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Why Won't Bernanke Come Clean on Glut?

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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.

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 Thailand began to build up large quantities of foreign-exchange reserves” and “China also built up reserves.”
“These ‘war chests’ of foreign reserves have been used as a buffer against potential capital outflows,” he said. “Additionally, reserves were accumulated in the context of foreign exchange interventions intended to promote export-led growth by preventing exchange-rate appreciation.”

He made similar remarks last November, admitting the international monetary system (the dollar standard) “has a structural flaw: It lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances.”

But he never explains how countries accumulate foreign exchange reserves. Foreign exchange is accumulated when a country’s central bank prints money and buys the foreign exchange.

Over the past decade total foreign exchange reserves held by central banks have increased by more than $7 trillion to $9.3 trillion. This involved paper money creation on a scale unprecedented during peacetime. To put this figure in perspective, the entire US federal government debt held by the public amounted to less than $5 trillion in 2007.

Practically all of this paper money creation was carried out by central banks in developing countries. China’s central bank alone holds nearly $3 trillion worth of foreign exchange reserves, a third of the total. China, by the way, has capital controls, so has no need to build up a “war chest” as “a buffer against potential capital outflows.” The acquisition of these reserves has been an act of currency manipulation, pure and simple.

Why has Bernanke never mentioned that the accumulation of foreign exchange reserves involves paper money creation by central banks? He may not know. Or he may not want the public to know. It’s difficult to say which is more disturbing.

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.”

[Please note: this was first posted as a guest blog on cnbc.com on March 7, 2011.]


  1. Hi Mr. Duncan,

    Your articles are the best economics and international trade lessons I’ve ever received. At last I understood what caused the latest financial crises and all the crises before that. You not only explain simply the reasons for the crashes but offer also a plan how to get out of this mess(spending money on the newest technologies). Thank You very much!

  2. Mr. Duncan,

    I read your material with interest. However, I’m having trouble understanding your argument with respect to China’s US$ reserves. Your observaton that “foreign exchange is accumulated when a country’s central bank prints money and buys the foreign exchange” does not seem to capture the dynamic behind China’s dollar position. I don’t believe it to be the case that China is trading RNB for $ in
    currency markets in large volume, but rather is accumulating dollars via the trade imbalance. China exports real goods to the U.S. in excess of of U.S. imports, accruing dollars that are then exchanged for U.S Treasuries. Seen from this perspective, the underlying problem isn’t Chinese monetary policy, but rather U.S. fiscal policy which results is a burgeoning supply of U.S. Treasuries for China to hold. Hence, it doesn’t seem accurate to suggest that China is somehow flooding us with Chinese fiat currency, but the dynamic is rather the other way around: we’re flooding them with forward contracts on U.S fiat currency, i.e. Treasuries. What am I missing here?

    Mark Bachmann

  3. Hello Richard and thanks as always for sharing your thoughts. One question i would have as a layman as far as economics, and accessorily as a forex trader, is, my view of money is as a simple lubricant to most forms of economic exchanges, while barter always remains an option, which means we only need so much lubricant at any point in time, at the same time it does make some sense for economic actors to store some of it for when it is most needed and might become expensive (high interest rates) and less at other times (low interest rates). In other words to me it is no different to any other tradable product except that:
    . it has positive carry unlike any other tradable asset i know
    . there is only one producer of it per country, it is generally referred to as a “central bank”, however the price of it (denominated in any other assets including other currency units) fluctuates according to how foolish or responsible an individual country’s GOVERNMENT is perceived to be from various and varying angles over time, kind of like a country PR unit of value aka “fiat”, but the same could be said of oil, or a stock index for that matter…

    Now similar to what OPEC countries do, the “central bank” will at times increase/decrease supply, of the various Mx aggregates, and/or increase/decrease incentives (by way of short/term interest rates, reserve ratios etc) according to the perceived need for more or less lubricant in the broader economy over a particular time period, seems to me from my layman viewpoint. Kind of like an injection mechanism, ie when i the economic actor step on the pedal, there is a lag time and then the mechanism kicks in, and conversely when i release the pedal, and i call that progress, as far as cars are concerned. Some people might prefer a bicycle, very predictable tool, no lag time whatsoever, and i think a return to the gold standard might be a good way to achieve that. But it’s not the same world.

    So my question is, why is a discussion of velocity of money so conspicuously absent in the various viewpoints expressed, including that of Mr Friedman?

  4. Thank you so much for your presentation in Winnipeg. It was very informative. I’ve read about the need to develop a global currency. In your opinion, would this solve the problem?

  5. “There is no mystery about the causes of inflation. As Milton Friedman put it, “Inflation is always and everywhere a monetary phenomenon.” ”

    I think this is simplistic. Money/liquidity is just another lubricant, can be created and removed/eliminated by its producer aka central bank at any time.

    Inflation is always and everywhere a consequence of the misalignment of overall perceived wealth (a volatile component whether marked to market or to model) and disposable cash versus the pool of available goods & services and investment opportunities. Tightening monetary policy essentially diminishes/removes the appetite for leverage, easing does the opposite. Especially during or after a crash, easing allows the spreading of the pain over longer timeframes, and helps prevents extreme price spikes, that only benefit cowboy type financiers…

    I apologize for not asking a question this time. I believe my earlier question about the deafening silence around velocity of money is still unanswered… which is consistent 🙂

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