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Capital Flow & Domestic v International Perspectives

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Intl-Capital-Flows 2

QUESTION: Hi Martin,

I listened to the interview you did with Financial Sense and you said something that struck me as odd. I think you said that the devaluation and failure of the Euro will drive capital to the US. Fair enough, sounds right to me. I think you then said that the Fed’s response would be to raise interest rates to slow or halt this capital flow. Seems to be that this would accelerate capital flow to the US. Hedge funds love the carry trade. If they can borrow at or near zero rate of interest in a currency that is depreciating (Euro) and invest invest in a currency that is appreciating (USD) at a higher rate of interest, I would think they would do so. What am I missing? Did I just hear what you said incorrectly?
Thank you in advance for your thought on this.

1927-Secret Cental Bank Meeting
ANSWER: You are correct. What you are missing is the Fed will have to respond to DOMESTIC criticism. They lowered rates in 1927 to try to deflect capital inflows from Europe. Those inflows sent the US share market into a bubble precisely as was the case for Japan going into its bubble in 1989. But the Fed was criticized for lowering the rates and accused of creating the bubble into 1929. People will judge the Fed based upon narrow minded domestic perspectives. This will only accelerate the inflows for the Fed will believe it must raise rates to stop the bubble and attract even more capital to the USA.
What I am saying is reality – not advice or how things SHOULD function. This is simply the way they DO FUNCTION because we do not understand International Capital Flows. and try to manipulate the economy based upon purely domestic views that are in opposite of how the world truly functions globally. If the Fed does not raise rates, they will be accused of creating inflation for the blame must always be within the domestic sphere assuming we are in control just like Global Warming.