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Stock market economy

By: Anthony Green

When a country runs a current-account balance the currency comes under pressure and real interest rates rise, tilting the balance of growth away from the domestic economy and towards the export sector.

But the United States has managed to defy the normal laws of economics by virtue of the fact that the dollar is the international reserve currency.

The negative flows across the US balance of payments on the current account were more than offset by the inflows on the capital account. Foreign investors were keen to buy American assets and overseas companies were busy acquiring American businesses.

During the bear market of these capital inflows fell away. The currency came under pressure between 2002 and 2004, but it did not fall by as much as might be expected give the size of the current-account deficit.

Economic imbalances do not necessarily result in a market crash or debt crunch. A smooth adjustment can occur through either market forces or official policies. But imbalances are easier to sustain when an economy is growing steadily. In this respect the economy is rather like riding a bicycle.

If a cyclist hits a small bump or pothole once a comfortable head of speed has been built up, it is not too difficult to steady the bicycle. There may be some loss of speed while the correction is occurring, but basically the bicycle continues on in the same direction.

If the same thing happens when the cyclist is moving very slowly or, alternatively, is racing ahead at full tilt, the chances are the bicycle would crash. The current imbalances will therefore pose more of a threat to financial stability if the global economy were to decelerate to a much slower rate of growth or to grow above its trend rate for a sustained period.

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