The Two Markets

generals always fight the previous war

All of this “forced savings” has had another effect: the so-called “global savings glut.” Through sterilization and other measures, China, Japan, other Asian countries, as well as countries like Germany (here not by sterilization but with the help of the fixed-currency regime of the euro), have generated a mass of global savings that has flooded the financial market with liquidity.

The liquidity was put on the financial market, precipitating the global “quest for yield,” as the supply of funds overwhelmed the capacity of the market makers on the financial market to find homes generating an adequate return. As a result, investment bankers and their like developed derivative products packaged in ever-more-complex forms, supposedly with optimal risk/return ratios. In fact, high-risk debt (e.g., sub-prime loans), rendered acceptable by the absence of alternatives given the masses of liquidity looking for a return, was being packaged with lower-risk debt in supposedly optimal risk/return packages.

This was a global phenomenon: these products were marketed and sold throughout the world, with countries like Iceland and Ireland becoming hubs of frenetic activity. The levels of absurdity that were reached at the height of the bubble have been documented in books like Boomerang by Michael Lewis.

What this led to was massive amounts of lending without sufficient regard to the quality of the loans. In the event, many proved non-performing, and given the opacity of the derivatives, in which the bad loans were packaged with the good, along with the ubiquity of these products (seemingly on every bank’s balance sheet worldwide), the entire financial system threatened to seize. In the event, the “system was saved,” i.e., lenders were not allowed to go under, but rather much of the debt was (and is still being) simply rolled over. 

The problem with this is that all of this debt not only keeps failed activities running, even though they form a net drain on the economy, but it crowds out lending to new activities, new production, new innovation – and here we see why there is so little life in the contemporary economy. It is reminiscent of the “transactions of decline” referred to in previous units. There is less room for new activities as old activities continue to be maintained on life support, as it were. This is the reality of the “zombie economy.”