THEME: BUBBLE TROUBLE
Thanks to Steve Sewall, an article from FT points out the following:

US monetary policy has produced great distortions on the periphery of the world economy as well. The most notable example is South Africa's currency market. According to data from the Bank for International Settlements, South Africa now has the largest currency market in the developing world. Its trading volume is now equal to 24 per cent of the country's gross domestic product compared with 4 per cent for Thailand and 2 per cent for Brazil. The rand's trading volume has increased ninefold during the past decade. South Africa also has a swap market nearly three times as large as the country's GDP. The size of South Africa's currency market and swap market is a by-product of surplus global liquidity, which has been attracted by South Africa's money market yields of 8 to 9 per cent. The large interest rate differential has produced a rand carry trade - investors borrowing in dollars to invest in the rand or rand-denominated assets - that has driven the rand/dollar exchange rate from nearly R14 to the dollar in late 2001 to R6.25 in March this year. Large flows of speculative "hot" money are behind this, which means the currency will remain volatile in the future.

Low interest rates in the US and Europe have also encouraged a large carry trade in other currencies. The volume of currency trading in Australia and New Zealand is now 35 per cent of GDP compared with 27 per cent for the US and 18 per cent for Europe. As with South Africa, investors have flocked to the south Pacific in search of higher yield, turning the currencies into global casino chips, rather than a simple means of payment.

The Fed's mandate is to make monetary policy for the US economy. It has adhered to a highly stimulative policy because, until recently, US employment growth was subdued and the core inflation rate had collapsed. The central bank has not seen much risk of a liquidity bubble in the US because margin debt - money borrowed from brokers to buy shares - has remained below 2 per cent of GDP, compared with 18 per cent on the eve of the 1929 stock market crash. US banks also behaved far more prudently in the bubble economy of the late 1990s than during previous booms. They securitised their potentially bad loans and sold them to pension funds, mutual funds and insurance companies rather than keep them on their own books. As a result, America has had only 21 US bank failures since 2000, compared with nearly 500 during the early 1990s, when banks experienced large losses on property lending.

Now, the buoyancy of the US economy has encouraged the Fed's rate- setting open market committee to open the door to a possible increase in interest rates, signalling an end to America's experiment with ultra-low money market yields. It will be up to other central banks to prepare for the consequences.

David Hale is a Chicago-based economist