The Economy Hits Bottom – theory
Economy, Uncategorized 
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While Phase III remains ongoing, the economic patient is still showing no major sign of recovery. Inflation peaks, which in turn allows domestic interest rates to peak. The trade account swings hugely, in many cases from a deficit to a surplus as import demand collapses. This accelerates the recovery in liquidity, helping to force down interest rates and thus causing the liquidity-based rally which we talked about earlier. Eventually, the trade surplus, low interest rates and basing effects help support the economy. Put bluntly, the economy hits bottom and a period of stabilization ensues.
Readers should note that economic stabilization does not mean the same as recovery, in the same way that hitting the ground after a fall from some height does not entail recovery (indeed, if the height is sufficient there is unlikely to be any recovery!). Both processes usually entail a prolongation of pain, but at least the pain is not getting worse. Thankfully, economies are not as frail as the human body. They can indeed fall from great heights, smack down hard on the concrete with a sickening thud and yet still recover; the timing of that recovery depending crucially on the extent of the fall.
At the microeconomic level, companies are still continuing the process of de-stocking of inventory. Consumers remain very cautious and retail prices continue to decline to levels aimed at causing them to buy. That said, the fall in interest rates eventually provides crucial support for cash-strapped companies and banks. These hastily complete their inventory de-stocking process, switching most of that supply to export markets unaffected by the crisis, and start the process of re-stocking. At the international level, the reality of the economy hitting bottom, as evidenced by declining contractions in economic indicators, leads to the expectation of Phase V, economic recovery. Phase IV is not plain sailing for local currencies however. As domestic economies stabilize, so do imports. Indeed, year-on-year basing effects accelerate that process. Thus, what we usually see in Phase IV is those trade and current account surpluses peaking on a monthly basis. During Phase III and the initial part of Phase IV, trade flows are actually more important than capital flows — as most offshore investors have already left by then, taking their capital with them. Reduced trade surpluses thus have a greater effect on market movements than would otherwise be the case, serving to weaken the local currencies.