International Economics

Global Imbalances And The Great Recession

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By Dr. Kurtulus Gemici | 01 April 2010


As Aldous Huxley put it, “Ye shall know the truth, and the truth shall make you mad.” The truth is that the world economy is in major disarray and in the grip of the most severe downturn since the Great Depression. The recovery does not seem to be waiting around the corner. In addition, even if the recovery occurs anytime soon, the structural weaknesses in the world economy, which were significantly worsened by the economic crisis, will depress employment and prosperity for quite a while. Two years into the Great Recession, are we mad enough?


Perhaps. It seems that there is palpable anger on the street. For an illustrious specimen, observe the brewing Tea Party extremism in the United States, which gathers further momentum by the day. Nevertheless, regardless of the degree of popular anger, the truth is that we are not mad enough to initiate sweeping changes that would tackle the economic turbulence. To the contrary, the response to the crisis so far, under various guises of financial and regulatory reforms, looks dangerously meek. This is unfortunate, because the David of reform is no match against the Goliath of the Great Recession.


That is not an accident. The discourse of reform itself, especially when its scope is restricted to regulation, is misleading. The reform ship is bound to sail adrift because the current recession has not resulted from regulatory oversight or accidental market failures. The causes of the Great Recession go deep: this is both a capital formation crisis and a crisis in the way national economies are connected to each other. Accumulation crisis is a relatively familiar terrain for students of capitalism. However, the international aspect of the current crisis involves various novel elements, few of which are understood well by policy-makers and the public. Accumulation and the nature of the global capitalist order are closely related to each other. The beginning point in disentangling their connection is the current financial quagmire.


On the surface, the current crisis originated in a classic credit-based boom under inadequate financial regulation and supervision. The economic, psychological, and social mechanisms of such booms have been repeatedly observed since the Dutch tulip mania in the mid-17th century. As outlined by Charles Kindleberger and Hyman Minsky, at the origin of a crisis one invariably finds a displacement in the financial system, such as a fundamental policy change, financial innovation, or structural imbalance. This displacement then leads to an expansion in credit and money supply, feeding an economic boom. Riding such economic boom creates a bubble, causing significant asset price increases. When the bubble bursts, euphoria leaves its place to panic; contraction in economic activity follows.


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