The Financial Crisis Reconsidered: The Mercantilist Origin of Secular Stagnation and Boom-Bust Cycles

299 Pages·2016·2.83 MB·English

by  Daniel Aronoff (auth.)

THE F INANCIAL
CRISIS
RECONSIDERED
The Mercantilist Origin
of Secular Stagnation and
Boom-Bust Cycles
Daniel Aronoff
The Financial Crisis Reconsidered
The Financial Crisis Reconsidered
The Mercantilist Origin of
Secular Stagnation and
Boom-Bust Cycles
Daniel Aronoff
THE FINANCIAL CRISIS RECONSIDERED
Copyright © Daniel Aronoff 2016
Softcover reprint of the hardcover 1st edition 2016 978-1-137-55368-3
All rights reserved. No reproduction, copy or transmission of this publication
may be made without written permission. No portion of this publication may be
reproduced, copied or transmitted save with written permission. In accordance with
the provisions of the Copyright, Designs and Patents Act 1988, or under the terms
of any licence permitting limited copying issued by the Copyright Licensing Agency,
Saffron House, 6–10 Kirby Street, London EC1N 8TS.
Any person who does any unauthorized act in relation to this publication may be
liable to criminal prosecution and civil claims for damages.
First published 2016 by
PALGRAVE MACMILLAN
The author has asserted their right to be identified as the author of this work
in accordance with the Copyright, Designs and Patents Act 1988.
Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited,
registered in England, company number 785998, of Houndmills, Basingstoke,
Hampshire, RG21 6XS.
Palgrave Macmillan in the US is a division of Nature America, Inc., One
New York Plaza, Suite 4500, New York, NY 10004-1562.
Palgrave Macmillan is the global academic imprint of the above companies and has
companies and representatives throughout the world.
E-PUB ISBN: 978-1-349-57547-3
E-PDF ISBN: 978-1-137-54789-7
DOI: 10.1057/9781137547897
Distribution in the UK, Europe and the rest of the world is by Palgrave Macmillan®,
a division of Macmillan Publishers Limited, registered in England, company number
785998, of Houndmills, Basingstoke, Hampshire RG21 6XS.
Library of Congress Cataloging-in-Publication Data
Aronoff, Daniel, 1961– author.
The fi nancial crisis reconsidered : the mercantilist origin of secular stagnation
and boom-bust cycles / Daniel Aronoff.
pages cm
Includes bibliographical references and index.
1. Global Financial Crisis, 2008–2009. 2. Financial crises. 3. Business cycles.
4. Mercantile system. I. Title.
HB37172008 .A76 2015
330.9(cid:2)0511—dc23 2015027275
A catalogue record for the book is available from the British Library.
Contents
List of Figures and Tables vii
Preface xi
Acknowledgments xvii
Part I The Current Account Deficit and the US Housing
Boom: Establishing the Connections 1
1 The Metamorphosis of China’s Trade Policy 3
2 The Current Account Deficit and the Housing Boom 15
3 Mercantilism and the Current Account Deficit 39
4 The Current Account Deficit: A Necessary Condition for
the Housing Boom 55
Part II The Capital Flow Bonanza, the Credit Explosion,
and the US Housing Boom: Channels of
Transmission 67
5 A Review of Explanations for the Housing Boom 69
6 Decision-Making during the Housing Boom 81
7 The Capital Flow Bonanza and the Housing Boom 99
8 The Role of Policy during the Housing Boom 127
Part III Accumulation and Secular Stagnation: Identifying
the Underlying Malady 131
9 Accumulation and Secular Stagnation: Part I, Theory 133
10 Accumulation and Secular Stagnation: Part II, Application 147
vi ● Contents
Part IV The Financial Crisis, I: The Meltdown and the
Successful Initial Policy Response 165
11 Descent into the Abyss 167
12 The Initial Policy Response 181
Part V The Financial Crisis, II: The Limits of Conventional
Policy in a Balance Sheet Recession 201
13 The Dilemma of Policy in a Balance Sheet Recession 203
Part VI Policy Options: How to Exit the Balance Sheet
Recession and End Secular Stagnation 219
14 Policy Options 221
Notes 239
Index 279
Figures and Tables
Figures
1.1 Total current account balance for China, 1998–2008 9
1.2 China/US foreign exchange rate, 1990–2008 10
1.3 Saving and investment in China, 1992–2008 11
1.4 US China bilateral trade in goods, 1999–2014 13
2.1 Home mortgage liability levels, 2000–2008 16
2.2 Home price and CPI growth, 2000–2008 16
2.3 Mean leverage of broker-dealers, 1996–2009 17
2.4 BAA corporate bond yield relative to yield on ten-year
treasury, 2000–2008 19
2.5 Household leverage versus household price change, 1997–2007 22
2.6 Total current account balance for the United States, 1960–2014 23
2.7 Capital mobility and the incidence of banking crises, 1800–2008 28
2.8 Real estate appreciation and change in current account,
2000–2006 30
2.9 (a) Southeast Asian and other flows into US government bonds,
1984–2005 (b) Southeast Asian and other flows on ten-year
treasury yield, 1984–2005 32
2.10 US corporate business: profits before tax, 1996–2008 35
3.1 10-/30-year treasury constant maturity rate, 1996–2008 40
3.2 US productivity growth, 1996–2008 41
3.3 Balance on current account and Federal government budget,
1990–2008 42
3.4 Foreign holdings of US securities, 2007 45
3.5 Crude oil prices, 2000–2008 47
3.6 Global imbalances (in percent of world GDP), 1997–2009 48
3.7 China’s stocks of bank reserves, forex reserves, and PBOC bills,
2002–2008 51
3.8 China’s monetary base and international reserves, 1998–2007 52
3.9 Real trade weighted US dollar index: major currencies, 2000–2008 53
4.1 Residential construction and mortgages as percent of GDP,
2000–2008 56
viii ● Figures and Tables
4.2 US unemployment, natural rate, 2003–2008 57
4.3 Expenditure growth, 2003–2008 57
4.4 Gross capital flows and current accounts, 1995–2010 64
4.5 Gross capital flows by region, 1995–2010 65
5.1 Mortgage origination by type, 2001–2007 70
5.2 MA LTV DTI subprime, 1999–2006 71
5.3 House price index rate of change, 1975–2009 77
5.4 HPI and subprime lending MA, 1988–2007 78
6.1 Broker-dealer leverage and VaR, 2001–2012 89
6.2 Shadow bank, commercial bank liabilities, 1990–2011 91
6.3 Market-based, bank-based holdings of home mortgages, 1980–2010 92
7.1 Not enough banks to source safety for cash pools 103
7.2 Asset-backed securities issuance, 2000–2008 105
7.3 Institutional cash pools, 1997–2013 106
7.4 Shadow banking diagram 110
7.5 Ten-year treasury constant maturity rate, 2000–2008 112
7.6 Actuarial ratio for public pensions, 1992–2013 113
7.7 Annual return for state and local pensions, 1992–2013 114
7.8 Net interest margin for large US banks, 2002–2008 115
7.9 Households and nonprofit organizations—net worth level,
2000–2008 119
7.10 MA foreclosures versus defaults, 1990–2008 123
7.11 MA foreclosures versus home price, 1990–2008 124
7.12 Home vacancy rates and home prices, 2000–2010 125
7.13 Margins offered (down payments required) and housing
prices, 2000–2009 125
9.1 Fed funds rate, ten-year treasury yield, 2004–2007 135
10.1 (a) Top 1 percent and 0.1 percent income share, including
capital gains, 1980–2013 (b) Average, top 1 percent and
0.1 percent income, including capital gains, 1980–2013 153
10.2 Real median household income, labor force participation rate,
1984–2013 157
10.3 Regression tests ten-year treasury yields on Fed funds rate,
1985–2006 164
11.1 Subprime ABX indices by vintage, 2006–2009 168
11.2 Output gap, 2007–2015 169
11.3 Household, corporate net worth, 2003–2010 170
11.4 Leverage Venn diagram 173
11.5 Home equity example 174
11.6 MPC based on housing leverage ratio 175
11.7 Spending in small versus large net worth decline countries 176
11.8 Bank balance sheet example 1 178
11.9 Broker-dealer balance sheet example 179
12.1 Thirty-day commercial paper and treasury rates, 2007–2009 182
12.2 Fed assets, 2007–2009 183
12.3 Fed liabilities, 2007–2009 184
Figures and Tables ● ix
12.4 Bank balance sheet example 2 184
12.5 Bank C&I loans, 2008–2011 188
12.6 Bank loan losses, 2005–2011 189
12.7 Loan rate spread versus loan volume example 190
12.8 (a) Bank loan financing—cost, 1998–2010 (b) Bank loan
financing—total amount, 1998–2011 192
12.9 Nonfinancial corporation bond issuance, 2005–2011 193
13.1 Civilian labor force participation rate, 1990–2014 204
13.2 Bank and household credit, 1990–2014 205
13.3 CBO 2014 budget outlook 214
Tables
5.1 Merril Lynch 2007 AR—residential mortgage 73
5.2 Mortgage related losses to financial institutions from
the subprime crisis—June 18, 2008 74
7.1 Subprime mortgage exposures, 2008 112
Preface
This book attempts to explain the broad features of the US housing boom
of the 2000s, the subsequent financial crisis and the slow recovery that
followed. Every acre of this territory has been surveyed by the most
eminent contemporary economists, historians, and journalists. The reader must
be provided a good reason to spend her time and attention (and money) on yet
another tome on the subject. In this preface I shall attempt to pique her interest.
Disagreement with the “Conventional Wisdom”
I n this book I present and substantiate a hypothesis that the mercantilist policies
of China and other Southeast Asian countries created a capital flow bonanza 1
in the United States that set off an unsustainable housing boom, which was fol-
lowed by a catastrophic financial crisis from which the United States has still not
fully recovered, seven years after the event. Many of the conclusions I reach in
this book differ from commonly held views on the housing boom, the financial
crisis and its aftermath (relevant sections are in parenthesis).
● Most people believe the housing boom was primarily caused by a reckless
increase in financial sector and household leverage and a decline in loan
underwriting standards—I disagree (part I).
● Most people believe reckless lending during the housing boom was perpe-
trated by unscrupulous bankers—I disagree (part II).
● Most people believe that housing investors, lenders, and borrowers were
motivated by irrational beliefs during the boom—I disagree (part II).
● Most people believe policymakers should have acted to slow the credit
expansion during the housing boom—I harbor some doubts (part II).
● Few people (if any) see the current account deficit and income concen-
tration as essentially similar phenomena in terms of impact on the US
economy—I propose a theory that explains why they are similar and why
they cause secular stagnation and boom-bust cycles (part III).
● M any people (particularly policymakers) believe it was prudent for the
government to shield bank bondholders from loss and banks from bank-
ruptcy during the financial crisis—I disagree (part IV).