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The Shape of Things to Come

Author: Brad W. Setser, Fellow for Geoeconomics
March 2009, Volume 46, Number 1
Finance and Development

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National decisions, not international summits, will remake the global financial system

After Asia's financial crisis, the world's leading economies launched a major effort to remake the international financial system. Ten years later, they decided to try again. The 1998 effort to revise the world's "financial architecture" followed a crisis that had originated in the unwinding of the external deficits in the emerging world - deficits that were for a time willingly financed by banks and private investors in the world's wealthy economies. The second effort will follow a systemic financial crisis that started in the United States, spread to European banks that had borrowed dollars to buy U.S. securities, and then infected most of the world economy.

A downturn in U.S. home prices that led to large losses at the large banks and broker-dealers triggered the current crisis. But the household deficit of the United States, the United Kingdom, and many euro area economies couldn't have been financed for as long and at as low a rate without an unprecedented increase in the assets of the emerging world's central banks and sovereign funds. Private investors were never that keen on financing large deficits in the slow-growing United States; they wanted to finance the fast-growing emerging world.

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