International capital flows are supposed to be good for two reasons. First, they divert capital to where it can be invested most productively, enhancing efficiency and growth. Second, they help diversify risk. As regards the first benefit, helping rich country consumers borrow and consume is not what we typically think of as a productive investment. As regards the second benefit — well, the less said the better, really.
In a widely noticed article in the FT, Nouriel Roubini has argued that capital flows are now creating major asset bubbles outside the US, as investors exploit the weakening dollar to borrow at negative interest rates and invest the proceeds overseas. If he is right, then central banks are faced with an impossible dilemna. Outside the US, if they raise interest rates to prick incipient bubbles they jeopardize the recovery, and/or attract even more capital inflows. Inside the US, raising interest rates clearly places the recovery at risk.
I understand where Wolfgang Münchau is coming from when he calls for interest rates to be raised sooner rather than later, but having seen the world economy edge away from the precipice, I am not keen on measures that would bring us closer to it yet again.
If the problem is indeed being caused by ‘the mother of all carry trades’, as Roubini suggests, then throwing a few bucket-fulls of sand into the wheels of international finance seems to me to be a far less risky way of trying to deal with it. International capital flows have been associated with enough crises to be going on with these last few years.