TCS Daily


Cheap Credit and Export-led Bubbles

By Christopher Lingle - March 30, 2006 12:00 AM

Ubud, BALI - INDONESIA -- Recent moves towards central banks having greater independence from political interference have been applauded in the belief this contributes to greater global stability. Whatever the presumed and unproven benefits, it does not appear that most Asian central banks have greater control over the monetary destiny of their respective countries.

The reality is that the independence of Asia's central banks, whether based upon laws or convention, is much over-rated. In many Asian countries, monetary policy is held hostage to misguided trade policies that support an inclination to intervene in foreign currency markets. And these policies also make them more inclined to follow US central bankers in the lockstep motions of an automaton.

But things get worse. Most central bankers in Asia and elsewhere have reinforced global economic imbalances and increased risks that set the stage for greater future economic instability.

Since many Asian economies are export-oriented as a matter of policy, they tend to attract large net foreign currency inflows. To avert inflationary impacts on the domestic economy, central banks must mop up excess liquidity by selling bonds at discounted prices that tend to push up interest rates.

Since current and trade account surpluses tend to induce an appreciation in the local currency, the reaction is to then to try to manipulate foreign exchange markets. As such, many Asian central banks, with or without support of their respective finance ministries, conspire to depress the value of their currencies. And so it is that central bank independence is sacrificed on the altar of export-led growth in most of Asia.

Most foreign exchange intervention reflects a belief that the high performance of East Asian economies from the 1950s to the late 1990s was based upon export-led growth policies. But export-led economic growth resonates with a neo-mercantilist logic that carries the seeds of its own destruction.

A key element of export-led growth is "cheap credit" (artificially-low interest rates) that encouraged excessive, ill-advised investments. The bad news is that when these go sour, a mass destruction of (net) wealth occurs and the banking system is weakened.

Indeed, a sort of "domino effect" followed attempts by other East Asian countries to pursue similar policies in hopes of imitating Japan's early success. But just as Japan's economic "bubble" burst in the late 1980s, similar problems led to the bursting of Southeast Asia's economic "bubble" in the late 1990s. And it is inevitable that China's economic "bubble" will burst sooner rather than later.

While devaluation and artificially-low exchange rates stimulate exports, increased production and employment from a weaker currency cannot improve overall economic conditions. This is because an expanding export sectors from a weaker currency lowers the real wages for workers in those industries since more is produced for less.

This cannot bring sustained economic growth since labor and capital are merely reallocated from one activity to another. What happens is changing relative prices induce labor and capital to shift away from production that would satisfy domestic needs to the production of exports.

As such, a weaker currency lowers living standards by cutting real wage rates without permanently increasing economic growth or raising real incomes. Income earned from exports sold under a depreciating currency will mean that fewer imports per unit of export can be purchased.

This leads to a decline in domestic consumption since labor and capital are diverted from production for domestic use to production for exports. Meanwhile, officials and observers in many Asian governments are perplexed as to why economic stimulus mechanisms do not boost domestic consumption.

This is quite vivid in Korea where messing with the value of the won caused a sharp decline in its terms-of-trade last year. The commodity terms-of-trade index indicating how many imports can be bought with export earnings fell to 79.2 in 2005 from 85.3 in 2004, the largest yearly drop since 2000. As such, both the real wage and living standards of Koreans employed in the international sector of the economy is lower.

So, obsessions with weak currencies and the irresponsibly loose monetary policy of the US Fed created and perpetuated domestic and global macroeconomic imbalances. First, the Fed flooded global markets with dollars that brought about unsustainable increases in trade flows.

Ballooning US trade deficits were balanced by trade surpluses in export-oriented economies and offset by massive increases in purchases of dollar-denominated assets. These conditions are unsustainable and are mostly a creation of cheap-credit policies that carries a virus of instability more threatening to global economic health than the bird flu is to global human health.

It appears that central bank independence is neither necessary nor sufficient to create conditions that are conducive for economic stability and growth in Asia or elsewhere. As it is, other economic policy choices continue to inject an undesirable political element into the shaping of monetary policy.

Christopher Lingle is Senior Fellow at the Centre for Civil Society in New Delhi.

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1 Comment

Export-led bubbles
It stands to reason that if you're selling more than you're buying-- i.e., if your economy is "export-led"-- it's not a bubble but rather a sustainable model. I don't see this as necessarily being a problem.

In fact, I like to organize my own life around that principle. And just as the author mentions, saving much of the profit rather than instantly spending it, can in the long run be seen as a virtue.

Damn those Chinese! So logical.

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