Tuesday, March 30, 2010

"Zombie Equilibrium"

Two weeks ago, there was a guest lecture on "financial globalization" in one of my classes. The lecture was critical of how the U.S. handled some of its foreign bank policies (an example given in the lecture was on how the U.S. used regulations that it helped make to benefit themselves, like the "separate entity principal." During Argentina's financial crisis, when U.S. banks in Argentina defaulted, depositors in Argentina could do nothing).

This post addresses the instability of the current global financial situation.


The US Treasury is borrowing more and more from global private banks that purchase U.S. securities at very low yields with money that essentially is created by the U.S. Federal Reserve in a cycle that "Spengler" calls "zombie equilibrium." The following figure of "Foreign purchases of US Treasury securities, private banks vs central banks" is taken from the post.

Both Spengler and the guest lecturer acknowledges that this could go on indefinitely but it's a dangerous game, quote from the article -

"Weaker governments like Greece and Spain, or even the United Kingdom, could snap the chain. A shift out of US dollars in response to monetary inflation could force the Federal Reserve to raise interest rates. An attempt by investors to ease out of the carry trade could provoke a stampede for the exits. Japan has managed to keep its bubble going for 20 years. But Japan did so on the strength of its domestic banking system under the supervision of the Bank of Japan; the United States depends on the reserve status of the dollar, which makes less and less sense when the Treasury is flooding the world with US liabilities."



3 comments:

  1. Isnt one contributing factor to the current excessive buying of us treasury bonds the ,flight to quality" caused by the recession. and would not this effect and thus the problems associated with it be mitigated as the world gets out of recession?

    - the optimist

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  3. Yes, I also read this:
    http://www.atimes.com/atimes/Global_Economy/LC18Dj01.html
    that mentions something similar.

    But I think US treasury bonds can give a false impression of security since there are so many foreign investors and too much depend on the value of the dollar.

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