Thursday, July 03, 2008

The Great Moderation

Currently, the Central Bank of China lends money to American consumers so they can buy Chinese goods -- think of it as vendor financing courtesy of China, Inc. Unfortunately the American consumer is overdrawn, and so has to reduce his consumption (and work out some of his debt). China is preventing this from happening by buying US treasury bills at an incredible rate and the US is politically and financially incapable of handling reduced consumption. Nonetheless, dollars spent eventually have to equal dollars spent, and Mark Thoma/Tim Duy has an excellent post detailing how the runup in commodity prices could be the mechanism for that adjustment.
But wait – that capital is gaining traction, but in such a way that forces the inherit overconsumption of the US economy to light. Pick a channel, speculative investment, portfolio rebalancing, or fundamental demand, and you find financial markets trying to drive a rebalancing by forcing up the cost of key commodities. What US policymakers are unwilling to allow directly, the markets are forcing indirectly.

Consider that the current account deficit will need to correct by some mixture of import compression and export expansion. The weaker Dollar encourages that correction, but Dollar-pegs prevent the full adjustment. But where currency adjustment fails, commodity price adjustment steps in as, for example, higher transportation costs support import competing industries. Indeed, we are learning that cheap oil, not just cheap wages abroad, was the critical force supporting offshoring of US production.
Worth reading in full.


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