Fiat Money and Business Cycles in Emerging Markets

6692Roger McKinney writes in today’s Mises Daily:

Internationally, the ABCT might work something like this: the Fed expands credit, and thereby the money supply, during a recession in order to stimulate domestic aggregate demand. But it creates more money than US citizens want to hold, so they buy more imported consumer goods from China and investments from EM countries. The export of investment funds causes the boom in the higher order phases of the capital structure in EM nations instead of the US where the Fed intended the funds to go.

Of course, Europe and Japan add to the world’s stock of reserve currencies and tend to expand credit in sync with the US, thereby multiplying the effects.

At some point, the Fed will begin to cut back on credit expansion in order to head off rising price inflation at home. Investors will repatriate their money from EM nations and cause a decline in the EM foreign exchange rate with respect to the dollar, yen, and euro. The IIF report from October warned that, “… other things equal, if market expectations for the U.S. policy interest rate were to rise from the current 1 percent at end-2015 to 2 percent, this could result in a retrenchment of EM portfolio flows of around $43 billion

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