Thursday, August 11, 2011

A World of Imbalances

As I've said before, the massive imbalances in the global financial system would lead to a financial crisis, and the tepid reforms after the crisis of 2008 could lead to a comparable--or worse--crisis down the road.

There are numerous imbalances, such as China's extreme spending on fixed assets relative to its overall economy.  When countries allocate such a large portion of their economies to such investments, it invariably has lead to excessive lending and productive capacity, causing an inflationary boom, ultimately leading to a sharp slowdown.  

Another imbalance is in foreign currencies, where amid alarm over developments in the Europe and the U.S., currencies such as the Swiss Franc and the Japanese Yen has soared from a flood of money in the search of a haven.  While a strong currency is generally thought of as good for a country, too much strength can be a major problem.

In Switzerland, exports account for half of GDP.  The sharp rise in the Franc has made the country's exports increasingly expensive and uncompetitive.  In just the last year, the Franc has risen 31% against the Euro.  Nestle recently noted that the currency strength reduced its reported first-half sales by 14 percentage points, as revenues denominated in its overseas local currencies were converted back into very expensive Swiss Francs.  Swiss authorities are now seeking ways to reduce the exchange value of the Franc.  But as global stock markets plunge and fear among market participants is soaring, it is not just European and American officials who seem to be scrambling to keep up with--forget about controlling--world markets.

Steve Lehman

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