First, he believes that the real exchange rate is determined by the savings surplus, while I argue that the causality for the countries targeting the real exchange rate (and that is what they are, without doubt, doing) is the other way round. In other words, countries target a nominal exchange rate and try to keep inflation down. They do so by pursuing monetary, fiscal and regulatory policies intended to curb domestic demand and so make room for the surplus on net exports. I am not suggesting they can do this forever. But they can do it for a very long time.

The current account tail wags the economic dog – this being a mirror image of what I think has happened in the US over the past decade. It is, after all, US assets that the intervening countries have been targeting and so the US exchange rate that they have been holding up, the US current account deficit they have been financing and US longer-term interest rates that they have been keeping down. A trade deficit is contractionary: for any given level of domestic demand, it lowers domestic output. Thus, the US needed to expand domestic demand, in order to offset the contractionary effect of the external deficits. Some groups within the economy needed to spend more than their incomes.

The most important such group turned out to be households. Thus the growth in US household indebtedness that led to today's “credit crunch” is a direct result not just of the global imbalances, in general, but of the exchange-rate targeting policies of a large number of emerging economies.