The global FX regime of the last 20 years has been characterised by a distinct pattern of capital flows. At its core, Asian countries (mostly China) recycled their current account surpluses into USD-denominated FX reserves, in order to weaken their domestic currencies and preserve export-led economic models.
Within this circuit of interdependence, the US – through its basic balance deficit (i.e. the part of its current account deficit financed by foreign flows into USD cash, Treasuries and other portfolio securities) – provided an essential global public good: the dollars that the rest of the world needed for trade.
This system generated large increases in money supplies and downward pressure on risk-free interest rates in most countries, thereby fuelling asset price inflation and various forms of asset and credit bubbles. However, thanks to a combination of reserve purchases, low inflation and low rates, FX volatility was generally very low as monetary policies tended to be synchronised across the world.
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