"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Monday, March 7, 2011

Bernanke and the "Global Savings Glut" Theory

CNBC, in a rare moment of clarity, has published on its website an economist's criticism of Bernanke and fiat money management by central banks.  Economist Richard Duncan addresses many of the issues this blog covers- rampant fiat money creation by Central Banks, and the unintended consequences.

The obvious question the article leaves unanswered is how this fiat money system created imbalance eventually will correct.

Here is the article:

Blog:  Why won't Bernanke Come Clean on Glut?
Perhaps the greatest mystery in the world of finance and economics is why Fed Chairman Ben Bernanke refuses to acknowledge that paper money creation by central banks produced the “global savings glut” which, according to him, destabilized the global economy and led to the crisis of 2008. 
Six years ago, Bernanke unleashed his Global Savings Glut (GSG) theory on the world. Since then, he has made numerous other speeches touching on this subject, including one last month in Paris. With each speech he came a little closer to admitting the obvious, but in every case he holds back, as if not at liberty to discuss the secret money-making powers of central bankers. 
The basic gist of GSG is Asians, and oil exporters, save more than they wish to invest in their own countries and they choose to invest the surplus in the United States because of attractive returns. Those capital inflows into the US, he claims, push up US asset prices and push down US interest rates, leading to asset-price bubbles and the US current account deficit
The GSG theory would be accurate if only he would add that most of the “savings” causing the “glut” originate because central banks created and “saved” the equivalent of many trillions of dollars over the past 15 years. 
The theory comes across as rather absurd when that fact is omitted. As it stands, the GSG theory clashes with reality in two important respects. First, US financial markets may be deep, but they are certainly not well regulated. Second, Asians do not believe US investments offer attractive returns. 
In June 2009, Treasury Secretary Tim Geithner was laughed at by an audience of Chinese students after insisting that China’s US assets are safe. Asians believe the United States and its dollar are in terminal decline and the future belongs to Asia. 
But the theory does make sense when it is modified to recognize that Asian “savers” investing in US assets are Asian central banks that bought US dollars in order to hold down the value of their own currencies perpetuating their low-wage trade advantage; and that those central banks must invest those dollars in US dollar-denominated assets to earn a return. 
Coming Close to Disclosing 
A few times over the years, Bernanke has come close to clarifying this. In the 2005 speech, he said "some East Asian countries, such as Korea and Thailandbegan to build up large quantities of foreign-exchange reserves" and “China also built up reserves." 
The article concludes with:
But in reality, he must know. How could he have missed the explosive growth of central bank balance sheets in China and many other developing countries? But why would he want to hide from the public the creation of trillions of dollars worth of paper money when it has played the driving role in destabilizing the global economy
This is the mystery. 
What's clear is that the equivalent of trillions of dollars was created by central banks in the decade leading up to the global economic crisis, that money played a leading role in causing the crisis, that central banks have created trillions more since the crisis began, that global food prices spiked, causing revolution across the Arab world and that central bankers are doing everything possible to avoid accepting responsibility for the havoc. 
There is no mystery about the causes of inflation. As Milton Friedman put it, “Inflation is always and everywhere a monetary phenomenon.” 
Full article HERE.


Jim Slip said...

Is this even accurate?

Afaik, central banks don't control fiscal policy, only monetary policy. Bernanke can't create "trillions of dollars" as Mr. Duncan claims. He can only add and subtract reserves from banks, thus setting the desired interest rate, aka the "price" of money.

I don't like Bernanke, but let's not accuse him of things he isn't responsible of.

The money supply is dynamic, not static, and as such central banks can't really control where the ammunition they create (bank reserves) ends up (credit growth) in a globalized economy.

Misthos said...

Correct, central banks don't control fiscal policy, but they can influence borrowing by making it attractive. What happens to the money, or where it flows is another issue.

Keep in mind, the writer is describing central bank actions prior to the crisis that began in 2008. He actually mentions 15 years back as a time frame - so that includes Greenspan's term as well. Unlike today, back then low rates stimulated the extreme bank lending that ultimately caused the 2008 financial meltdown.

He is criticizing not just Bernanke, but Greenspan as well as other Central Bankers in Asia.

Remember, prior to the 2008 crisis, the US experienced a bull stock market and housing bubble - and the Federal Reserve's policy contributed to this - easy money - for example, the "Greenspan put."

Here's another example - low rates in Japan during the early 2000s created the Yen carry trade - which also contributed to bubble building in the US.

Jim Slip said...

Misthos, I'm not sure who the villain is anymore.

Clearly the problem started when production "left" the West and "moved" to Asia, and clearly credit-growth camouflaged the extent of the problem.

Who was really in charge when this happened? Politicians? Central Bankers? Bankers? Multinational companies?

Surely it's only a matter of time before persistently high unemployment levels force politicians to scale back globalization and return to good old protectionism.

It's the easiest way to make it happen, instead of waiting for people to get poorer, governments to vote for liberal frameworks, get someone (who?) to invest, and THEN have an imbalance correct itself.

And I don't see the gold-standard returning, and I'll tell you why. Because when a number of countries return to protectionism directly or indirectly (devaluation), then governments will want to have their hands free on spending, so that they stimulate specific areas of their economies (food, energy). With the gold-standard, they will not have that liberty.

Just my two cents.

Misthos said...

Jim, there's no one villain. I take an all of the above approach.

But some factors you can blame, other factors, you can't. Why, because there is no one person to blame.

I'll admit, I and many others try to create a tight nit narrative to explain how we got here. But in a complex world of many moving parts, there's no such thing as simple explanation. At least that's what I think.

What I try to address is what I think is an underlying contributor - the fiat monetary system.

Without it, the imbalances of debts and trade, the rampant/overnight globalization, the offshoring/ outsourcing, etc... would have been much more difficult to accomplish under a gold standard regime.

But I am increasingly becoming an economic agnostic. No theory is 100% foolproof. They all have their faults.

But a gold standard is the one system no one wants. Why? Because they can't be as naughty as they want to be. That's the best way I can put it.

Under a gold standard: banks can't be bailed out as easily, Pensions can't grow as easily, welfare payments can grow as easily, military and wars can't be financed as easily, debt based consumption can't be accomplished as easily either.

No wonder gold has so many enemies.

In my opinion, it's just that simple.

I'll admit, if we de-globalize to a degree - fiat could last a little longer or even stay.

But my view of gold returning is based on a meltdown/conflict scenario. Where trust is shattered and people and nations want the "real deal" when they exchange things. No more debt promises that can be manipulated after the transaction.

Gold by default, not by design.

Jim Slip said...

Maybe. I can't picture how a return to the gold-standard would take place. It would have to be a colossal systemic failure for that to happen.

I have an easier time picturing someone, the US probably, announcing they stop issuing bonds to finance their economy, because, who needs them? And let interest rates drop to zero.

That would be neat. Everybody would suddenly face the reality of money not really being a store of value anymore. Then citizens would demand their governments organize their economies in a more efficient way, so that there's less (if any) unemployment etc. Think of it, would anybody even save money anymore if there's guaranteed employment and health-care?

But I'm getting ahead of myself. -)

I don't even know what the Europeans are going to decide in the upcoming summit. Maybe they don't know either, judging by how they tackle things in general. -)