Global Markets: The Problem With Success

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Marc Chandler

NEW YORK (BBH FX Strategy) -- Failures are humbling and costly; but ultimately, it is success that is more challenging.

The strains that broke the back of the economic and financial system emanated from its successes. Years of economic growth produced surpluses in Asia (and emerging markets more generally) after the 1997-1998 financial crisis, which could not absorbed. These surpluses were exported.

The financial deregulation can be traced to the late 1970s, they accelerated in the 1980s and 1990s. This widened the financial pipes, broadening capacity and multiplying the number of financial instruments, while weakening the walls of those very pipes.

Europe's financial system could not absorb its own surpluses. Instead, European banks feasted on U.S. securitization of debt instruments before turning to its own peripheral sovereign bond markets.

In an environment characterized by de-leveraging, fiscal austerity and weak wage growth, the ability to sustain aggregate demand is critical for social, political and economic stability. A parallel issue exists in the financial system. Ultimately, it needs to be able to absorb and distribute greater amounts of savings and investment and at a lower societal price.

Using Central Banks' Balance Sheet: Is This Permanent?

The recent string of U.S. data has helped relieve fears that the pattern of the past couple of years was going to repeat, by which respectable fourth-quarter growth is followed by a disappointing first quarter. While a broad number of economic indicators continue to suggest the U.S. economy is on the mend, the financial system remains in disrepair.

Central banks have moved to fill the breach. The Federal Reserve and the European Central Bank reject that they are engaged in what the market calls "quantitative easing". Yet the fact of the matter is that their balance sheets, like those of the Bank of England, the Bank of Japan and the Swiss National Bank, have all expanded markedly since the onset of the crisis.

Out of the Great Depression grew a nearly universal recognition among policy makers of the value of counter-cyclical government spending. But more: the size of government (expenditures as a percentage of GDP) has grown markedly since then and on a seemingly permanent basis.