Currency Wars: Bernanke Defends Fed Policy, Calls for Emerging Market Currency Appreciation

Fed chairman Ben Bernanke is at odds with Brazil, China, and even the IMF over his policies. Please consider the BBC report Bernanke defends Federal Reserve stimulus measures

Brazil has said US monetary easing to keep interest rates low and weaken the dollar has hurt emerging economies.

And International Monetary Fund chief Christine Lagarde warned on Sunday of consequent asset bubbles developing in emerging nations.

Speaking in Tokyo, where the International Monetary Fund and World Bank are holding annual meetings, Mr Bernanke said: "The linkage between advanced-economy monetary policies and international capital flows is looser than is sometimes asserted."

On Friday, Brazil's finance minister, Guido Mantega, warned that his country would take "whatever measures it deems necessary" to fight the problem.

"Emerging markets can't passively endure large and volatile capital flows and currency fluctuations caused by rich countries' policies," Mr Mantega said in Tokyo.

"Advanced countries cannot count on exporting their way out of the crisis at the expense of emerging-market economies," he said. "Currency wars will only compound the world's economic difficulties."

In a speech at the end of the IMF meeting, Ms Lagarde said: "We have seen several bold initiatives by major central banks certainly that the IMF highly praises and values as major contributing factors to stability."

But she acknowledged that "there are diverging views within and across countries about important issues including the management of capital flows".

She said monetary easing "could strain the capacity of those economies to absorb the potentially large flows and could lead to overheating asset price bubbles.

Bernanke's Speech

Let's take a closer look at Bernanke's speech that has Brazil clearly upset, and the IMF questioning what Bernanke is doing. Here are a few snips from "Challenges of the Global Financial System: Risks and Governance under Evolving Globalization," by Ben Bernanke in Tokyo, Japan.

Although the monetary accommodation we are providing is playing a critical role in supporting the U.S. economy, concerns have been raised about the spillover effects of our policies on our trading partners. In particular, some critics have argued that the Fed's asset purchases, and accommodative monetary policy more generally, encourage capital flows to emerging market economies. These capital flows are said to cause undesirable currency appreciation, too much liquidity leading to asset bubbles or inflation, or economic disruptions as capital inflows quickly give way to outflows.

I am sympathetic to the challenges faced by many economies in a world of volatile international capital flows. And, to be sure, highly accommodative monetary policies in the United States, as well as in other advanced economies, shift interest rate differentials in favor of emerging markets and thus probably contribute to private capital flows to these markets. I would argue, though, that it is not at all clear that accommodative policies in advanced economies impose net costs on emerging market economies, for several reasons.

Three Point Defense

Here is Bernanke's three point defense of Fed policy followed by my rebuttal.

Bernanke: First, the linkage between advanced-economy monetary policies and international capital flows is looser than is sometimes asserted.

Mish: That is a meaningless statement. Here is an equally true but also meaningless statement. The linkage between advanced-economy monetary policies and international capital flows is tighter than is sometimes asserted. The key word is "sometimes". It all depends on who is doing the assertion.

Bernanke: Second, the effects of capital inflows, whatever their cause, on emerging market economies are not predetermined, but instead depend greatly on the choices made by policymakers in those economies. In some emerging markets, policymakers have chosen to systematically resist currency appreciation as a means of promoting exports and domestic growth.

Mish: Of course it depends on how policymakers in those countries react. They can bend over and kiss Bernanke's ass or they can promote exports just like the Fed is attempting to do.

Bernanke: Finally, any costs for emerging market economies of monetary easing in advanced economies should be set against the very real benefits of those policies. The slowing of growth in the emerging market economies this year in large part reflects their decelerating exports to the United States, Europe, and other advanced economies. Therefore, monetary easing that supports the recovery in the advanced economies should stimulate trade and boost growth in emerging market economies as well.

Mish: If monetary easing in the US was supposed to boost growth in emerging markets, then why didn't it? The fact is that all of this manipulation is undesirable, regardless of what county is doing it. Proper signals come from free market flows, not central-planner fools who have a track record of producing boom and bust cycles of ever-increasing amplitude.

In regards to the latter point, note that IMF chief Christine Lagarde speaks out of both sides of her mouth at once, each saying different things.

One side of her mouth praises the Fed, the other says "monetary easing could strain the capacity of those economies to absorb the potentially large flows and could lead to overheating asset price bubbles."

So which is it Christine?

Bernanke Calls for Emerging Market Currency Appreciation

The Wall Street Journal reports, Bernanke Calls for Emerging Market Currency Appreciation

Federal Reserve Chairman Ben Bernanke encouraged policy makers in developing economies to let their currencies appreciate, delivering a strongly worded counterargument to their own critiques of the Fed.

"In some emerging markets, policy makers have chosen to systematically resist currency appreciation as a means of promoting exports and domestic growth," he argued. "However, the perceived benefits of currency management inevitably come with costs, including reduced monetary independence and the consequent susceptibility to imported inflation." Capital surges and inflation in these markets, in other words, are problems that policy makers in these markets could address themselves if they chose to, he argued.

The passage was an apparent shot at authorities in China, who intervene aggressively in foreign-exchange markets to keep their currency closely tied to the dollar, though Mr. Bernanke didn't mention any countries by name.

His comments come as other policy makers have been very critical of the Fed. Brazil's finance minister, Guido Mantega, has accused the Fed of starting a "currency war."

Mr. Bernanke has made similar arguments before, but these were especially pointed and come at a sensitive moment. The Fed in September launched a new bond-buying program that has sparked a new wave of global criticism.

Mr. Bernanke argued that central bankers in developing economies should "refrain from intervening in foreign-exchange markets, thereby allowing the currency to rise."

What's Good For the Goose

Bernanke has the gall to bitch about currency manipulation when his policies are designed to do the same thing. QE is designed to weaken the US dollar, and somehow that is OK, but not straight-up currency intervention.

Speaking of which, why is Bernanke and the entire rest of the world willing to sit back and say nothing about the biggest straight-up currency manipulation in history? I am talking of course about the Swiss National Bank and its unlimited measures to prevent the rise of the Swiss Franc vs. the Euro.

Quite frankly, they are all beggar-thy-neighbor hypocrites, which is what currency wars are all about.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com