Financial Crash, Commodity Prices and Global Imbalances

In this paper we argue that the persistent global imbalances, the subprime crisis, and the volatile oil and asset prices that followed it, are tightly interconnected. They all stem from a global environment where sound and liquid financial assets are in scarce supply. Our story goes as follows: Global asset scarcity led to large capital flows toward the U.S. and to the creation of asset bubbles that eventually crashed. The crash in the real estate market was particularly complex from the point of view of asset shortages since it compromised the whole financial sector, and by so doing, closed many of the alternative saving vehicles. Thus, in its first phase, the crisis exacerbated the shortage of assets in the world economy, which triggered a partial recreation of the bubble in commodities and oil markets in particular. The latter led to an increase in petrodollars seeking financial assets in the U.S. Thus, rather than the typical destabilizing role played by capital outflows during financial crises, petrodollar flows became a source of stability for the U.S. The second phase of the crisis is more conventional and began to emerge toward the end of the summer of 2008. It became apparent then that the financial crisis would permeate the real economy and sharply slow down global growth. This slowdown worked to reverse the tight commodity market conditions required for a bubble to develop, ultimately destroying the commodity bubble.