Saturday, February 19, 2011

[Global Dollar Liquidity: +11.9%; Endogenous Liquidity Index: +24.9%; bullish]

Ben Bernanke on Global Imbalances (*). Overall, Mr. Bernanke aims to downplay the argument according to which QE is exacerbating competitiveness problems caused by hot money flows — particularly in emerging economies. Here's my takeaway:

. The cost of capital & property rights. Note the link: "... capital flows from emerging markets to advanced economies will tend to be directed to the safest and most liquid assets, of which, these researchers argue, there is a relative shortage in emerging markets."

. Global flows & changes in behavior. This is what Jacques Rueff had predicted all along: "The preference by so many investors for perceived safety created strong incentives for U.S. financial engineers to develop investment products that 'transformed' risky loans into highly rated securities. Remarkably, even though a large share of new U.S. mortgages during the housing boom were of weak credit quality, financial engineering resulted in the overwhelming share of private-label mortgage-related securities being rated AAA."

. The US's responsibility. "These findings are not to be read as assigning responsibility for the breakdown in U.S. financial intermediation to factors outside the United States. Instead, in analogy to the Asian crisis, the primary cause of the breakdown was the poor performance of the financial system and financial regulation in the country receiving the capital inflows, not the inflows themselves". Note the reference to "risk-management deficiencies among financial institutions". No checks and balances, baby!

. Argentina & Brazil. Although not explicitely named by Mr. Bernanke, these two countries provide a vivid illustration of the problems caused by sudden capital inflows: "The maintenance of undervalued currencies by some countries [read: Argentina] has contributed to a pattern of global spending that is unbalanced and unsustainable, as those countries that have allowed their exchange rates to be determined primarily by market forces [read: Brazil] have seen their competitiveness erode relative to countries that have intervened more aggressively in foreign exchange markets.

(*) Ben S. Bernanke: "Global Imbalances: Links to Economic and Financial Stability", At the Banque de France Financial Stability Review Launch Event, Paris, France, February 18, 2011.