Global Capital Flows and Payment Imbalances

The current financial and economic crisis is not a single phenomenon, with a single cause. In the Anglo-American heartland, it began and remained until September 2008, primarily a financial crisis, though with ‘real economy’ causes (a structural deficit in the production of tradable goods and services), and also ‘real’ economy effects. In Japan, Germany and much of the periphery, it began later, primarily as an export crisis, in response to slow-down in the Anglo-American heartland, reflecting a structural surplus capacity to produce tradable goods and services but the export crisis then fed through finance and wider growth problems. The explosion of international financial intermediation after the 1980s and the rising incidence of financial crisis, with cross-border affects, were obviously related. For policy makers, the principal question was what it has long been—when ‘real’ economy growth rates were sought in excess of those capable of being generated by domestic savings, how were the benefits and costs of financial openness to be distributed? In principle, inward flows of privately owned capital make it possible for real economies to grow more rapidly than if they rely solely on domestic resources. In practice, the extra costs associated with crisis-induced capital outflows, bailouts, and the lost confidence of investors occasionally, threaten to undermine the real economies, and set back the process of industrialization and disrupt underlining political and social order. The current crisis shows that the basic premise of the traditional risk management theory is wrong and that financial markets indeed can be inherently unstable, especially due to their increasing complexity.