Alleghany’s Thoughts on the Big Picture and Financial Crisis

Over the weekend I got around to reading some more annual reports. One that stood out was Alleghany Insurance. The reason Alleghany’s report stood out was because of its thoughts on the “big picture,” or rather, the reason for the financial crises of 2008. The general theme for most companies was to blame the availability of easy credit, the Fed, derivatives, and/or American consumers spending more than they were earning.

With this back drop, Alleghany’s thoughts were a real curve-ball. This is how they begin their “thoughts on the big picture” (as contained in their 2008 annual report):

The imbalances that are evident today in the global economy trace their origins to August of 1994, when China embarked upon a course of a managed, nominal currency peg of the renminbi (RMB) against the U.S. dollar. Few remember today that as recently as 1981, the RMB/USD exchange rate was as strong as 1.53 yuan per dollar; by 1994 it had weakened to as low as 8.76 yuan per dollar, and was pegged at 8.28 until 2005. Over the following decade and a half, this currency policy contributed to stagnant U.S. household incomes (real median U.S. household income is lower today than it was in 1998), as U.S. labor could not compete with a massive, artificially priced Chinese labor pool due to the currency devaluation. The mechanism with which China (and other countries with pegged currencies) kept its currency artificially depressed was to recycle dollars into U.S. treasury securities and agency securities, thereby keeping U.S. interest rates artificially low, exporting deflation, and importing inflation. The prime beneficiary of this policy in the United States and other OECD (Organization for Economic Cooperation and Development) countries was the financial services industry, which took advantage of excessively easy money and low interest rates to fund credit expansion to middle class households, who sought to improve their standard of living despite stagnant incomes by borrowing to fund consumption.

So rather than blaming something that was particular to America, Alleghany pinpoints China’s currency peg as a large reason for the worldwide financial crisis. Very interesting.