Why did the Global Financial Crisis (GFC) happen?
All accounts would place debt at the centre of the story. For many people, there was just too much debt out there in the global economy, capital markets effectively imploded under the weight of all that debt. Alongside those concerns about debt, other concerns have developed more recently. People suggest that an ageing economy just cannot grow very quickly anymore or that we are running out of natural resources.
What is wrong with the popular view of the GFC?
The popular view, the idea that because of all that debt and all those other concerns, the global economy was built on sand and was an accident waiting to happen. It is inaccurate. The problems were in the financial sector itself, not in the global economy. When we look at what actually went wrong in 2008 it was a problem with some very specific problems focused in the sub-prime component of the US housing market. This occurred because of a mix of overly ambitious policy and reckless lending. Collateralised debt obligations, really complex securitisations and so forth, meant that when things went wrong, it was tremendously difficult to unravel exactly what had gone wrong. We saw some institutions become insolvent, and when they went bust, they effectively froze the global money supply as other banks wouldn't lend to the stricken banks.
Why does it matter if the popular view is mistaken?
If you feel that the world economy can't grow because there is too much debt, you're going to be pretty pessimistic about the prospects for the economy and for investment markets as a result. The total amount of debt is not going to fall any time soon. It was never going to fall any time soon because as the global economy becomes wealthier, balance sheets get bigger and every financial asset is matched by a financial liability and It's quite likely that that process will continue. In aggregate, the global financial crisis could only be a liquidity crunch, not a solvency issue. This can be solved easily as central banks create liquidity on demand. The global economy now is roughly two fifths bigger than it was at the peak before the global financial crisis. Unemployment in the United States, the U. K, Germany and Japan is at the lowest levels we've seen for decades, and corporate profitability is pretty healthy. If you had focused too much on that big caricature, the idea that the global economy couldn't grow because of all that debt, you would have missed out on a lot of opportunity.
