Consider two views of the global financial crisis. One view looks across the border: it blames external imbalances, the unprecedented current account deficits and surpluses in recent years. Another view looks within the border: it faults domestic financial systems where risks originated in excessive credit booms. We can use the lens of macroeconomic and financial history to confront these dueling hypotheses with evidence. The credit boom explanation is the most plausible predictor of crises since the late nineteenth century; global imbalances have only a weak correlation with financial distress compared to indicators drawn from the financial system itself.

Did “global imbalances helped to fuel the financial crisis”? In the years since, imbalances have muted, but endogenously, as trade collapsed and EM economies outgrew the U.S. and other DM economies. But prior to 2008 these flows were much larger. Many prominent policymakers, commentators, and economists had focused on large current account imbalances, in the United States, but also in other countries with pronounced booms, and had warned about the potential for a jarring shock should those flows see adjustments due to incipient changes in portfolio allocation, and concomitant shifts in interest rates, growth rates, perceived country or currency risks. Harsh adjustments, sudden stops, or reversals, it was thought, could wreak serious havoc. Much attention was given to the role of the large lenders/creditors in Emerging Asia (especially, China) causing a “savings glut” whilst others focused on savings shortfalls in large borrowers/debtors like the United States. In these arguments, the public or official sectors tended to attract the most scrutiny, be it the official reserve accumulation trends in developing countries, or the path of government deficits and debt in the United States.2 But those focusing on the public sector dimensions of the flows ended up missing the main story. Without minimizing fiscal challenges going forward (many of them a result of the crisis), the kind of crisis we ended up having was in almost all cases not a fiscal crisis at all. In the United States, where large-scale financial pressure was first seen, the dollar has rallied on the flight to safety, as have Treasuries, notwithstanding what credit rating agencies have said. In Europe, intraregional imbalances are now seen to have been a source of instability, but ex ante (with the exception of Greece) these cross-border flows were largely private sector debt flows, much of them flowing through bank channels from savers in the “North” to finance real estate or consumption booms in the “South”; public debts and deficits in places like Ireland and Spain only exploded later, as harsh recessions and banking rescues ate resources.