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Lesson from Lehmann Brothers: a bubble-led growth could harm US economy

Trump needs to take a call on whether the United States should have a strong dollar, or a current account surplus. He can’t have both.

It has been 10 years since the fall of Lehmann Brothers, which triggered the Great Recession. One of the important lessons the world learned, as the recession unfolded, was the importance of regulation of the market. What was characterized as self-regulation by former Fed chief Alan Greenspan proved to be an unmitigated disaster in the run-up to recession.

In the wake of the recession, countries on both sides of the Atlantic sat down to come up with a regulatory framework, much to the consternation of the bankers. Over time, however, the depth and extent of the regulation has been watered down though, by the US establishment, especially since Donald Trump became president.

Much water has flown through the Atlantic in the past 10 years. The European banks, major subscribers of the asset backed securities through the borrowings from the money markets, witnessed huge downsizing. Be it international financial centers like the Netherlands, or leading banks like Deutsche Bank, the balance sheets have thinned down. Europe had its worst setback from global financial crisis as evidenced by the Sovereign Debt Crisis.

In terms of total international assets held, as per the recent statistics of Bank of International Settlements, Japanese banks are far ahead of banks from all other the nations. But the risks posed by their international dollar balance sheets is a big matter of concern.

But in the aftermath of the global financial crisis, the rise of Chinese banks and their increase in international exposure has been steep. In fact, some of them have already made it to the top 20 list in terms of size.

The large increase in capital flows to emerging countries in Asia and Latin America could very well result in a bubble there. Of emerging economies, it is only to the emerging European countries that finance been a little hesitant to venture to. Local governments over there have been going strong on regulation. In Poland, there has been an increase in the share of government in bank ownership. What a grand reversal!

With years of quantitative easing, the risk lovers have never had it so good in the United States, with US market capitalization already scaling high levels. Even in terms of percentage of the GDP, it is likely to outstrip the levels of the old dotcom bubble years. With the feeble challenge from euro, the dollar is gaining redoubled strength.

Moreover, the yuan hasn’t reached such strength to pose a challenge to the dollar yet. President Trump needs to take a call as to whether the United States should have a strong dollar, or have a current account surplus. You can’t have both. Shirking away from responsibilities by abandoning its principles of multilateralism would cost it as much.

Going by the libertarian argument, Trump would try to over-do the bubble in the United States. Given the steep appreciation of the shares of companies such as Apple, early warning signals of which has been hinted at in the latest Global Financial Stability Report, any reversal of the current run would cut the United States to size.

The world should know that though the relative share of the United States in the world economy has declined only marginally from 28 percent to 25 percent of the world economy between 2000 and 2017. Euroland, which was similar in size to the US in 2000, has dwindled with its relative share at 16 percent of the world economy, which is the same as the share of China now.

Even when its relative share in the international financial markets is very low, the steep increase in its relative share between the last two Triennial Central Bank Surveys of BIS provides sufficient evidence on the challenge it could pose in the event there is another crisis. So any attempt to ride a self regulation driven, bubble-led growth, even if it could deliver instant gratification for the Wall Street and his Republican friends, could cut the US economy to size. Therefore, President Trump better tread softly.

(Krishnakumar S. teaches economics at Sri Venkateswara College, University of Delhi.)

More from Krishnakumar S.:

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US intransigence led to collapse of WTO’s Buenos Aires ministerial (December 27, 2017)

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India’s war on black money likely to result in a big bonanza for government (November 10, 2016)

With Brexit, is it going to be a season of referendums in Europe? (June 24, 2016)

Raghuram Rajan’s exit provides more fodder to the volatile financial markets (June 20, 2016)

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Yanis Varoufakis is Keynes of our generation (July 7, 2015)

Will Modi’s plan to channelize gold holdings from temples to banking system succeed? (May 8, 2015)

All eyes on Yellen, as global markets brace for reversal in US monetary policy (March 21, 2015)

Asian Infrastructure Investment Bank – Are the Bretton Wood twins being dislodged? (March 17, 2015)

Are the political duopolists in New Delhi colluding? (December 19, 2012)

Solitude on the banks of Meghalaya’s Umiam Lake (December 26, 2016)

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