>The Global Economic Crisis (UNCTAD)

The Global Economic Crisis: Systemic Failures and
Multilateral Remedies

(Report by the UNCTAD Secretariat Task Force on Systemic Issues and Economic Cooperation)

Executive summary
The global economic crisis has yet to bottom out. The major industrial economies are in a deep recession, and growth in the developing world is slowing dramatically. The danger of falling into a deflationary trap cannot be dismissed for many important economies. Firefighting remains the order of the day, but it is equally urgent to recognize the root causes for the crisis and to embark on a profound reform of the global economic governance system.

To be sure, the drivers of this crisis are more complex than some simplistic explanations pointing to alleged government failure suggest. Neither “too much liquidity” as the result of “expansionary monetary policy in the United States”, nor a “global savings glut” serves to explain the quasi-breakdown of the financial system. Nor does individual misbehaviour. No doubt, without greed of too many agents trying to squeeze double-digit returns out of an economic system that grows only in the lower single-digit range, the crisis would not have erupted with such force. But good policies should have anticipated that human beings can be greedy and short-sighted. The sudden unwinding of speculative positions in practically all segments of the financial market was triggered by the bursting of the United States housing price bubble, but all these bubbles were unsustainable and had to burst sooner or later. For policymakers who should have known better to now assert that greed ran amok or that regulators were “asleep at the wheel” is simply not credible.

Financial deregulation driven by an ideological belief in the virtues of the market has allowed “innovation” of financial instruments that are completely detached from productive activities in the real sector of the economy. Such instruments favour speculative activities that build on apparently convincing information, which in reality is nothing other than an extrapolation of trends into the future. This way, speculation on excessively high returns can support itself – for a while. Many agents disposing of large amounts of (frequently borrowed) money bet on the same “plausible” outcome (such as steadily rising prices of real estate, oil, stocks or currencies). As expectations are confirmed by the media, so-called analysts and policymakers, betting on ever rising prices appears rather riskfree, not reckless.

Contrary to the mainstream view in the theoretical literature in economics, speculation of this kind is not stabilizing; on the contrary, it destabilizes prices. As the “true” price cannot possibly be known in a world characterized by objective uncertainty, the key condition for stabilizing speculation is not fulfilled. Uniform, but wrong, expectations about long-term price trends must sooner or later hit the wall of reality, because funds have not been invested in the productive capacity of the real economy, where they could have generated increases in real income. When the enthusiasm of financial markets meets the reality of the – relatively slow-growing – real economy, an adjustment of exaggerated expectations of actors in financial markets becomes inevitable.

In this situation, the performance of the real economy is largely determined by the amount of outstanding debt: the more economic agents have been directly involved in speculative activities leveraged with borrowed funds, the greater the pain of deleveraging, i.e. the process of adjusting the level of borrowing to diminished revenues. As debtors try to improve their financial situation by selling assets and cutting expenditures, they drive asset prices further down, cutting deeply into profits of companies and forcing new “debt-deflation” elsewhere. This can lead to deflation of prices of goods and services as it constrains the ability to consume and to invest in the economy as a whole. Thus, the attempts of some actors to service their debts make it more difficult for others to service their debts. The only way out is government intervention to stabilize the system by “government debt inflation”.

To see full report: GLOBAL ECONOMIC CRISIS