Tuesday, February 3, 2009

Global economic imbalances

Chastened by the bitter experience of the currency crisis of late nineties and in order to keep their exports competitive, the Asian Central Banks built up massive foreign exchange surpluses...



... simultaneously the American households, buoyed by the wealth-effect generated by the easy money (low interest rate) driven bubbles in tech-stocks and real estate and fuelled by the cheap imports from Asia-Pacific, indulged in an orgy of consumption, running up massive debts...



... the massive current account surpluses of the developing world (and few others like Germany and Japan) fed the equally massive current account deficits of the US generating global economic imbalances on an unprecedented scale, with all its dangers ...




... and given the lack of adequate depth and breadth in their domestic financial markets, the Asian Central Banks funnelled their burgeoning surpluses and savings into the relative safety and liquidity of dollar assets like the American tresuries, despite their poor returns. This inflows were in turn used to finance the appetite of American consumers and the purchases of foreign financial assets by American financial institutions (with its illusory "dark matter" dimension!) ...



... as dollar depreciated and the emerging economy equity markets rose, American overseas assets (predominantly denominated in foreign currency) rose sharply, thereby softening the adverse American Net International Investment (NII) position (difference between net assets abroad and external liabilities at home, mainly to Asian economies). But once dollar started appreciating and the emerging equity markets started sliding, the NII position rocketed downwards, leaving America with the investment position typical of a hedge fund - "safe, low-yield liabilities and risky, high-yield assets"!



(HT: The Economist survey - here, here, here, here, here, here, and here)

Update 1
Brad Setser has this description of the global economic imbalances.

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