30 years: Macroeconomist
Many contrasting view are held about the causes of the global financial crisis. Kevin explains his view on the matter and why it differs to the popular opinion.
Many contrasting view are held about the causes of the global financial crisis. Kevin explains his view on the matter and why it differs to the popular opinion.
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9 mins 42 secs
The common view of the global financial crisis of 2008 that there was too much debt in the economy is a bit misguided. Instead the cause can be related back to the collapse of the US housing market and the complicated securities that mortgages were backing.
Key learning objectives:
Discuss the popular view for the cause of the financial crisis
Explain the the real cause of the financial crisis in 2008
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All accounts would place debt at the centre of the story. For many people, there was just too much debt out there in the global economy, capital markets effectively imploded under the weight of all that debt. Alongside those concerns about debt, other concerns have developed more recently. People suggest that an ageing economy just cannot grow very quickly anymore or that we are running out of natural resources.
The popular view, the idea that because of all that debt and all those other concerns, the global economy was built on sand and was an accident waiting to happen. It is inaccurate. The problems were in the financial sector itself, not in the global economy. When we look at what actually went wrong in 2008 it was a problem with some very specific problems focused in the sub-prime component of the U. S. Housing market. That occurred because of a mix of overly ambitious policy and reckless lending. Collateralised debt obligations, really complex securitisations and so forth, meant that when things went wrong, it was tremendously difficult to unravel exactly what had gone wrong. We saw some institutions become insolvent, and when they went bust, they effectively froze the global money supply as other banks wouldn't lend to the stricken banks.
If you feel that the world economy can't grow because there is too much debt, you're going to be pretty pessimistic about the prospects for the economy and for investment markets as a result. The total amount of debt is not going to fall any time soon. It was never going to fall any time soon because as the global economy becomes wealthier, balance sheets get bigger and every financial asset is matched by a financial liability and It's quite likely that that process will continue. In aggregate, the global financial crisis could only be a liquidity crunch, not a solvency issue. This can be solved easily as central banks create liquidity on demand.
The global economy now is roughly two fifths bigger than it was at the peak before the global financial crisis. Unemployment in the United States, the U. K, Germany and Japan is at the lowest levels we've seen for decades, and corporate profitability is pretty healthy. If you had focused too much on that big caricature, the idea that the global economy couldn't grow because of all that debt, you would have missed out on a lot of opportunity.
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