Fault lines by Rajan Raghuram

Fault lines by Rajan Raghuram


A very nice synopsis of the world economy following the latest financial crisis and directions on where we may be headed.
Some key points I took away:

*Three Major “Fault” lines where tensions create the possibility of future crises:
1) Domestic Political Stresses (need to deal with growing inequality)
2) Trade imbalances (America has been the economic engine by over consuming the rest of the world’s output; the developing world needs to consume some of its own output)
3) Different types of financial systems (arms-length vs. relationship)

*The role of credit in America
1) Starting in 1991, recessions have mostly been “jobless”, where subsequent increases in output are not accompanied by new jobs. Inefficient jobs are shed and replaced by more efficient technology.
2) Politicians look for quick fixes to unemployment, and instead of focusing on the root cause (retooling workers/ improving grade school education) they promote easy credit so that consumption can increase even without an increase in wage. Promoting home ownership is a key part of this strategy.
3) Low interest rates are an implicit transfer from savers to consumers
4) The lack of a strong safety net (unemployment insurance and health coverage) increase the anxiety of the jobless, and push politicians to more extreme and abrupt actions (putting out fires) instead of more carefully addressing the core issues
5) There has been a change in mentality; no longer possible to become wealthy. Land of opportunity now closed

*The role of Exporting
1) Developing countries need both physical capital (machines) and organizational capital (companies to service those machines and their supply chain)
2) Institutions develop along with economies, not before them
3) Crony (managed) capitalism is an important step in an economics early stages
4) US managed to consume the world’s output, financed by their savings

*The Path of Crises
1) excessive investment in a new technology leads to a bubble (railroads, tech stocks, real estate, etc.)
2) One ore more companies begin to falter, creating anxiety among investors who promptly flee the market
3) Economy crashes and currency devalues. Debt burdens increase, and countries are unable to meet their debt obligations

*Reforms Proposed
1) Use contingent regulation (need regulation to automatically be tougher when things are going good and lenient when things are going poorly)
2) Use lagged public disclosure of risk by regulators to maintain the effectiveness of regulators
3) Use bonus escrow accounts, where subsequent losses are clawed back from these pools
4) Public disclosure of a “living will” on how financial companies would unwind under distress to discourage a bailout belief
5) Get government out of housing
6) Do away with deposit insurance (an unfair source of subsidized financing, and unnecessary for investors when there are other equally safe places to invest, such as treasury bills)




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2 thoughts on “Fault lines by Rajan Raghuram

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