Here’s a chart to ponder as regulators continue their forensics of the financial crisis:
It’s countries’ current account balances in 2007 against the change in the non-performing loan ratios of their banking systems between 2007 and 2009. And as you can see, there’s a bit of correlation.
Now correlation ≠ causation, and in this instance the direction of ‘causation’ could go both ways — but we find it interesting since it comes from a paper released on Friday by Bank of England governor, Mervyn King.
So here’s another interesting graph from King:
Can you guess the theme yet? It’s “Global imbalances: The perspective of the Bank of England” and it’s really quite heady stuff for a central bank head. There’s a not-so-subtle yearning for Bretton Woods, plus a tacit admission that regulation can only go so far in combating banking crises, which, at their heart, are caused by gluts and greed.
Here’s an extract:
The pattern of growth, with the associated imbalances and mis-pricing of risk, was not sustainable: as we know only too well, the ensuing ﬁnancial crisis threatened the entire stability of the ﬁnancial system. Indeed, as Chart 6 illustrates, ﬁnancial crises have been a hallmark of the current incarnation of the international monetary and ﬁnancial system (IMFS), with the reappearance of global ﬁnancial instability coinciding with the rapid increase in capital mobility. Chart 7 shows that the change in countries’ non-performing loan (NPL) ratios between 2007 and 2009 and their current account balance in 2007 are correlated, though of course the direction of causation could go both ways. By comparison, the relationship between the change in countries’ NPL ratios and their banks’ capital ratios is insigniﬁcant… relative to Bretton Woods, today’s IMFS has proven durable, but it has also coexisted, on average, with: slower, more volatile, global growth; more frequent downturns; higher inﬂation and inﬂation volatility; larger current account imbalances; and more frequent banking crises, currency crises and external defaults. However, to some extent these period-average metrics obscure signiﬁcant improvements over the current period, with the ‘great moderation’ period post-1990 associated with much better outcomes than those achieved in the 1970s and 1980s. Nevertheless, with the important exception of inﬂ ation, the outcomes achieved during the Bretton Woods period were better than those attained since 1990. While this does not imply causation of course, it does suggest that better outcomes may be possible.
Indeed, the main lesson from the crisis is the need to ﬁnd better ways of ensuring the right collective outcome. Reforms to ﬁnancial regulation and the structure of the banking system need to take place in order to prevent another ﬁnancial crisis. Many of these reforms are already underway. Improved financial regulation will help to intermediate the flows associated with global imbalances. But we cannot expect too much of regulation: it may well be circumvented or diluted over time, and there will be leakages, both across borders and through the shadow banking system. So the global economy will remain vulnerable to the risks associated with imbalances if they are not tackled at source. That will require some way of ensuring that countries’ policies result in a sustainable outcome.
What is needed now is a “grand bargain” among the major players in the world economy. A bargain that recognises the beneﬁts of compromise on the real path of economic adjustment in order to avoid the damaging consequences of a move towards protectionism. Exchange rates will have to be part of such a bargain, but they logically follow a higher level agreement on rebalancing and sustaining a high level of world demand.
King’s subject matter was well-timed too — over the weekend G20 finance ministers drew up a list of ‘indicators’ for external imbalances. The full guidelines will be finished by April but early reports suggest there’s already been some compromising on current account measures, in an effort to placate China.
Not quite, as “grand” as King might have hoped for, then.
G20 sceptics wait for shift in behaviour – FT
Trichet says G20 deal won’t undercut central-bank independence – WSJ
“Mr. Chairman, listen also to the emerging markets” – Mohamed El-Erian, FT Tilt
Global imbalances? Blame the west – FT Alphaville