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Monday, March 25, 2013

Paul Krugman, "Hot Money Blues": Does China Hold the US by the Short and Curlies?

Does China hold the US by the short and curlies?

In a New York Times op-ed entitled "Hot Money Blues" (, Paul Krugman writes:

"It’s hard to imagine now, but for more than three decades after World War II financial crises of the kind we’ve lately become so familiar with hardly ever happened. Since 1980, however, the roster has been impressive: Mexico, Brazil, Argentina and Chile in 1982. Sweden and Finland in 1991. Mexico again in 1995. Thailand, Malaysia, Indonesia and Korea in 1998. Argentina again in 2002. And, of course, the more recent run of disasters: Iceland, Ireland, Greece, Portugal, Spain, Italy, Cyprus.

What’s the common theme in these episodes? Conventional wisdom blames fiscal profligacy — but in this whole list, that story fits only one country, Greece. Runaway bankers are a better story; they played a role in a number of these crises, from Chile to Sweden to Cyprus. But the best predictor of crisis is large inflows of foreign money: in all but a couple of the cases I just mentioned, the foundation for crisis was laid by a rush of foreign investors into a country, followed by a sudden rush out."

Absent from Krugman's list of financial crises is Turkey's 2001 economic crisis in which fiscal profligacy certainly played a role. However, in the instance of Turkey, the almost overnight withdrawal of $70 billion of foreign funds certainly had much to do with the debacle.

Krugman's conclusion:

"Now what? I don’t expect to see a wholesale, sudden rejection of the idea that money should be free to go wherever it wants, whenever it wants. There may well, however, be a process of erosion, as governments intervene to limit both the pace at which money comes in and the rate at which it goes out. Global capitalism is, arguably, on track to become substantially less global.

And that’s O.K. Right now, the bad old days when it wasn’t that easy to move lots of money across borders are looking pretty good."

Remarkably there is not even a mention by Krugman that China owns more than $1.2 trillion in US bills, notes and bonds, or some eight percent of US debt. What would happen if China were hurriedly to remove these funds from the US? You don't want to know.

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