“Moral panic” in capital markets

Stephen Kirchner makes a strong case for learning to stop worrying and love global liquidity (nice job if you can get it…) bq. The notion that domestic demand should be constrained by domestic production is increasingly anachronistic in a globalised world. While many people grasp the welfare-enhancing nature of trade in goods and services, it seems that few can fathom that the same principles apply to global trade in capital and labour. This is not surprising, given that hostility to cross-border flows of capital and labour is even more pervasive than hostility to free trade in goods and services. In part, this may simply be due to lack of recent experience. International capital and labour mobility is much lower today that in the late 19th century, despite all the talk about globalisation. Singapore provides a good example of a country that is very open to trade in goods and services, but relatively closed to foreign capital through capital account restrictions and the failure to internationalise its currency. The moral panic over current account deficits is thus partly symptomatic of a closed economy mindset. It is this mindset that is far more dangerous than current account deficits. (“Institutional Economics”:http://www.institutional-economics.com/) I share Stephen’s philosophy on this and agree that thanks to open global capital markets, the ability to sustain persistent deficits on current account is simply an expression of market values. Still…there’s no reason to believe that capital markets will get those values right in particular cases or that they will take up, or climb down from, their enthusiasms gracefully. It’s a matter of record that they don’t. No matter how sophisticated the exchange markets and their derivatives, in the real world adjustment is costly (in trade or financial markets)—particularly when it’s rapid or unexpected. I’m prepared to be cool about deficits, to avoid ‘moral panic’ about spending unconstrained by the value of production, and to acknowledge the unarguable benefit of an open and active global capital marketplace (for exporters as well as importers). But I don’t have to love “crackpot fiscal policies(link to Gerard Baker in the Financial Times—subscription)”:http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1045511355071&p=1012571727092 (or “policy vacuums”:http://www.inquit.com/article/321/the-great-sucking-sound-revisited) that force foreigners to adjust early and often and threaten—one day, possibly—a spectacular adjustment squeeze in which we may all have to share.

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