THE GREAT MODERATION Good luck? Structure? Policy?

BERNANKE  In the United States a deep and liquid financial system has promoted growth by effectively allocating capital and has increased economic resilience by increasing our ability to share and diversify risks, both domestically and globally ”  (15 June 2007)

AS % OF GDP

ASSET BUBBLES “where assets trade in high volumes at prices much higher than intrinsic value…”

DOTCOM (NASDAQ)

+ ASSET BACKED SECURITIES

+ COMMODITY INDEX

+ HEDGE FUND ASSETS 10x

+ CREDIT DEFAULT SWAPS 2000$1 TRILLION 2008 $58 TRILLION (not to scale) 58x

WHAT DROVE THE BUBBLES? American over-borrowing? Low interest rates? Asian over-saving?

THE GLOBAL IMBALANCES USACHINA IMPORTS GOODSEXPORTS GOODS CONSUMER DEBTSAVINGS NATIONAL DEBTNATIONAL SURPLUS IMPORTS CAPITALEXPORTS CAPITAL

US TRADE DEFICIT

+ CHINA DOLLAR RESERVES 2008 = $2 TRILLION

THE GLOBAL IMBALANCES “Capital now flows upstream, from the world’s poor to the richest country of all…” Martin Wolf

A QUICK RECAP  Low interest rates  + Oversupply of savings (Asia)  = Rising debt in USA  2001: Dotcom bubble bursts  Asset backed security bubble begins  Where to find new, high-risk, high-interest borrowers? …

folks like these…?

…folks like these?

SUBPRIME  Detroit, Michigan  2004:  75% of all new mortgages = subprime  2007:  65,000 homes foreclosed  1/5 homes empty  “We buy homes for cash”

US HOUSING COLLAPSE % change y-o-y Case Shiller 10x cities

HOUSING + DOW JONES

HOUSING + DOW + OIL $147

THE RECKONING OCT  $2 TRILLION WRITTEN OFF BY BANKS  $2 TRILLION MORE TO COME? (IMF)  $12 TRILLION IN GLOBAL BAILOUTS (INC CREDIT GUARANTEES)  $2.4+ TRILLION FISCAL STIMULUS  $1 TRILLION IMF LENDING  $32 TRILLION OFF EQUITIES  GLOBAL GDP = $64 TRILLION  GLOBAL FINANCE = $196 TRILLION

WHERE ARE WE NOW?

 END OF Q109  US ECONOMY: -6.1%  UK ECONOMY: -4%?  CHINA: growth down from 12% to 6%  WORLD ECONOMY: -2%?  WBANK/11 JUNE -3%  MFR EXPORTS: - 40% yoy Q1  IMF: 11% chance of global deflation (Jan)

THE STATE  Rescued freemarket capitalism  Owns large chunks of banking system  A generation of moral hazard?  A generation of fiscal pain?

CHINA  $580 stimulus, 2/3 from banks  Micro-level policy change  Exports down 26% yoy  Domestic investment up 30%  End of export-led growth model?

IDEOLOGY?  Those of us who have looked to the self- interest of lending institutions to protect shareholders’ equity, myself especially, are in a state of shocked disbelief… I made a mistake in presuming that the self-interest of banks and others was such that they were best capable of protecting their own shareholders”  Greenspan ( )

THE DANGERS?  Debt overhang = global lost decade  Fiscal stimulus ‘borrows’ 2010 growth  …or does not happen? (USA)  Monetary stimulus = competitive devaluations  Global trade doesn’t recover: national “pools” of capital  UXBs: Germany? Sweden? China?