Ben Bernanke's recent speech, "Rebalancing The Global Recovery," was significant for many reasons, signifying another change in Bernanke's stance on global imbalances. In the speech, he described how imbalances are being driven by currency manipulation, and how they can pose a major threat to the world economy. That's a big step. He's now totally reversed his original position on this issue.
The Mythical Saving Glut
In a famous 2005 speech, Bernanke blamed imbalances on a “global saving glut.” Emerging nations have an excess of saving over investment, he argued, and this is the original cause of global imbalances. His argument contained three big mistakes.
Mistake 1 was to even talk about a global saving glut. There is no such thing. It's a myth, uncovered here. To explain briefly, in a closed economy, national saving (private saving less the government deficit) will equal investment. It has to, by identity. So, because the world is a closed economy, global saving must equal global investment. There can be no global “glut” of saving over investment. It's impossible.
Saving is distributed around the world via current and capital accounts. A current account deficit equates to a deficit of national saving. This is offset by an equal increase in foreign owned capital. These movements give the appearance of saving gluts and shortages, but the global level of saving is always equal to investment, as it has to be.
Mistake 2 was to downplay the role of the mercantilists and currency manipulation. For Bernanke, trade and the current account were “the tail of the dog,” where the dog was surplus saving. In his most recent speech, he corrects that mistake. Global imbalances are much better explained by trade than saving.
Mistake 3 was that he was complacent about the dangers. In 2005, Bernanke thought that we needed to “be patient” and wait for changes to happen “in the long term.” He was wrong. Right under his nose, global imbalances were moving us toward ...
The Financial Crisis
Global imbalances were not the sole cause of the crisis, but without them, the crisis could not have happened as it did. The crisis was caused by the interaction between global imbalances, dysfunctional banking, and inadequate governance.
The imbalances were caused by our trading partners. They kept their currencies devalued, by recycling their revenues back to the U.S. as capital. This also kept the dollar artificially strong. The result was a dangerous cocktail of effects:
- U.S. industry and workers became uncompetitive, resulting in an underlying weakness in the economy.
- The artificially strong dollar and cheap imports made inflation lower than it would otherwise have been.
- With underlying weakness in the economy and low inflation, the Fed kept short term rates low.
- The influx of cheap capital pushed down Treasury yields and long term interest rates.
- With increasing capital and stimulus, but a loss of international competitiveness, the economy became focused on speculation in non-traded sectors, like real estate.
When these dangerous forces were combined with dysfunctional banking and inadequate governance, the result was a leveraged real estate bubble, and ultimately the financial crisis.
In a 2009 speech, Bernanke regretted his earlier complacency:
The world is suffering through the worst financial crisis since the 1930s, a crisis that has precipitated a sharp downturn in the global economy. Its fundamental causes remain in dispute. In my view, however, it is impossible to understand this crisis without reference to the global imbalances in trade and capital flows …
The global imbalances were the joint responsibility of the United States and our trading partners, and although the topic was a perennial one at international conferences, we collectively did not do enough to reduce those imbalances.
We still haven't done enough.
The Growing Risks
The financial crisis has now happened, but the imbalances remain. It's hard to predict what form the next crisis will take, but it's easy to see there will be one, unless something changes. The world economy is walking a tightrope towards recovery. If it stays out of balance, it could fall disastrously.
Bernanke now seems more conscious of this danger:
...large and persistent imbalances in current accounts represent a growing financial and economic risk.
Encouragingly, he now seems to understand the cause too. There is no more talk of surplus Asian saving looking for a home. He now points his finger directly at mercantile currency manipulation:
...currency undervaluation on the part of some countries has been part of a long-term export-led strategy...
Bernanke's new position is inconsistent with his “saving glut” theory. He must have changed his mind. Think about it. Why would he focus on currency manipulation if he still thought that imbalances were caused by saving decisions? It would be irrelevant. Saving decisions don't depend on exchange rates.
Further, given that currency manipulation exists as Bernanke now acknowledges, the saving glut theory requires irrational decisions on where to put savings. For example, the Chinese, having deliberately undervalued their currency and overvalued ours, are now knowingly taking their saving out of undervalued yuan and putting it in overvalued dollars! In terms of saving, that's crazy. It only makes sense in the context of mercantile trade.
As Bernanke now acknowledges, this is a long-term problem. He says it started in the mid 1990s. It's no coincidence that this corresponds with China's major yuan devaluation. China sits right at the heart of this issue, because of its central role in Asian trade. Where it leads, others follow.
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Only now are our leading economists waking up to this issue and recognizing the cause. That's scandalous. Sadly, a lot of time has been wasted and these problems will take a long time to resolve. We will now have to act quickly and strongly, just to achieve slow progress. Meanwhile, as Bernanke now acknowledges, the risks keep on growing.
Disclosure: Author long emerging market stocks