Sunday, May 16, 2004

Comment to Brad Delong's site,

Here was my comment on the Chinese dilemma at Brad's site:

Well the fundamental things being juggled are inflation, GDP growth, current accounts balances, debt, interest rates, and market stability.

In the simplest scenario, you get the Fed going too slow, China picking its peg, and the Chinese economy has a hard landing, inflation grows, and the dollar corrects somewhat. This is a mixed market and central bank strategy.

A pure market strategy would be to let the currency and current accounts balance correct to sustainable levels, and see gold and oil jump about 25% each. A pure banking strategy would be for the Fed to raise faster, retain lower inflation and the currency peg, but at the cost of a twin recession - Chinese and American. However in either pure scenario there is a chance of a market crisis.

There really is no happy ending here, just a choice of preference of poisons. I think the Fed is going to go slow and the chinese pick their currency peg, and so pick a kind of worst of all worlds scenario where we have some inflation, some debt market crises, some currency devaluation, and some part of an economic recession.

Who knows, maybe they're even right to make this choice.


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