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Recession: Where the local is the global

Jeremy Hobson Dec 26, 2011

Jeremy Hobson: The latest news on the European debt crisis is brought to you by the letters G-R-D.

That’s the code banks use for the old Greek currency, the drachma. And according to the Wall Street Journal, some global banks are trying to figure out how they’ll get their computers to recognize that code again if the euro breaks up, and the Greeks go back to the drachma.

The idea of a eurozone collapse is raising red flags with international banks because it could bring another global financial crisis, even perhaps a global recession. Here to talk about that with us is Simon Johnson. He’s a senior fellow at the Peterson Institute for International Economics. Simon Johnson, welcome to Marketplace.

Simon Johnson: Hi, how are you?

Hobson: I’m doing well. Let me ask you first: When we hear about a recession these days, it seems like we’re talking more and more about a global recession. So when was the last non-global recession that we had?

Johnson: That’s a good question. If you look at Asia in the late 1990s, they had a big slowdown — a series of crises, really — and the rest of the world kept going fairly strong. Other places including Argentina and Brazil had crises and big slowdowns at the beginning of the 2000s, and the world was pretty strong. We haven’t seen, though, a really serious slowdown in the United States that doesn’t spill over to the rest of the world for quite some time. The U.S. is so central to the way the world’s trade works, and increasingly to the way the world’s financial system works, that I think it’s all global from here on out.

Hobson: It’s all global from here on out. So if we are about to go into another recession, it’s going to be a global recession just because we’re so intertwined with everybody else?

Johnson: Yes. The key dimension of intertwining in this respect is the financial intertwining. If you have a Lehman-type panic, that spreads around the world very, very quickly. If you can imagine a U.S. recession without those kinds of financial spillovers, perhaps the effects on other countries will be limited. But I think for 2012, what we’re looking at most likely is a crisis with the epicenter in Europe around sovereign debt and around European banks. That would then spread to us through our banking linkages and also around the world, either through tightening credit or runs of various kinds away from major financial players. That combination is almost certainly going to be toxic for everyone.

Hobson: What’s the reason for this? Why should every recession be a global recession? Is this simply because our banks have gotten too big or what?

Johnson: Yes, the banks have become very big, they’ve become very global. They’re enmeshed themselves in non-transparent ways, ways that perhaps they don’t understand — and certainly the regulators don’t understand. And that means that a relatively small shock of fear about a shock can lead to consequences far away in the United States — or perhaps even in China or in Africa. I don’t think anyone in the world is immune from these kinds of modern financial shocks.

Hobson: And is this something that you as an international economist look at and say, ‘it’s too bad we made such mistakes and now we’re in this situation,’ or do you say ‘this was inevitable: globalization, global trade, global banking — this had to happen’?

Johnson: I don’t think it had to happen in exactly this form. Part of the problem is we’ve allowed a lot of moral hazard to build up in the system, meaning people feel they’re going to be protected on the downside, so they can’t lose their deposits, they can’t lose the money they’ve lent to Goldman Sachs or whatever the big international player. So what happens when there is a big slowdown, when there are major losses when someone actually fails, there’s a big repricing of risk. That fear spreads widely across an asset class and people move together in the modern financial world, much more than they did in the past.

Hobson: Well what do you we do to deal with this new reality of every recession being a global recession? How do you prepare for it?

Johnson: I think you need firewalls. People talk about this a lot, but it’s like the way that they talk about it, but nobody actually does anything about it. Firewalls means you should have systems so that if a big French bank or a big German bank goes down, we need to be immune in the United States from the major shockwaves. You can’t be completely immune — that would be an illusion — but you have to wall yourself off much more, you have to break those linkages; the transactions and markets have to become much more transparent. We’re interconnected, big bad things can happen in faraway places, and nobody is ready for what will come next.

Hobson: Simon Johnson is a senior fellow at the Peterson Institute for International Economics, also a professor at MIT’s Sloan School of Management. Simon Johnson, thanks so much.

Johnson: Thank you.

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