The vicious cycle of overinvestment

With countries like Japan, China, the US, and Europe fighting deflating bubbles in major market sectors, it’s important to understand how overinvestment in certain sectors becomes an intractable problem when currency markets are too manipulated.  As the graphic shows, falling prices cause ripple effects throughout the economy that create serious unemployment problems as demand drops.  This cycle becomes self-reinforcing since prices drop even more if demand continues to fall.  One way that this cycle can be broken is by allowing the currency to float upward, making all the goods and services in the economy more expensive.  As prices rise, it restores some equilibrium to markets that allows economic growth to resume.

Countries like China have seen historic interventions by central banks in an effort to boost demand by providing cheap cash.  In 2008, China introduced a stimulus package worth about 14 percent of GDP with the idea that boosting demand was key to preventing crisis.  China’s intervention kept Chinese currency from adjusting according to market prices, and as a result, the popping Chinese bubbles are now causing a large slow down in Chinese manufacturing, housing, and exports.  If China allows its currency to adjust, perhaps they can break the vicious cycle.

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

Daniel
Hanson

What's new on AEI

Rebuilding American defense: A speech by Governor Bobby Jindal
image Smelling liberal, thinking conservative
image Stopping Ebola before it turns into a pandemic
image All too many reasons for pessimism about Europe
AEI on Facebook
Events Calendar
  • 20
    MON
  • 21
    TUE
  • 22
    WED
  • 23
    THU
  • 24
    FRI
Monday, October 20, 2014 | 2:00 p.m. – 3:30 p.m.
Warfare beneath the waves: The undersea domain in Asia

We welcome you to join us for a panel discussion of the undersea military competition occurring in Asia and what it means for the United States and its allies.

Tuesday, October 21, 2014 | 8:30 a.m. – 10:00 a.m.
AEI Election Watch 2014: What will happen and why it matters

AEI’s Election Watch is back! Please join us for two sessions of the longest-running election program in Washington, DC. 

Wednesday, October 22, 2014 | 1:00 p.m. – 2:30 p.m.
What now for the Common Core?

We welcome you to join us at AEI for a discussion of what’s next for the Common Core.

Thursday, October 23, 2014 | 10:00 a.m. – 11:00 a.m.
Brazil’s presidential election: Real challenges, real choices

Please join AEI for a discussion examining each candidate’s platform and prospects for victory and the impact that a possible shift toward free-market policies in Brazil might have on South America as a whole.

No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.