from Follow the Money

How Europe finances the US

December 29, 2004

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Europeans invest in emerging Asia. That capital inflow would naturally tend to drive up emerging Asian currencies v. the euro. But emerging Asian currencies are generally stable v. the euro. In many cases, emerging Asian currencies are actually falling v. the euro. China, for example, is tracking the dollar down. To avoid appreciating v. the euro -- or v. the dollar -- Emerging Asian central banks intervene in the foreign currency market. Rather than financing a current account deficit in emerging Asia, the capital inflow from Europe finances reserve accumulation in emerging Asia. Most of those reserves are invested in US dollars.

The net effect: Europe lends some of its current account surplus to emerging Asia, and emerging Asian central banks onlend some of Europe’s surplus to the US. Asia provides the cheap financing that fuels US consumption, but the central banks of Asia -- not Europe’s private investors -- get stuck with the risk that the dollar will fall v. emerging Asian currencies.

Funny how the world works. Sustaining the current pattern of global growth requires that Asian central banks subsidize both European private investors and Asian exporters.

With consumer confidence soaring and housing strong, this weeks’ indicators point to continued strong growth in US demand. That likely will translate into continued strong import growth (right now, non-oil imports are growing at 15% y/y). If China is not going to buy new Boeings for a while,

China will have more money to lend to the US. The US will need China’s money: strong consumption growth in the US can only continue so long as the rest of the world keeps on lending. Alas, this week’s indicators point to continued unbalanced world growth -- not to the beginnings of Steve Roach’s global rebalancing. Global rebalancing implies growth led by exporters (say Boeing), not by housing and the Neiman-Marcus consumption economy ...

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