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Falling dollar is good for the world economy

October 18th, 2010 · 2 Comments

But not for Japan and Europe..
There is a significant minority of economists who blame the 2008 crisis on the persistence of “global imbalances.” By this they mean the excess savings in (large parts of) Asia and the lack of savings in the US. This situation produced large trade imbalances with the Asian countries reinvesting their export bounty in the US to keep their currencies from rising.

This lowered interest rates in the US, further punishing savings and inflating a bubble in asset prices.

There is something to be said for this, although we don’t think it has been the main issue (which is one of unregulated financial markets, as other countries, like Germany had very low interest rates without this leading to asset bubbles).

Now that the smoke produced by the crisis is clearing, the asset bubble in the US is deflating (at least the one in housing, which was the one that mattered) but those fundamental imbalances remain.

To soften the impact of the de-leveraging overhang of the puncture of the housing bubble, the Fed is now considering another bout of bonds buying (QE, or quantitative easing).

While we firmly belong to the sceptics camp (it essentially just creates bank reserves but without necessarily leading to increased lending to business) and we think there are more effective ways of stimulating the economy (public investment, like China did in 2008), we do note one favourable effect of QE2 (that is, of markets expecting QE2), a falling dollar.

As long as this doesn’t become a rout this should go to some length in redressing those global imbalances (apart from the biggest one, the Chinese savings/trade surplus, as the Chinese currency isn’t freely tradable and the authorities have it firmly pegged to the dollar).

Asian economies run the risk of overheating, triggering inflation which is already quite high. Higher currencies will go a long way in providing necessary cooling.

The US, on the other hand, could do with a cheaper currency to stimulate export and production. Higher inflation also helps to cut the real value of debts, speeding up the de-leveraging process and defusing fears about unsustainable public finances.

Poor Japan and Europe, they are firmly caught in the cross-fire.

Krugman doesn’t have any sympathy with the Europeans, though:

A Fine European Whine

A senior European policy-maker, who asked not to be named, said a further aggressive round of monetary easing by the US Federal Reserve would be “irresponsible” as it made US exports more competitive at the expense of its rivals.

In other words, how dare you act to protect your economy from deflation and double-digit unemployment? By doing so, you make our inappropriate tight-money policy even more destructive!

Tags: currencies

2 responses so far ↓

  • 1 Darcy Patten // Oct 18, 2010 at 7:37 pm

    This isn’t good for my investment in IOC either. If it was back in the good ole days where the US $ was 1.4 times the Cdn $ then my IOC investment would be worth 96 bones.

    But perhaps, I shouldn’t be so worried about selfish me 😉

  • 2 admin // Oct 18, 2010 at 7:43 pm

    Forgot Canada there (and a bunch of other countries..), sorry. Some comfort can be drawn from the fact that currencies have a tendency to reverse to mean around their purchasing power parity (but that can take years)..