MARKETS The global credit bubble, which reached its climax in 2007, took the form of a vast over-extension of credit with an associated mispricing of risk. Assets became hugely overvalued and the convergence of yields assumed away risks of default and, for currency carry trades, ignored the risk of exchange rates returning to fair values.
At the time very few observers had a good understanding of what was happening on the balance sheets of financial institutions. But the credit bubble produced a number of obvious macroeconomic symptoms. Real estate prices became very high relative to incomes in many countries. In economies for which savings rates are particularly sensitive to wealth – the US being the most obvious example – savings rates fell too low to be consistent with long-term economic growth. Most high interest rate economies developed enormous current account deficits because of the tendency for capital to flow from lower yields to higher yields, which caused high interest rate currencies to become extremely overvalued.
