shortcomings in financial regulation and supervision.

How new is all this? An acceleration or magnification, but not essentially really new. What is different is the enormous amount of energy that has been dedicated (apparently not too successfully) to ensuring financial stability through regulation in recent years. More than half a century ago, Karl Polanyi wrote:

By the fourth quarter of the nineteenth century, world commodity prices were the central reality in the lives of millions of Continental peasants; the repercussions of the London money market were daily noted by businessmen all over the world; and governments discussed plans for the future in light of the situation on the world capital markets. Only a madman would have doubted that the international economic system was the axis of the material existence of the race.

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