Monday, July 7, 2008

A Macro view

For as complicated as global finance and the global economy is, it's actually possible to tell a fairly simple story about what's going on right now -- the US borrowed too much money to finance its spending, and now we're defaulting on the debt. Defaulting when you own the reserve currency is different though. Instead of the dollar falling dramatically, or domestic inflation running rampant, we are forcing the rest of the world to accept inflation in their currencies. The vast reserves of dollars piled up around the world are not being sold, and the consequence is the inflation springing up everywhere these reserves are being stubbornly held. The US has exported its default.

This would be an ingenious strategy if the rest of the world could be counted on to keep growing and keep absorbing this inflation. Unfortunately, the dynamic of the debt pile-up that got us into this mess in the first place means that the US has been the consumer of last resort and the engine for the industrialization of China and Asia. If this final link in the chain falters, these export led economies may not be stable enough to deal with the inflation a US default imposes on them. If they slow dramatically things could get really ugly, which is the conclusion of the post that inspired this line of thinking.

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