By Neil Irwin
Washington Post Staff Writer
Friday, February 18, 2011; 9:26 PM
Federal Reserve policy isn't to blame for the steep inflation and other woes affecting developing nations, the central bank's chairman, Ben S. Bernanke, said Friday as he tried to rebut a rising chorus of criticism of the Fed's easy-money policies from abroad.
Officials in China, Brazil and other developing nations have argued that the Fed is stoking a new round of investment bubbles and global inflation with its policy of ultra-low interest rates in the United States. Bernanke deflected those arguments and - while acknowledging that the United States needs to make policy changes of its own - again made the case that countries such as China that deliberately depress the value of their currencies are endangering the world economy by making it more prone to financial crises.
The remarks came in a presentation at a central banking conference in Paris before a meeting of the Group of 20.
During the event, put on by the Banque de France Financial Stability Review, Bernanke made clear the dangers that can emerge when vast sums of money gush into a nation, as is the case now in many emerging markets. The U.S. financial crisis from 2007 to 2009, Bernanke argued in the speech and an accompanying research paper, was partly the result of factors including loose oversight and bad lending practices that enabled money from abroad to flow into risky investments, such as mortgage-backed securities.
"To achieve a more balanced international system over time, countries with excessive and unsustainable trade surpluses will need to allow their exchange rates to better reflect market fundamentals" and work at boosting domestic demand rather than relying on exports to feed their economies, Bernanke said, according to a text released by the Fed. When a nation's currency is devalued, its lower-cost exports lure foreign investors and consumers, bringing greater amounts of cash into the economy. That can pose risks, depending on how that money is invested.
Although he did not mention China by name, Bernanke made clear that he thinks the world's most populous nation needs to let the value of its currency rise on global markets to help balance the flow of capital and trade among nations and create a more stable global economy.
"At the same time, countries with large, persistent trade deficits must find ways to increase national saving, including putting fiscal policies on a more sustainable trajectory," he added, a clear reference to the United States.
Much of the gush of capital into emerging markets is driven by their rapid growth and desirable investment opportunities, Bernanke argued. The Fed's policy of low interest rates will help stimulate stronger growth in the United States, which would in turn be good for the world economy, he said.
The developing nations have their own policy tools that could blunt the impact of capital inflows, such as letting their currencies rise, he added.
The Fed chairman also offered his most expansive effort to date to explain the global underpinnings of the wrenching financial crisis.
"The failures of the U.S. financial system in allocating strong flows of capital, both domestic and foreign, helped precipitate the recent financial crisis and global recession," Bernanke said.
Although Bernanke phrased his argument about the root causes of the crisis in cautious, technical language, it boils down to this: The trillions of dollars that global investors poured into the United States from 2003 to 2007 fueled a gigantic housing and mortgage bubble. When it popped, the financial system imploded and the country fell into a deep recession. Bernanke argued that if that money had been channeled into building new factories and roads in the United States, instead of ever-higher property values, it might have had long-term payoffs and global investors and ordinary Americans might have been better off.
Bernanke's latest comments are essentially an update of a concept he first laid out in 2005: the global savings glut. He theorized then that low long-term U.S. interest rates were the result of huge numbers of people in emerging Asian nations such as China and oil-producing nations in the Middle East wanting to save money, outstripping the supply of safe, easy-to-trade investments.
Bernanke's paper, co-authored with Fed economists Carol Bertaut, Laurie Pounder DeMarco and Steven Kamin, offers new evidence that from 2003 to 2007, there was vast worldwide demand for safe investments in the United States.
Developing Asian nations invested in Treasury bonds and the debt of government-backed mortgage companies Fannie Mae and Freddie Mac. Middle Eastern countries did the same with the vast profits from oil sales. In Europe, the desire for such U.S. assets was so great that banks and other investors bought up private mortgage securities, which were, through financial engineering, deemed to be safe, even if they didn't end up that way.
These purchases served to lower interest rates on mortgages in the United States, which helped lead to the housing bubble, according to the paper.
Bernanke and his colleagues took pains to note that they are not arguing that foreigners are to blame for the U.S. mortgage crisis.
"In no way do our findings assign ultimate causality for the housing boom and bust to factors outside the United States," they wrote. They name several domestic factors as the primary reasons for the financial free-fall: flaws in the mortgage system, weak lending standards, slack risk management by financial firms, poor design of government mortgage companies, and mistakes in regulation. Those, they wrote, "were the primary sources of the boom and bust and the associated financial crisis."
Bernanke drew an explicit parallel between the crisis in the United States in 2007 and that in East Asia a decade earlier. Like the United States, Thailand, Singapore and other rising Asian nations had taken on a gush of international capital (though in that case it was because investors hoped to profit from those economies' extraordinary growth, not because they were viewed as a safe harbor for savings).
But starting in 1997, Bernanke said in his speech, investors began to realize that "because of institutional weaknesses, inadequate regulation or other deficiencies," those nations "had not effectively channeled the surge of incoming funds into productive investments." That caused investors to pull out, triggering a painful and prolonged downturn.
While U.S. officials have frequently given highhanded advice to leaders of other nations, Bernanke acknowledged that the events in the United States in the past few years have made him more understanding of their predicaments.
"In reflecting on this experience, I have gained increased appreciation for the challenges faced by policymakers in emerging-market economies who have had to manage large and sometimes volatile capital inflows for the past several decades," he said.