More summary of the crisis!

More summarizing on the crisis, this time the lead up to the big meltdown.

In many ways, the developing economies, especially of Asia, have played crucial roles in triggerring and sustaining US economic growth since the nineties. Despite the numerous financial shocks, the US economy has motored along relentlessly, pulled along by the vibrancy of these Asian economies. It would not be too much off the mark to claim that they have been the engine of US and global economic growth in the past decade. Let me illustrate this here.

The high quality, cheap imports from developing economies have kept a consumer prices low and fuelled an unprecedented consumption boom in the US. Anecdotally it has been suggested that the US consumption boom is "Made in China". The rapid emergence of markets in outsourcing of services, coupled with reduced restrictions on high skilled labor migration, have controlled wage increases in the developed world. The cheap imports of both goods and labor have kept a lid on inflationary expectations.

The cheap labor and goods have been accompanied by cheap capital. The spectacularly successful, export led economic growth of the East Asian economies, historically high commodity prices, especially of oil, have resulted in massive accumulation of foreign exchange reserves by the Asian and other emerging market and the East European economies. The rising reserves have also coincided with a considerable global savings spurt, growing from 24% in 1999 to 33% in 2006, far in excess of the investment rate.

In the absence of adequate depth and breadth in their own local financial markets, these countries have been investing their burgeoning reserves in the relative safety and liquidity of US T Bonds, despite its very low yields. This "global savings glut" and rising forex reserves have been a manna from heaven for the US economy, financing the insatiable US debt greed at the rate of $ 2 bn per day, and blowing up one asset bubble after the other.

The triple coincidence of cheap goods, labor and capital helped drive global long term interest rates to historic lows and also sustain them at that level for nearly two decades. The low interest rates have in turn spawned a massive spurt in financial engineering and innovation, resulting in the proliferation of large number of complex financial instruments and products. While the jury is still out on whether, this has diversified and lowered credit risk, it has surely increased global liquidity and increased the alternatives available for raising capital.

The low interest rate assisted sharp rise in liquidity has been critical in blowing up asset bubbles and "irrational exuberance", first in tech stocks and then real estate. This has in turn fuelled a "wealth and income effect" that has encouraged Americans to throw caution into the winds and spend like there is no tomorrow. Household savings have been on a terminal decline falling into negative territory recently.