Over the past four decades the global economy has largely experienced prolonged imbalances, with countriesrunning large current account deficits in symbiotic relationships with those running large surpluses. In thisletter we revisit our long held belief that the current monetary order as defined by a constellation of exchangerate arrangements between the major global currencies, and which maintained these imbalances artificially,has led to excessive global liquidity and credit creation. This in turn drove a litany of asset price bubbles.The bursting of these asset bubbles has continued in a series these past two decades, each one's demiseleading to more disruptive policy responses which have only succeeded in igniting yet more bubbles, only for those too to fail.Finally in 2008 we witnessed the finale of decades of credit creation, rising in what appeared to be acrescendo of credit excess and widespread asset booms. We saw this event as the death throes of an unstablemonetary regime, only then to see an unprecedented global reaction by policymakers in a coordinated fashionto keep the global system alive. For a moment here today, there are those who dare to believe they havesucceeded, with rising equity markets a testimony to a reviving global economy. Nothing could be further from reality.We stand by our assessment that the disproportionate reaction of central bankers and policymakers alike hasmerely succeeded in compounding and exacerbating the error of this highly imbalanced monetary system.Recent events in emerging countries are a manifestation of the continuing unravelling of our monetary order.In a recent HindeSight letter we described how the world is faced with a binary situation of global deflation or hyperinflation. We believe the odds have tilted firmly towards deflation. It would appear the unwinding of theglobal imbalances that led to the 2008 crisis is continuing unabashed, irrespective of the recent monetaryexcess used to abate them.Large current account deficits led to unsustainable debt creation and as a consequence the trade deficitcountries were the first to experience a severe financial crisis, but now on the other side of the equation thesurplus countries are experiencing their reaction to the crisis. For balance of payments have two componentsto the equation both the financiers and the borrowers, so by definition changes in savings and investments inone such country has a profound impact on those of another.The recent instability in emerging market economies and especially China is a direct consequence of theseglobal imbalances which became stymied briefly by global bail-outs only to have been left in a morevulnerable economic position.
The deleveraging process which began in 2008 has been a slow burner butis likely now in full swing. The deflationary risks are very high.