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Against the Tide: Liquidity and the dollar

The ability of the US to run a high current account deficit rests on a widespread belief that inflation and the cost of capital will remain low. But the conditions that underpin the deficit and the dollar’s role as the principal source of global capital are unlikely to be sustained for long.

A few years ago I wrote in Euromoney that a country whose currency was in demand as global capital could run a relatively high current account deficit without suffering a currency collapse. That country was the US and the currency was the dollar.

It is tempting to view the world’s imbalances as the result of a new economic order, whereby the rich economies become shopping malls filled with old age pensioners and the emerging economies produce everything for the malls and invest their economic gains there. Thus, the US becomes the world’s consumer and Japan and China are the world’s producers. And everything is priced and paid for with dollars that can be printed at will by the Federal Reserve. So the world economy moves forward seamlessly in a new long-term sustainable economic paradigm.

But does it? If you look at the world from the point of view of money flows, things do not look so stable. And if the monetary explanation is right, then the world of the dollar will not last.

Dollars exported by the US current account deficit flow fast to China and Japan. Normally, such dollar inflows would cause those countries’ currencies to rocket.

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