Saturday, September 15, 2007

Bernanke's Saving Glut II Speech

I haven't had time to post on Bernanke's latest global imbalance speech. Nonetheless, it is important so I direct you to Menzie Chinn's excellent post on it.


Both Menzie Chinn and Michael "Mish" Shedlock touch on what I think is an important point: loose monetary policy in the United States has been an independent (i.e. exogenous) contributor to global economic imbalances. Specifically, they claim that monetary policy-generated low real interest rates are a good explanation for the low U.S. saving rate and hence the large U.S. current account deficits. Note, they are not arguing it is the only cause of the global economic imbalances. Like I have argued before (here, here, here), this (exogenous) liquidity glut perspective is complementary to the saving glut story--there is no reason why they cannot both be at work. (Why the Fed would push rates so low is something I have discussed here and here.) Here is some of what what Menzie and Mish have to say

"While I'm not going to assert that monetary policy was the cause of unnaturally low real interest rates (that in turn might have contributed to the housing boom and the associated mortgage equity withdrawal...), I will claim there is a plausible argument that the extended period of monetary ease was a contributing factor. It's even more plausible, when one considers the rise in real (risk free) real interest rates even as China and oil exporting countries continue to run large surpluses after the increase in the target Fed Funds rate. This latter observation is documented in this post from January. (I'll also observe the notion of real interest rates being equalized across borders with free capital mobility is not necessarily validated by the data -- so low US real interest rates might or might not be indicative of anything, [5].) It all sort of depends whether you think relative PPP holds instantaneously; if you don't think so, then monetary policy can cause divergences in real interest rates."

"In a long winded article Bernanke is yapping once again about Global Imbalances and the Global Savings Glut. The article is complete with charts and 11 footnotes but mostly twisted logic as well as stunning statements like "There is no obvious reason why the desired saving rate in the United States should have fallen precipitously over the 1996-2004 period."

Actually, there is every reason for the U.S. savings rate to have fallen: The Fed continuously held interest rates too low thereby creating a negative incentive for anyone to save. Eventually a near unanimous belief set in that asset prices were a one way street headed North and the purchasing power of the dollar a one way street headed South. So why save?And after the Greenspan Fed foolishly cut rates to 1% in the wake of the dotcom bust, there was a mad dash out of cash, culminating with panic buying of houses. That panic in turn was followed by cash out refis to support consumption as people bit off more house than they could really afford. This is the origin of the much talked about negative savings rate. It is also one of the moral hazards of Bernanke's proposed inflation targeting scheme...

Yes, it really is as simple as that.

Nowhere does Bernanke address those simple constructs. Instead his mind sits in long winded academic theory and models that do not even take into account real world constructs like global wage arbitrage, asset bubbles, overcapacity, U.S. deficit spending, the War in Iraq (that has to be funded somehow, and if not by domestic taxes then by foreigners) or disincentives to save caused by interest rates held too low too long.But there is now no way to pay back what has been borrowed as there are no real savings.

In Austrian Economist terms, the pool of real funding is simply tapped out. And once psychology changed, there was a mad scramble for cash with no bids for commercial paper as all the savings (and then some) had already been lent out. The result is a credit crunch and a new dance craze called
The Bernanke Shuffle."

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