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Saturday, May 14, 2011

Fault Lines

As futile as trying to read up on political, literary and historical issues already is, I also like to read the occasional economic book. In fact I wish I had more time to simply read all the books that I've already bought or plan on acquiring in the future, but that's a different story for another day. Raghuram Rajan's Fault Lines - How Hidden Fractures Still Threaten The World Economy was possibly the economic analysis that received the most public attention in 2010. As the title states, Rajan offers up a number of economic and political fault lines that brought about the financial crisis. These fault lines are far from being resolved today and thus hold the potential of contributing to another bubble and the ensuing crash.

Rajan as an (Indian-)American economist is a believer in the ultimate superiority of the market economy of course, yet this just lends further credence to his observations of the defaults of the American system. Thus he exposes the extreme rise of income inequality coupled with the lack of a social safety net in the United States as a fault line for the economy there - and in extension the world - because of resultant the political need to push for easy credit in order to sustain consumption of poorer households. Similarly, the urgent need for the quick creation of jobs in the United States versus Europe -where social assistance makes higher unemployment rates much more politically sustainable - in combination with the kind of job-less recoveries that emerged in the 1980s creates political incentives for expansionary monetary policy. Both of these political forces arising out of the peculiar situation of the - almost pre-modern - American social system hold the potential of creating future bubbles that then will inevitably burst. Rajan sees these - in combination with a few others of course - as the underlying basis of the sub-prime crisis.
Politicians favor access to easy credit as a means to overcome rising inequality. [...] The weak safety net and the emergence of jobless recoveries imply that the American electorate has far less tolerance for downturns than voters in other industrial countries [...] In an attempt to induce recalcitrant firms into creatin jobs, both the government and the Federal Reserve, especially the latter, ended up aiding and abetting a house price bubble and the financial crisis.
Rajan also finds an international component of this fault line of easily available credit.
Somewhat ironically, the developing country central banks did to the United States what foreign investors had done to them in their own crisis.
They pushed easy credit into the US due to their desire to build up reserves following their experiences in the Asian financial crisis of the 1990s and in that way helped construe the bubble that just blew up in all of our faces.

I am far from giving this book and its overview of the American and global politico-financial interactions justice of course. Let it suffice to say that the above-described mechanism is still in place today and to some extent has even been reinforced with the Fed as expansionary as ever - and far more so in relative terms than say the ECB - and income inequality - I assume - only having risen even more due to the crisis. Rajan is an astute, optimistic Cassandra - as little sense as that makes - and his book gave me a much better understanding of the forces behind the crisis we just experienced and the ones we will be facing in the future.

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