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Great Recession Caused by U.S. External Account Deficit
Jesse Richman, 3/26/2013

A recent article by Thomas Oatley and coauthors in the Political Science journal Perspectives on Politics argues that the global financial system is particularly vulnerable to systemic crisis when that crisis originates in the U.S. because the U.S. and U.K. banks are centrally located in the international finance system. 

 In a follow-on blog post, and an in-progress book manuscript, Oatley extends that analysis to focus on  that the decision to finance the War on Terror through borrowing rather than taxes led to a worsening of the U.S. trade deficit, which led to the financial crisis.  

"The choice to finance the War on Terror by borrowing rather than by raising taxes worsened the US external imbalance and the resulting "capital flow bonanza" triggered the US credit boom.  The credit boom generated the asset bubble the deflation of which generated the great global crisis from which we are still recovering." 

"... Regulatory considerations and the global savings glut may be important conditioning factors.  But, the more I research this the more I conclude that these factors are less important than most of us believe.  Hence my decision to compare the case to the Vietnam War experience and to the Carter-Reagan buldup sparked by Soviet invasion of Afghanistan in 1979.  This was financed in the same way as the other two (budget deficits) and had the same economic consequences (housing bubble and the savings and loan crisis) as the War on Terror buildup."

Oatley makes an excellent point.  But it should be extended beyond simply the case made for the U.S.  More broadly, one of the key drivers of financial crises is running a large current account imbalance.  The savings inflows associated with such financial flows seem to invested wisely in only rare instances.  When the influx of savings is squandered on consumption or asset bubbles, it leads to misery.

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Comment by Ken Wiseman, 3/31/2013:

An excellent angle for the discussion, I would also add that the ramifications of added taxes would have made the wars of Iraq and Afghanistan much more meaningful in the average American's life.  Without delving into statistics and citations here, one can also see the lack of connection in the lower number of American homes with a family member in uniform.  Also, by looking into the past wars of the US, taxes passed for the sole purpose of financing a war had impact by creating some famous protests from people such as Henry David Thoreau who refused to pay the taxes.  Next, add the long-term costs of veterans health care and benifits for survivors to the debt and the effects of not raising money internally to pay these debts and the amount of the annual budget given to entitlements will continue to eat the overall budget. 




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