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By Root 1160 0

side effect of the success described above. Low inflation, global growth, swift technological advancement: these trends, played out over decades, led to an enormous increase in liquid assets, the ever-growing piles of money moving around the world. That liquidity kept credit cheap and assets (including real estate, stocks, and bonds) expensive. At the same time, the boom in low-wage countries prevented inflation from rising too much. One way to think about India and China is as two great global deflation machines, pumping out goods (China) and services (India) for a fraction of what they would cost to produce in the West.10 This is one of the chief reasons that central banks haven’t had to worry much about inflation and have been able to maintain low interests for almost two decades, an unusually long stretch of time. That led to arrogance, or more technically, the death of risk.

The businessmen and financiers who cautiously prepared for political disruptions—unstable governments, terrorism—let their guard down when it came to economic risk. They assumed that the growth of complex financial products (remember the infamy of credit-default swaps, which brought down AIG?) actually reduced risk by spreading it around. They believed that levels of debt that were once considered dangerous were now manageable, given what they assumed were permanently changed conditions owing to the Great Moderation. As a result, investors piled into what would normally be considered dangerous investments, all for the promise of relatively little reward. Credit spreads—the difference in yield between a U.S. treasury bond, considered the world’s safest investment, and the bonds of companies with limited track records—hit historic lows. In 2006 and 2007, volatile countries like Ecuador and teetering companies like Chrysler could borrow almost as cheaply as the U.S. government. (By 2009, of course, Ecuador had defaulted on its debt and Chrysler was kept alive only by a last-minute government bailout.) And since debt was cheap, financiers and homeowners used it to excess, spending beyond their means. The banks and investors who supplied all the cheap cash were reassured by fat corporate coffers—with profits that rose at a double-digit clip for eighteen consecutive quarters between 2002 and 2006—and bankruptcy rates that were well below normal. The good times seemed never-ending.

The world economy became the equivalent of a race car—expensive, with incredible range, and capable of performing at breathtaking speed. In the decade before 2008, everyone rode it and experienced the adrenaline rush and the highs. There was only one problem: it turned out that nobody really knew how to drive a car like this one. Over the last ten years, the global economy had become something no one had ever seen—an integrated system of about 125 countries, all participating and all going at unheard-of speeds. It was as if that race car was being driven by 125 different drivers—and no one remembered to buy shock absorbers.

There were those who wanted shock absorbers. They were seen as naysayers during the boom years. They asked why packages of subprime mortgages should be rated as highly as bonds from General Electric. But each successive year ended with another eye-boggling earnings report or billion-dollar payday for the hedge fund manager of the moment, the much promised correction failed to materialize, and the naysayers grew quieter and quieter. A kind of reverse natural selection occurred on Wall Street. As Boykin Curry, a managing director at Eagle Capital, said, over the last twenty years “the DNA of nearly every financial institution had morphed dangerously. Each time someone at the table pressed for more leverage and more risk, the next few years proved them ‘right.’ These people were emboldened, they were promoted, and they gained control of ever more capital. Meanwhile, anyone in power who hesitated, who argued for caution, was proved ‘wrong.’ The cautious types were increasingly intimidated, passed over for promotion. They lost their hold on capital.”

Warren