International Monetary Fund at the Economic Society of Singapore, May 24, 2006.
Global imbalances must eventually unwind. The risk is that they will be unwound in an abrupt and disorderly way. For example, there could be an abrupt fall in the rate of consumption growth in the United States, perhaps triggered by a slowing housing market. Or a disorderly adjustment might be triggered by developments in financial markets. Trends in exchange rates in recent months are in the right direction to help aid the adjustment process and, so far, have been orderly. But if investors become suddenly unwilling to hold U.S. financial assets at prevailing exchange rates and interest rates, this could lead to an abrupt depreciation of the U.S. dollar and increases in U.S. interest rates. This could cause global financial market disruptions as well as a downturn, and both could affect the open, trading economies of Asia seriously.He said nothing about a change in policy at the Bank of Japan which began last month and about which the financial press has headlines today. A search of the IMF web site indicates that none of the IMF specialists, including their man in Japan, said anything about this. Maybe they know, but are unwilling to say, fearing that they'll make a bad situation worse by calling attention to it.
There is a broad consensus among policy makers on the measures that are needed to reduce global imbalances. Most policy makers around the world agree that what is needed is fiscal adjustment and measures to stimulate private saving in the United States, further exchange rate appreciation and measures to stimulate domestic demand in some countries in emerging Asia, and structural reforms to stimulate demand and improve productivity in the non-tradeables sector in Europe and Japan. But this consensus has so far been translated into only limited action.
Ambrose Evans-Pritchard, writing in the Telegraph, has the clearest explanation of what's going on.
It's worthwhile reading the whole article. Evans-Pritchard says Japan has stopped battling it's long-term deflation and the Bank of Japan has been, since early this year, reducing its cash holdings. It's purchasing fewer US securities and allowing the Yen to increase its value, particularly against the dollar. Its action is causing an increase in interest rates across the world, particularly bond interest rates and in that sector particularly US Treasuries.
The fallout from this event is a slump in global stock markets, particularly markets in emerging-market countries, as investment capital becomes more expensive and thus more scarce.
The housing market may be the first economic sector to unwind (or burst, since most think of it as a bubble). Evans-Pritchard writes:
"Housing mayhem seems unavoidable. The US hard landing begins now," said Charles Dumas, global strategist at Lombard Street Research.
Mortgage applications are down 17pc in a year. House sales are down 5.7pc, and inventories of unsold new houses are at their highest since 1996. The central prop holding up the US consumer boom is crumbling, leaving behind record household debts equal to 127pc of disposable income.
Teun Draaisma, Morgan Stanley's chief European equity strategist, had a warning for bargain hunters, even after the 8pc fall in European stocks and 15pc fall in the MSCI emerging markets index. "Do not be tempted to buy. The first violent part of this correction took nine trading days: the second part may well take several months," he said.
The world has enjoyed a magnificent boom for 24 years, punctuated only by light downturns along the way. The cycle has been kept alive beyond its natural life by ever-laxer monetary policy, feeding ever bigger asset bubbles and encouraging ever-higher levels of debt.
Central banks can draw down prosperity from the future for a while. In the end - now? - the future arrives.