Just a few thoughts on the Clownbuck:
Suppose there are two countries, Country A and Country B. Country A produces very little of what it consumes, and Country B produces not only for itself, but also pretty much everything that Country A needs: cars, clothing, phones. One would assume that the denizens of Country B would very quickly grow tired of supporting Country A and tell them to "p*ss off" - go make your own stuff.
Now introduce a Global Currency Exchange. The people of Country B expect to be paid in Currency B, so the huge current account deficit between A and B would presumably nail Currency A until the people of Country A actually had to come up with something REAL to exchange with Country B.
Not so fast. Now introduce Central Banking, clever financiers in Country A, a historically strong currency for Country A, and a burst bubble in Country B. The clever financiers realize that the huge current account deficit will most certainly destroy the "good thing" they've got going, so they must do something to alleviate the problem. There is a huge outrush of Currency A that must be offset, but how to do it? They hatch a brilliant scam - er, scheme. They realize that Country B has its own economic problems to deal with, and so has no borrowing costs in an attempt to extricate itself from the decade-long mess it's in. They also realize that if everyone in Country A pays for everything on credit, borrowed straight from Country B, the flow can be entirely offset, for the time being. What's best, they can earn a spread on all that money, because interest rates in Country A are far higher than Country B. So the large finance companies in Country A run to Country B and borrow large sums of money at 0%, sell Currency B, and buy Currency A, in amounts that totally offset the current account deficit. Then they loan it out at double digit rates to consumers in Country A. Some of them hedge the currency risk, some don't; Currency A is historically a store of value, so no one is faulted for not hedging the risk.
Now introduce economic cycles. Country A, with ample capital flowing from Country B to fund its voracious consumer appetite, launches out of its slump first. Country B lags, so Currency A actually experiences net demand and rises relative to Currency B, thanks largely to having the current account deficit offset. A rising Currency A attracts ever more people to establish carry trades, selling Currency B and buying Currency A bonds, since it is basically "free money" and there's no risk of losing.
So how does this all end? Well, Country B finally starts to recover, and realizes it can't have 0% interest forever. Further, Country A begins to slow a little. The relative difference squeezes Currency A until all the carry trades begin to go under water. Currency A must eventually be sold to repay all the loans made in Currency B. All the accumulated deficit for years must be paid in full, it's just been delayed, stored up like water behind a dam. However, thanks to the Efficient Market, several years' worth of deficits can actually be paid down in a matter of months, as no one can afford to be the last up to the currency counter to exchange Currency A for Currency B to repay all the loans. When Currency A begins to slip, and its picture doesn't look pretty to the clever Country A financiers, they all attempt to get out at the same time. Currency A collapses and prices skyrocket in Country A, since everything they buy comes from Country B. The economy of Country A weakens further thanks to the pressure on the currency, but the Central Bank can't do anything to alleviate the problem. If they lower interest rates to stimulate the economy, it merely pressures the currency further.
The moral of the story: I really don't know. Who's responsibility is it to keep the scenario from unfolding this way? Central Bank A? Central Bank B? The financiers? The problem is that the blame is distributed, and no one individually recognizes their role in contributing to a global financial mess. Nobody wins when it unwinds. Sure, Country B eventually gets paid in Currency B that is now more valuable, and Country A is forced to pay up in kind, but Country A was responsible for most of the demand that Country B relied upon for employment.
I guess that's why markets tend to have bubbles and busts, and why I'll always be suspicious of things that look like bubbles: independent parties make decisions in their own best interest, but (believe it or not) that doesn't always result in the best outcome for the whole.
BC |
