Saturday, June 21, 2008

Role of forex market interventions on inflation and US credit squeeze

Martin Wolf feels that the current inflation crisis is part of a larger global picture of credit crunch in the US, soaring commodity prices, and interventionist policies in the foreign exchange markets by the Asian Central Banks to keep their domestic currencies low.

He links up the story,
"Many emerging economies have intervened in currency markets on a huge scale, principally in order to keep export competitiveness up and current account deficits down. Over the seven years to March 2008, global foreign currency reserves jumped by $4,900bn (€3,175bn, £2,505bn), with China’s reserves alone up by $1,500bn. Indeed, as much as 70 per cent of today’s reserves have been accumulated over this period.

Interventionist policies aimed at sustaining export competitiveness expand economies. The results normally include rapid rises in net exports, low interest rates, aimed at curbing the capital inflow, and expansion in the monetary base, despite attempts at sterilisation. The Chinese economy is overheating as a direct result of this trio of effects.

Most of these reserves were accumulated by countries more or less explicitly targeting the US dollar and accumulating US liabilities. The resulting capital flow financed the US trade and current account deficits. But a trade deficit is contractionary: for any given level of domestic demand, it lowers domestic output. Thus, the US needed to expand domestic demand, in order to offset the contractionary effect of the external deficits. Some groups within the economy needed to spend more than their incomes. The most important such group turned out to be households. Thus the growth in US household indebtedness that led to today’s "credit crunch" is a direct result of the global imbalances."

2 comments:

India Forex said...

Thanks for sharing this piece of forex news with us. Is there a way i can subscribe to your blog.

Thanks

forex training said...

Thanks Gulzar for sharing the information. great article.