December 21, 2009

IDEALLY, RATES FOLLOW INFLATION (OR DEFLATION AS IN THIS EPOCH):

The 'Global Imbalances' Myth: Different countries have always played different roles in the world economy (ZACHARY KARABELL, 12/21/09, WSJ)

When officials and economists today speak of correcting global imbalances, it is unclear what benchmark they have in mind.

So-called excessive American consumption, East-West trade flows, Chinese savings and the like were not responsible for the recent crisis. That was instead triggered by massive misplaced bets on the U.S. housing market and trillions of dollars of derivatives built upon that flimsy foundation.

Yes, many have woven a compelling narrative of how the relationship between China and the U.S.—distorted by China's fixed and nonconvertible currency on the one hand and America's debt-fueled appetites on the other—led to massive flows of capital out of the U.S. But that money flowed right back into the U.S. in the form of Chinese purchases of Treasury bonds, mortgage-backed securities and other dollar-denominated assets, which then flowed into our banking system, which then made its way back to U.S. business and to the Treasury, some of which then circulated back into China.

What some see as imbalances can also be described as a system of capital and goods in constant motion. Chinese reserves and U.S. government debt didn't trigger the meltdown, nor did U.S. consumers cause the meltdown. It wasn't even U.S. consumer debt—after all, more than 90% of Americans have remained current on their credit cards and their mortgages. The real (and much messier) cause of the meltdown was a potent brew of financial innovation, electronic and instantaneous flow of capital, greed on the part of banks and investors world-wide, against a backdrop of an economic fusion between China and the U.S. that kept interest rates low and inflation lower.

Posted by Orrin Judd at December 21, 2009 7:09 AM
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