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The more persuasive is this “liquidity” story, the more plausible it becomes that the correction is going to be more painful than conventional wisdom believes.
Commenting on Wolfgang Münchau and Lawrence Summers
Martin Wolf, FT 10/1 2007
The US has absorbed about three-quarters of the excess savings of the rest of the world; the second has been a long period of relaxed monetary policy, particularly in Japan and the eurozone, but also for some time in the US as well.
This, it is argued, has had powerful effects on asset prices, particularly house prices in a number of high-income countries. Strong house prices have, in turn, sustained demand at high levels, particularly in the US, the UK and Spain.
One reason for this is that even a relatively mild slowdown might shift policy in high-income countries, especially in the US, in a much more protectionist direction.
The economy may be global. But democratic politics are local. An open economy will become unsustainable if a majority concludes it is against its interests.
If consumer spending declines and interest rates fall or appear likely to fall, there is the real possibility that the foreign lending to the US that has financed imports far in excess of exports will start to dry up,
leading to a combination of higher long-term interest rates and a weaker dollar.
Lawrence Summers, FT, March 26 2007