ABSTRACT
The queen of England was reported to have asked why economists did not foresee the GFC. There were a few who had warned of financial risks building up. But a large number had regularly predicted a dollar crisis. Large US double deficits were sustained by EM CBs investing their reserves in US treasuries. There was fear of a crash in foreign demand for these. Therefore, despite obvious financial sector failures, a section of the literature saw global imbalances as the fundamental cause of the GFC. The reasoning seems to be since precrisis what was predicted was a dollar crisis it must have been underlying currency stresses that caused the GFC! This chapter carefully examines this argument in a discussion of the causes of the GFC, including endogenous creation of leverage that aggravates booms. A simple model presented shows how banking can become unstable in the presence of factors causing cycles.
