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

In year four of Dodd-Frank, over-regulation is getting old
image Halbig v. Burwell: A stunning rebuke of a lawless and reckless administration
image Beware all the retirement 'crisis' reports
image Cut people or change how they're paid
AEI on Facebook
Events Calendar
  • 21
    MON
  • 22
    TUE
  • 23
    WED
  • 24
    THU
  • 25
    FRI
Monday, July 21, 2014 | 9:15 a.m. – 11:30 a.m.
Closing the gaps in health outcomes: Alternative paths forward

Please join us for a broader exploration of targeted interventions that provide real promise for reducing health disparities, limiting or delaying the onset of chronic health conditions, and improving the performance of the US health care system.

Monday, July 21, 2014 | 4:00 p.m. – 5:30 p.m.
Comprehending comprehensive universities

Join us for a panel discussion that seeks to comprehend the comprehensives and to determine the role these schools play in the nation’s college completion agenda.

Tuesday, July 22, 2014 | 8:50 a.m. – 12:00 p.m.
Who governs the Internet? A conversation on securing the multistakeholder process

Please join AEI’s Center for Internet, Communications, and Technology Policy for a conference to address key steps we can take, as members of the global community, to maintain a free Internet.

Thursday, July 24, 2014 | 9:00 a.m. – 10:00 a.m.
Expanding opportunity in America: A conversation with House Budget Committee Chairman Paul Ryan

Please join us as House Budget Committee Chairman Paul Ryan (R-WI) unveils a new set of policy reforms aimed at reducing poverty and increasing upward mobility throughout America.

Event Registration is Closed
Thursday, July 24, 2014 | 6:00 p.m. – 7:15 p.m.
Is it time to end the Export-Import Bank?

We welcome you to join us at AEI as POLITICO’s Ben White moderates a lively debate between Tim Carney, one of the bank’s fiercest critics, and Tony Fratto, one of the agency’s staunchest defenders.

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