Outsourcing recession

Daniel Drezner follows up on Tyler's original post which posed the question "why are Asian central banks buying dollars?", when the dollar seems to be an overpriced asset who's value is dropping relative to other currencies, and says that, most likely, its a combination of politics and the historical propensity of East Asian corporate & state investors to buy overpriced assets.

The primary explanation, says Drezner, is that the central bankers are buying dollars to keep their own currencies weak, to promote mercantilist export policies. The side effect of this, aside from keeping the US dollar overpriced (and, I presume, enriching/subsidizing currency traders as they bleed away the overvalue by turning around and buying Euros), seems to me to be twofold- as Don Boudreaux points out, the forced export policies' outcome of artificially lowering prices essentially subsidizes US consumption. The second effect is that Asian central banks are absorbing the massive currency inflation of the Fed, helping to prevent or at least slow credit-based consumer price inflation.

In a credit expansion, people are using credit generated out of thin air to buy real services and goods. All things being equal, more money chasing the same amount of goods and services will cause the prices to rise. In the case of free flowing capital markets, though, the US can use the extra dollars to chase more goods and services, which flow in from the rest of the world. If that flow into the domestic economy is faster than the flow of new credit into the domestic economy, it would seem that inflation could stay low, and asset prices would rise while subsidizing American consumption.

This, to me, explains the 90s boom fairly well.[1] The massive trade deficit that erupted at the collapse of the US boom is also consistent with that explanation- when the rate of inflation slowed, and interest rates were increased, the massive amount of malinvestment in the economy was revealed and the costly correction period began, requiring real goods and services to rebuild and retool businesses to reflect the new economic reality. US savings rates are preposterously low, but the absence of consumer and investment opportunities around the rest of the devloped and developing world leads to a surplus of real saving there, and that money flowed into the US hand over fist. When money flows into the US, it's reflected as a negative current account balance (trade deficit)[2]. Foreign savings replace domestic savings, subsidizing American consumption habits (which didn't really take much of a hit during the recent recession), as well as investment activities.

But since there ain't no such thing as a free lunch, as a result of the flows into the US, foreign countries' savings are not available for consumption or investment there. So essentially, the rest of the world took the hit during our recession to keep American consumption high and at the same time retool the economy, at the expense of their own economies. We "outsourced our recession", so to speak.

Viva globalization![3]


fn1. Aside from, of course, the predictions of Austrian Business Cycle theory. The ABCT is the general why and wherefore, while pointing to foreign capital flows as an explanation for low consumer good inflation in the face of massive monetary expansion would be a specific why/wherefore.

fn2. We're 'importing' cash, as it were.

fn3. Of course, anything that can't go on forever, stops. Either foreigners will eventually demand returns on their money in excess of US growth or they'll have more attractive investment opportunities closer to home (which is usually tied in and contemporary with the first development), both of which will cause the flow to stop or reverse. But the bottom line is that, as Don Boudreaux also says, so long as we have a global capital market, only the global rate of savings ultimately matters.

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