Bernanke Blames the Global Financial Crisis on China

They must put something in the water at the Fed, certainly the Board of Governors and the New York Fed. Everyone there, or at least pretty much everyone who gets presented to the media, seems to have an advanced form of mental illness, namely, an pronounced inability to admit error. While many in public life suffer from this particular affliction, it appears pervasive at the Fed. Examples abound including an overt ones like an article attempting to bolster the party line that no one, and hence certainly not the central bank, could have seen the housing bubble coming, or subtler ones, like a long paper on the shadow banking system that I did not bother to shred because doing it right would have tried reader patience Among other things, it endeavored to present the shadow banking system as virtuous (a necessary position since the Fed bailed it out) because it was all tied to securtization and hence credit intermediation. That framing conveniently omits the role of credit default swaps and how they multiplied the worst credit risks well beyond real economy exposure levels and concentrated them in highly geared financial firms.

Another example of the “it is never the Fed’s fault” disease reared its ugly head in the context of the G20 meetings. The big row is over global imbalances with the US mad at China for not doing enough to rebalance its economy (code for consume more, export less). China is admittedly trying to take the barmy position that its huge reserves really don’t count (huh?) so I suppose the Fed thinks it can trot out some whoppers of its own.

Actually, this is an old whopper, since the Fed has maintained for some time that the “savings glut,” meaning emerging markets and in particular China saving too much, had a lot to do with the crisis. From the Financial Times:

Foreign investors’ hunger for safe US assets helped to cause the 2007-2009 crisis by encouraging banks to turn risky mortgages into AAA rated bonds, Ben Bernanke, US Federal Reserve chairman, argued in Paris on Friday.

“The preference by so many investors for perceived safety created strong incentives for US financial engineers to develop investment products that ‘transformed’ risky loans into highly rated securities,” said Mr Bernanke, presenting a new research paper that he co-wrote with other Fed economists.

Mr Bernanke has previously argued that a “global savings glut” led emerging markets to send large amounts of capital to the US in the 2000s, pushing down US interest rates. His new paper says that those emerging markets wanted safe assets – and US regulators failed to keep the financial system from creating them.

“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,” Mr Bernanke said, adding that the US crisis had given him new sympathy for developing countries that have to manage large capital inflows.

This argument supports Mr Bernanke’s view that low Fed interest rates did not make an important contribution to the financial crisis and the main errors were in regulation.

According to the paper, more than 75 per cent of investment from “savings glut” countries was in AAA rated US assets in 2007, whereas such assets accounted for only 36 per cent of total US securities.

Help me. If this really passes for analysis at the Fed, as opposed to a mere cynical effort to create a talking point, no wonder we had a global crisis.

First, correlation is not causation.

Second, how material was that 75% in terms of the total market for AAA securities of all types?

Third and most important, the savings glut countries liked Treasuries and Agencies. They did not buy the AAA securities that were at the heart of the crisis, namely AAA rated CDOs (far and away the most important driver of the toxic phase which turned a mere housing bubble into a global financial crisis) or AAA RMBS. Without a convincing explanation of a transmission channel between for Treasuries and Agencies, and the seeming free lunch of higher yield AAA paper that these foreign buyers for the most part shunned, this story remains unconvincing. And notice the Fed has been telling the global savings glut story for nearly three years now and still has not found a way to make a causal connection.

In addition, as we’ve pointed out repeatedly, when the Fed started increasing interest rates, demand for prime mortgages fell yet demand for subprime was supercharged. That is an unheard of pattern. When the Fed tightens rates, the outcome usually is for spread of risky credits to rise first and most and safer borrowers to rise less. Unless you can explain this deviation, you have again failed to explain the crisis, and this savings glut twattle does not cut it.

We debunked this thesis in ECONNED:

Now let’s take this one step further: where did the lending boom come from, exactly? As you may recall from the last chapter, the Fed and Treasury would have us believe that the “savings glut,” a.k.a., the Chinese, was the culprit. And the Chinese, along with other central banks in trade surplus countries, did play a role in this drama, through their continued appetite for AAA securities, along with others predisposed toward AAA paper (recall that starting in 2001, foreign central banks became the major actors in buying U.S. Treasury and agency paper).

The average global savings rate over the last 24 years has been 23%. It rose in 2004 to 24.9%. and fell to 23% the following year. It seems a bit of a stretch to call a one-year blip a “global savings glut,” but that view has a following. Similarly, if you look at the level of global savings and try deduce from it the level of worldwide securities issuance in 2006, the two are difficult to reconcile, again suggesting that the explanation does not lie in the level of savings per se, but in changes within securities markets.

At the same time, other data do lend support to the notion that the shadow banking system was the main culprit in the meltdown. Bank lending has contracted far less than its murky twin. Although global corporate lending did fall from its peak of $2 trillion in 2007 to $1.5 trillion in 2008, that level was on par with 2006. Between the second and third quarter of 2008, U.S. bank credit increased 1%, and between the third and fourth quarter, banking industry consultants Oliver Wyman estimated that it contracted by 0.5%.

By contrast, while $1.8 trillion of asset-backed bonds were issued in 2006, only $200 billion were floated in 2008, and issuance through mid-2009 was “minimal.” Similarly, Credit Suisse pegs the contraction in “shadow money” in private debt securities since 2007 at $3.6 trillion, or 38%, due primarily to the substantial increase in repo haircuts, plus a dearth of new issues and a fall in prices.

But of course, the Fed has to continue to assert that its super low rates really have no distorting effect on the wider world. The learned blindness is truly astonishing. Anyone with an operating brain cell can see that the object of Fed policy is to blow a new asset bubble to create a wealth effect to stimulate demand (or more accurately to prop up asset prices, and since the Fed has said it does not believe in asset bubbles, it won’t recognize it has created one till after the fact). And as we have also said repeatedly, the Japanese demonstrated in the late 1980s when they explicitly tried to create a bubble to stimulate domestic spending, that the end result is a financial crisis and a bad economic hangover.

So it does not take much in the way of imagination to see that goosing assets prices in thing you’d like to stabilize, like US housing and stocks, is going to leak into all sorts of other markets, like commodities. But the Fed is insistent on dodging responsibility for its past mistakes as well as its current actions.

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  1. attempter

    The big row is over global imbalances with the US mad at China for not doing enough to rebalance its economy (code for consume more, export less).

    I’m still trying to figure out the fundamental contradiction between this proclaimed desire and the proclaimed desire to get American consumerism (and exponential personal debt) fired up again.

    The latter also contradicts literally every US policy offensive, all of which seek nothing but the total liquidation of America’s middle class.

    The answer which fits the evidence is that the multinationals have actually given up on American consumerism and are looking to Asia as the last great consumer frontier. (That requires ignoring Peak Oil, which I’ll leave aside for this comment.)

    The obvious explanation for China-bashing is the same old xenophobia misdirection trick, and that’s probably the proximate reason for it here. (That must be the reason Krugman keeps engaging in it.)

    But on a deeper level it’s probably true that the global kleptocracy wants to move the main bubble to China and elsewhere in Asia. There’s no chance of reflating for long in the US, and US policy proves that they’re not really serious about trying to do so. Here it’s just steal everything which isn’t bolted down, and chase the rightful owners away from everything that is. But moving the bubble’s hard to do as long as the Chinese ruling class thinks it can do better with the status quo. (And it isn’t the utter whore of the Western banks and corporations the way the US government is.)

  2. craazyman

    I think you have to be a highly trained PhD economist to really understand this stuff. ;)

    Just look at the numbers. There are 1 billion Chinese and only 300 million Americans. That means, just as a starting point, there are three times as many people to blame over there as there are here. And none of them even vote.

    And how many economists work at the Fed? I have no idea. Maybe a few hundred.

    Consider the math. A few hundred PhD’s compared to 1 billion Chinese who don’t even vote. Now that’s leverage!

    1. Cedric Regula

      “I think you have to be a highly trained PhD economist to really understand this stuff. ;)”

      And I for one sure am glad we got ’em.

      If memory serves, the Chinese were up to around $500B in simple AAA Agency MBS (some of it was F&F corporate bonds but I think they dumped all that). That’s out of a approx. $11T total mortgage market. ( think they add up all ABS to get that number, but not sure)

      So what Ben is telling us is that the United States of America is like a great piggy bank for the entire world, (Ben outstreches his arms to illustrate the point)and the smart money all around the world takes their hard earned money(fiat currency, to use general macroeconomic terms) and tosses it into the piggy bank.

      This causes the cost of money to go down.

      Ok, I get it. So where can I pick up my Honorary Degree in economics and get a good job before I go broke?

  3. tom

    Yves, I think the emphasis on the Fed’s low interest rate policy post 2001 misses the structural sources of the crisis, and risks aligning your analysis with that of John Taylor (“things would have been fine if only they had followed my rule”). In fact, it was the underlying structural weakness of business investment and the resulting jobless recovery that created the need for those low interest rates as the Fed desperately tried to avoid Japan-style deflation. Without low rates, the structural problems would have surfaced earlier, perhaps less spectacularly to be sure, but who knows. Bernanke is wrong, as you point out, to blame the savings glut–its really more of an investment shortage. This ties in nicely with your repeated and astute observation that net business saving (sectoral saving minus investment) swung positive before and now after the crisis. I hope you will take this as a friendly criticism.

    1. johnbougearel

      Tom observed “it was the underlying structural weakness of business investment and the resulting jobless recovery that created the need for those low interest rates”

      First Tom, the Fed is using the jobless recoveries as cover for its reckless monetary policies. Even worse, Fed policies can’t create one stupid little job in an economy where there is weak business investment. You have to ask yourself how the US economy over the past thirty years came to have such weak business investment in the first place.

      Globally, business investment is booming, just not in the US. Howard Rosen, a labor economist at the Peterson Institute observed “US companies are investing in plants and equipment, just not in our borders…They are privatizing the gains of globalization.” US companies are “returning the spoils of globalization and technology” to new projects overseas.

      Globalization, Free Trade Agreements FTAs are also justified under the false claim that they create jobs, improve global imbalances and trade deficits), tax incentives to offshore, etc, have all contributed greatly to the export business investment overseas.

      It is bad meme and a falsehood to claim that low or zero interest rates create sustainable jobs and use that to justify bad policy and bad outcomes for most Americans.

      This trend of weak business investment has accelerated in the past decade. That is because multinationals have gone “nuts” on China in the past decade. Quoting from GE’s CEO Jeffery Immelt in 2002

      “When I am talking to GE managers, I talk China, China, China, China, China. [Five Chinas] You need to be there. You need to change the way people talk about it and how they get there. I am a nut on China. Outsourcing from China is going to grow to 5 billion. We are building a tech center in China. Every discussion today has to center on China.”

      The trend will probably continue until the Great Wage Convergence reaches some sort of equilibrium point.

      Unless business incentives to outsource and offshore are changed, business investment in the US will remain structurally weak period. We will have one jobless recovery after another as we move through waves of “rolling recessions” and social unrest.

      1. LeeAnne

        A Chinese official (I remember it clearly, but am sorry I don’t have time to look up exactly which official), commented about Hank Paulson’s commuting to China, that Paulson, at the time he was Secretary Treasurer of the U nited States, did not represent anyone but Goldman Sachs.

        That this so-called democracy, this representative government would permit, indeed encourage multinationals domiciled in the State of Delaware to also incorporate in off-shore tax havens and worse, to rape America’s workers, resources and assets to increase stock prices, consolidate capital, and pay executives 500X workers’ salaries while the likes of the psychopathic Ted Turner mouths off about too many people in the world about which, no doubt, he has a solution, and Walker tries to pull a Mubarak in Wisconsin, demands a 1776 after Supreme Court Justices Thomas, Alito and Roberts are impeached for the lying crooks they are.

      2. craazyman

        “What do you do when you see a whale men?”
        “Sing out for him!” was the impulsive rejoinder from the score of clubbed voices.
        “Good!” cried Ahab, with wild approval in his tones; observing the hearty animation into which his unexpected question had thrown them.
        “And what do you do next, men?”
        “Lower away, and after him!”
        “And what tune is it ye pull to, men?”
        “A dead whale or a stove boat!”
        More and more strangely and fiercely glad and approving grew the countenance of the old man at every shout . . . as Ahab, now half-revolving in his pivot-hole, with one hand reaching high up a shroud, and tightly, almost convulsively grasping it, addressed them thus:
        “All ye mast headers have before now heard me give orders about a white whale. Look ye! d’ye see this Spanish ounce of gold?” — holding up a broad bright coin to the sun –“it’s a sixteen dollar piece, men. D’ye see it? Mr. Starbuck, hand me yon top-maul . . . Look ye, whosoever of ye raises me that same white whale, he shall have this gold ounce, my boys!”

          1. Cedric Regula

            Personally, I prefer China Miéville to Herman, although I’m rather certain his Perdido Street Station novel most certainly added to your deep insights into reality, but you really don’t expect us to believe this crap, do you?

            –”it’s a sixteen dollar piece, men. D’ye see it? Mr. Starbuck

          2. Cedric Regula

            Also check out Drood by Dan Simmons. It’s an excellect study of how one first finds self awareness, then learns to project this awareness and illuminate reality.

            The more I think about it, it is quite supportive of your DNA Is A Radio Theory.

          3. skippy

            According to historians, Pollard and members of his crew were adrift in the Pacific for three months after the Essex sank. As later accounts made clear, the ordeal was harrowing, with survivors staving off starvation and mental anguish, and resorting to cannibalism in order to survive. In fact, Pollard was forced to eat his own cousin in the waning days of the shipwreck’s aftermath. It’s no wonder that he may well have held a grudge against the whale that sank his ship. Nevertheless, Pollard, unlike Ahab, did not surrender his life to the pursuit of whales: After he survived the sinking of the Two Brothers, Pollard retired from the whaling business.



            Look into the history guys, their is soooo much underlining, industry, commerce, religion, et al with regards to this story.

            Skippy…extra points for anyone that can finger the real economic bosses at the story’s geographical/industrial center…Mass…hint…absolution for crimes committed under duress.

      3. Yves Smith Post author

        Per your point, US businesses have been net savers since 2003. The uptick in investment that started late last year is by most estimates 3/4 replacement capex, hardly a sign of real “investment”.

      4. wtf

        Then sitting around waiting for business to start investing is a rather stupid move, isn’t it? But that’s exactly what our overlords at the Fed and the Whitehouse are doing.

    2. financial matters

      Poor corporate governance and misdirection of capital as well as poor government oversight seem very common in many corporations…. Especially troubling when it occurs in corporations that should be acting in the public’s interest

      CEOs From 10 Health Insurers Took Nearly $1 Billion in Compensation, Stock Options in Last Decade

      “”The jaw-dropping compensation for 2009 set new standards for the industry and for what CEOs will pay themselves in the future. Last year’s compensation for health-insurance CEOs was enormous, enough to fund stress tests to check the heart health of up to 776,000 patients, or to pay for every resident of Philadelphia, Dallas and Minneapolis combined (3.2 million people) to go to their regular doctor for an office visit. Over the full decade covered in the report, average CEO pay has reached nearly $10 million a year per company.””

      “””It’s unconscionable that insurance companies are jacking up premiums and giving their CEOs multi-million dollar pay packages when families are struggling to make ends meet and businesses are barely keeping their doors open,” Rome said. “We need to be creating jobs for America, not creating wealth for a handful of CEOs.”””

      1. Paul Repstock

        fm…There is the smoking gun of evidence that there is no “Free Market” in opperation. A Free Market ould solve the imbalances through competitive pricing and bring these compensation packages crashing back into the relm of reality.

        1. financial matters

          It’s hard to apply pure free market strategies to health care. It seems more a problem of what society deems appropriate. Fiscal constraints are of course important. Transparency would help. Many people don’t know what their insurance actually covers and the insurance companies don’t make it easy to understand. Many states don’t regulate health insurance premium increases. I think health care reform helps here by getting into the financials of the insurance companies and for one thing mandating the percentage of revenues that have to be spent on health care vs ‘administrative costs’. Then the next step is to try and ensure that these dollars are well spent… It’s hard to talk about fiscal responsibility without tackling healthcare…

          Four Steps to US Fiscal Health

          Simon Johnson and James Kwak


          “””But efforts to tackle health-care costs continue to be hampered by widespread reluctance to tackle sensitive issues, as epitomized by the “death panel” tempest of a year ago. Reshaping the US health-care system to focus on successful outcomes and quality of life, rather than on employing the newest and most expensive technology, is a challenge for which no one yet has a proven solution. It remains, more than any other single factor, the key to long-term fiscal sustainability.”””

          1. Paul Repstock

            Actually Simon and Kwak, are ignoring the fact that the defence budget dwarfs health care costs and is much less productive.

            However, If you want to cure high health and insurance costs, just “Outsource” it. I know this will never happen, the lobby is far too strong. There are medical tourism promotions taking Canadians to places like India, where proceedures not available or with long waiting lists cost less than half of what they would even with our subsidized system. The facilities and personel are top notch and aiting times are short.

      2. Ray L Phenicie

        As an off topic subject here this really should be taken up elsewhere. I’ll just put this out there–

        There is an even more insidious side to health care however, as a delivery system its broken nature keeps too many people from receiving care and too often harms the folks who seek treatment for a medical condition.
        “To Err Is Human – Building a Safer Health System”
        Published by the Committee on Quality of Health Care in America as part of the Institute of Medicine’s report on our national Health care system the report shows a major flaw that is systemic-individuals working inside the system are unable to change it-we need to restructure it from the top to the bottom

        —– Two large studies, one conducted in Colorado and Utah and the other in New York, found that adverse events occurred in 2.9 and 3.7 percent of hospitalizations, respectively.2 In Colorado and Utah hospitals, 6.6 percent of adverse events led to death, as compared with 13.6 percent in New York hospitals. In both of these studies, over half of these adverse events resulted from medical errors and could have been prevented.

        When extrapolated to the over 33.6 million admissions to U.S. hospitals in 1997, the results of the study in Colorado and Utah imply that at least 44,000 Americans die each year as a result of medical errors. The results of the New York Study suggest the number may be as high as 98,000. Even when using the lower estimate, deaths due to medical errors exceed the number attributable to the 8th-leading cause of death. More people die in a given year as a result of medical errors than from motor vehicle accidents (43,458), breast cancer (42,297), or AIDS (16,516)—–

        Unions for the average person have been destroyed and wages stagnate-at very best-or edge downward –
        The report on health care quoted above was written in 1999 but nothing has changed in the quality of care area-Why?
        Because the Professional Union, aka the American Medical Association, keeps salaries high for medical professionals and resists having any system instituted that would check on quality of care. Yes, I know, there are the high costs of doing business inside of the medical profession. Everyone faces high costs in their daily lives as well.

        But to place this on the larger scale of events surrounding us, the government, in several major groundswells that have moved the ground under our feet, it has sabotaged the average worker and his or her household and facilitated the flow of wealth in this country upward until we now face a mere 2-5 percent who really own or control the country’s wealth vs. the rest of us who eke out a living. So instead of focusing on the outrageous compensation packages of the few, I’d like to focus on the outrageously shortchanged many who reside at the bottom of the population, say 35th percentile and downward.

        Why are there no social programs to alleviate the suffering caused by wage shortfalls? Low income families have no mass transit system to fall back on so they pare back on spending to feed the automobile. Subsidies for housing are difficult to grab onto if not nonexistent so another shifting away from housing is done and real estate values in low income areas decline over the decades. Food subsidies are a joke, stopping when the family income reaches 29k/yr-family of four. Care for medical subsidies are likewise too hard to achieve or stop short of relieving income burdens for those who move beyond subsistence into the desert of low income. The idea, once upon a time, was out there, since Charles Dickens had Marley’s Ghost lecture Mr. Scrooge on how ‘Mankind was my business’ that charity and a general social consideration for taking care of the ‘least among you’-this was part of the original message of many of the world’s major religions,- that we could all get by through merely looking out for each other. That Idea, while operating to motivate all social programs, is out for another major bashing as we watch the fiscal responsibility hawks swoop in on every shred of social program. Bye the bye, remember that social programs, (national retirement funding, Medicare, Food Stamps,) were designed to make up for the difference in the harsh realities imposed by the workings of 19th capitalist theory doing business in the twentieth century.

  4. Conscience of a conservative

    Bernanke’s comments fuel the prospects of a currency war. He’s basically saying that the world cannot blame the U.S. for having low interest rates and printing a great deal of money because they could choose to respond by letting their currencies rise. Ironically letting the dollar depreciate and other currencies rise is very much a goal of U.S. policy which hopes that such a move would increase exports. From Bernanke’s speech see below:

    In light of the relatively muted recoveries to date in the advanced economies, the central banks of those economies have generally continued accommodative monetary policies. Some observers, while acknowledging that an aborted recovery in the advanced economies would be highly detrimental to the emerging market economies, have nevertheless argued that these MONETARY POLICIES are generating negative spillovers. In particular, concerns have centered on the strength of private CAPITAL INFLOWS to many emerging market economies, which, depending on their policy responses, could put UPWARD PRESSURE on their CURRENCIES, boost their INFLATION RATES, or lead to ASSET PRICE BUBBLES.

    Third, policymakers in the emerging markets have a range of powerful–although admittedly imperfect–tools that they can use to manage their economies and prevent overheating, including EXCHANGE RATE ADJUSTMENTS, monetary and fiscal policies, and macroprudential measures

    1. Pixy Dust

      Maybe the Chinese have seen too many hangovers from too many tequila traps.
      I think they want to stay sober. Not a bad thing.

      1. Pixy Dust

        But the idea of a currency war is amusing. Will it be fought with rock, paper, scissors, or matches, because the American public is in no mood for another boogeyman fight.

  5. Conscience of a conservative

    Additionally by saying,”Foreign investors’ hunger for safe US assets helped to cause the 2007-2009 crisis by encouraging banks to turn risky mortgages into AAA rated bonds, Ben Bernanke, US Federal Reserve chairman, argued in Paris on Friday” misses a huge point. BASEL and other regulations create huge capital incentives for holding AAA assets, especially mortgages which can qualify for a zero risk based weighting. Bernanke misses a huge point when discussing foreigners appetite for “safe” U.S. assets.

  6. John Emerson

    It really seems that the US is a failed state. The supposed technocrats at the Fed failed, and contrary to myth they aren’t neutral, but have a political agenda. It’s just an anti-democratic political agenda completely insulated from the voters.

    The supposed economics profession and their supposed science failed. I don’t understand economics and for that reason cannot be part of the debate, but by observing it from the outside it seems to be all agenda, half fraud, and very little science.

    The political system has failed. There aren’t 100 Congressmen whose lives would be worth saving in an emergency. The process s designed for graft and influence-peddling at the expense of both democracy and good government. (I’d be happy with one of the two, but we get neither).

    The media have failed. There’s a whole counter-media explaining how the official media is worthless: in economics alone you have Dean Baker, Brad DeLong, Yves here, Mark Thoma, and as many others as you can name.

    I just don’t see how this can continue. We’re finally now reaching the “sharpening the contradictions” phase, when people lose their homes and their livelihoods, and there are no positive political forces, but only the Teapartiers.

    1. Larry Elasmo

      John Emerson said: “The political system has failed. There aren’t 100 Congressmen whose lives would be worth saving in an emergency.”

      Excellent post. Agree with everything except the sentence above. In a real emergency, I can’t think of a single Congressman whose life would be worth saving.

      1. joel hanes

        > can’t think of a single Congressman whose life is worth saving

        Jackie Spier is a keeper
        Nancy Pelosi is another
        Henry Waxman another

        My own district’s Mike Honda is a non-entity, but not evil;
        Anna Eshoo and Zoe Lofgren from the neighboring districts likewise — John Garamendi’s a little more prominent, and Jerry McNerny is a pretty good guy …

        Bernie Sanders
        Keith Ellison

        Darrell Issa, OTOH, should DIAF, and the sooner the better.

  7. John Merryman

    One is reminded of the snake eating its tail, as Capitalists do everything possible to avoid the fact that capital is subject to the laws of supply and demand, as they try to support infinite amounts of supply, after decades of screwing over demand, ie. borrowing. The problem with such linear, blinkered thinking is that the eventual blowback is just that much greater, the further you manage to push it. Money is a contract and when those controlling the clearing mechanisms are cheating everyone else, it’s only a matter of when, not if.

    1. nonclassical

      John, “recklessness and sabotage”, as bespoken by Perkins’
      “Confessions Of An Economic Hit Man”, and also disaster capitalism=Noami Klein’s, “The Shock Doctrine-The Rise of Disaster Capitalim”…

  8. Fred Bethune

    Actually, Bernanke is pretty much right. People who think that Bernanke is an idiot or simply a liar are SORELY, SORELY mistaken. Read Bernanke’s papers with Gertler if you want a complete explanation of the crisis — written in the early 90s.

    Transmission mechanism? Easy. Relative rates of return between safe assets. Chinese, asian and gulf state buying of treasuries drove down the yield, and in order to get a decent return, investors that would normally buy treasuries were willing to get into the AAA subprime paper. Anyone here remember the “search for yield” in the mid noughties?

    The causal argument? The skewed distribution of savings between China and America (global aggregates don’t tell us anything) caused a low natural real rate to prevail in the United States. In order to maintain employment and GDP growth under these conditions, the Fed had to run a low interest rate to match the natural rate (the interest rate at which we maintain full employment and output). This led to bubbles and to search for more “safe” assets that would yield more (subprime).

    Anyways, the issue is not necessarily the saving itself. The exchange rate that should have adjusted to even out this imbalance was pegged by the Chinese. The “savings” were mainly a byproduct of the peg (and other pegs like it). If you want my chain of causation it goes like this:

    -late 90s China devalues massively and keeps its exchange rate fixed there
    – in order to maintain the exchange rate, China accumulates large amounts of dollars that must be invested outside the country to avoid inflation (Mundell-Flemming)
    – China buys large amounts of Treasuries, which pushes down the return on safe assets and lowers the real natural rate.
    – The Fed has 2 choices in the early 90s: allow a huge recession, or match the natural rate with unprecedentedly low interest rates. They choose the latter
    -Low interest rates and overvalued currency results in asset bubbles
    -Everything collapses

    1. Fred Bethune

      Also, I should point out that I’m not writing off the role of deregulation, fraud, etc. in creating the bubble. Nor do I think that Bernanke’s policy of trying to re inflate asset prices (because they have a strong effect on credit intermediation) is a good idea. IMO the absolute number 1 priority should be forcing the Chinese to stop pegging their currency. That’s really the core problem that should have been addressed 10 years ago.

      My main point is that the Chinese peg was a necessary, but NOT SUFFICIENT, condition for the crisis to occur. It’s an important part of the story, but so is shadow banking, fraud, deregulation etc.

      1. craazyman

        I don’t think Chairman Bernanke is an idiot or a liar. But how did the Chinese get all those dollars?

        Because the kleptocratic psychopaths who “run” our “system” financially raped, sacked and looted the nation disemploying tens of millions of Americans just so their psycopathic cadres can elevate themselves from multi-millionaires to multi-multi-millionaires while they help China dump its big bag of plastic toxic crap onto us like a typhoon of shitt falling from the skies.

        And the banks that bankrupted themselves pulling the levers of the loot machine, raking in billions in fraudulent bonuses, they get bailed by the Big Ben while the sheep get fleeced one more time.

        Well, what else could he do, when the storm finally hit full force? He’s not Saint Augustine, after all. Or Mother Teresa. He’s a lever puller. But what sort of machine is it? And does he really understand all the moving parts?

        Maybe he has had some hard conversations behind the scenes that we don’t know about. I’m willing to give him that consideration, and withhold judgment. But at some point, this becomes a moral issue, not merely a matter of abstract policy constraints.

        Racial Jim Crow didn’t work. It was an obscenity. And financial Jim Crow won’t work either. It’s also an obscenity.

        1. Fred Bethune

          ” But how did the Chinese get all those dollars?”

          That’s kind of obvious, isn’t it? They got them in exchange for consumer goods, mainly through places like Walmart. The forex exchange has to go through the chinese government. It keeps all the dollars and gives the manufacturers renminbi. If it spent the dollars in China AND gave the manufacturers renminbi that would obviously cause inflation, so they had to find somewhere outside the country to park the dollars. Treasuries and agencies are the natural choice.

          “Because the kleptocratic psychopaths who “run” our “system” financially raped, sacked and looted the nation disemploying tens of millions of Americans just so their psycopathic cadres can elevate themselves from multi-millionaires to multi-multi-millionaires while they help China dump its big bag of plastic toxic crap onto us like a typhoon of shitt falling from the skies.”

          I more or less agree. The main lever through which they did this was Rubin’s high dollar policy and complicity with allowing the Asian pegs. Overvalues USD is very good for Wall Street so they can snap up foreign factories on the cheap, and very bad for workers who lose their jobs. In a sense it is hypocritical for the US to chide China so much, given that Wall Street and the Treasury went along with the scheme quite willingly at first.

          1. kievite

            The main lever through which they did this was Rubin’s high dollar policy and complicity with allowing the Asian pegs. Overvalued USD is very good for Wall Street so they can snap up foreign factories on the cheap, and very bad for workers who lose their jobs. In a sense it is hypocritical for the US to chide China so much, given that Wall Street and the Treasury went along with the scheme quite willingly at first.

            This was quit a feeding frenzy. During Asian financial crisis US corporations managed to buy quite a bit on cheap and with fleshly printed by Fed dollars. I remember Business Week cover depicting Uncle Sam with factories in the shopping basket. Talk about globalization served as a useful anesthesia for the assets grab.

            Moreover at this point foreign corporations who previously put quite a bit of efforts (and money) to build a production base for themselves in the USA market, started moving from manufacturing in the USA to just distribution.

            Essentially it was a Congress approved swap of the US manufacturing and infrastructure development for oversees manufacturing and infrastructure development in hopes that the US status as the only superpower and the owner of reserve currency (exorbitant privilege as De Gaulle used to call it) allow extraction of enough profits to sustain the USA domestic consumption. Typical imperial play.

          2. craazyman

            You know Fred I was just remembering the movie from the late 1990s with Morgan Freeman as the President and he had to deal with the fact that an asteroid was heading straight for the earth.

            I was thinking Shitt, an afro-dude gets elected president and look what happens. bowahahahahah. Not cause and effect, mind you, just bad luck. It could have been Herbert Hoover or even James Garfield.

            Who knew, in 1998, that the asteroid would be neoliberalism, and the president would be Professor Obama himself? Not me. Frankly I don’t care what ethnic background anybody is from. I’m on eharmony now and was trying to get something going with a hot 38-year old from Jamica (the Island, not Queens). And I was chatting up another from somewhere else down that way. My last girlfried was Chinese. But she was a psychotic. The one before that was from India. That one really really hurt. That’s why I’m crazy. Otherwise, I really don’t care where they’re from, as long as they’re hot. :)

            I try to follow all that economics back and forth with dollars and renminbi and trade balances and etc. and etc. and frankly it all kind of runs together. I’ll have to re-read Fredric Mishkins’s excellent textbook, which I read once just to get the basics reinstalled in my RAM. Most of it was pretty good. But it’s clear that economics is neither a science nor an art form.

            It’s more like the instruction manual for a cable TV set top box. Only certain individuals will find that useful. Most people, including me, don’t bother reading the manual. We just start pushing the buttons until the dam picture comes on. I’m old enough now to faintly remember when whacking the TV often solved the problem of reception. I guess that’s what’s happening now across the world.

        2. Cedric Regula


          I get what your say’n about it being one happy global village, so deal with it. And this global economic-financial thing is no easy thing to get your head around, so sometimes we just give up with that and focus on the day-to-day.

          But sometimes I doodle in my spare time, something like drawing a cartoon, except using words, and come up with ridiculus little things like this:

          American Rice Farmer vs. Chinaman Rice Farmer in deadly competition for American Market

          Both rice farmer grow 1 lb rice this season.

          Chinaman Rice Farmer has brother that emigrated to America and has job (doesn’t matter what), but does favor and offers to sell rice for brother as favor to eliminate global marketing cost.

          American Rice Farmer puts up his lb of rice for sale for $1.01, Chinaman Rice Farmer say one dollar delivered and we have done deal. Chinaman Rice Farmer brother deliver rice, pick up dollar and mail dollar back to China. Chinaman Rice Farmer take dollar to bank to exchange for RMB. He ask how many. Bank teller say “PBoC print up 6 RMB for dollar”. (rice farmers don’t know about sterilization bonds, so we won’t talk about that.)

          Chinaman Rice Farmer say ok and go home and pay production cost (all local “input costs”) and then calculate savings rate. 30% (he small and skinny). PBoC bureaucrat review transaction and calculate 100% dollar savings rate and put in pot to buy treasury.

          American Rice Farmer not know Chinaman Rice Farmer production costs, but he worried, and decides to go out of business to be on safe side and saves his rice for dinner.

          1. craazyman

            cedric I sort of lost you on that one but I remember the one about Chippendales. that scene would scare the shitt out of me. I can take them one or two, but not dozens. bowahahahah.

            do you think they’re really mailing dollars back to China? why not. I guess anything is possible. But it probably wouldn’t be much in the scheme of the whole capital flows.

            Frankly, I wonder how reliable any economic statistics are. Even ours. Most people can’t even keep their checking accounts straight. And look at corporate accounting. and then the cash economy. I don’t know. The errors magnify each other into nonsensical numbers that cease to bear any accurate relation to things in themselves. They become the things and the rest of real life just sort of unhooks itself and goes invisibly where it will.

          2. Cedric Regula

            All the dancers were gay bodybuilders, so isn’t life strange?

            Sorry I lost you with my made up story. Make believe it’s Wal-mart mailing dollars then, and the PBoC says what they’re worth to Chinese business and workers, replaces them with RMB and buys treasuries with the dollars.

            But I just have this suspicion that the PBoC dollar savings rate is much higher than China’s RMB savings rate.

            I probably shouldn’t have said anything because we always run the risk that some economist reads this stuff and will come along and straighten out my misunderstanding.

      2. Paul Repstock

        Fred, I’m not here to consider Bernanke’s mental competence. But, I do know he is a damn liar! Exactly how would you turn subprime mortgages and broken chains of conveyance into AAA rated bonds without the conivance of the government? Banks are not alchemists. If banks claimed to convert lead into gold without the use of liberal amounts of givernment Pixy Dust, they would all be in jail for fraud.

        1. nonclassical


          records show “investment banks” themselves sent “tranches”
          to offshore banks every country loves for themselves, but hates any other country these offshore locations, the banks themselves “created” these tools of financial destruction…

          there were several layers of “oversight” prior to all this,
          but big-shot friends at Countrywide tell me there are no regulatory processes at mortgage layer.

          Look, we KNOW banks held this stuff in separate accounts, so they KNEW..

          also, last days of Clinton era legislation, Texas Rethuglican Senator Phil Gramm placed flyer in leg. stating
          that U.S. government could NOT AUDIT banks-therefore Obama
          “stress tests”..Gramm was qid-pro-quod by his wife getting seat on Enron Board…

          1. Paul Repstock

            Take it from the top nonclassical: The SEC is one of the financial oversight arms of the Fedral Government. The SEC has oversight authority over the valuation of “all” financial instruments within the United States whether domestically generated or offered for sale in the US, They also have authority over adherance to risk disclosure and by extension over the rating agencies.

            I’m sure you have read the Rolling Stone article..


          2. Paul Repstock

            When Mr. Mozillo is innocent, you might as well disband the justice department and probably the Supreme court as well. The funds spent supporting these institutions further would be better applied to continuing Social Security for a few more days.

    2. RebelEconomist

      The problem I have long had ( ) with this analysis is that I would have expected that if the US current account deficit was driven by official reserves inflows, which were mostly invested in treasuries and agencies, spreads should have widened. As it was, as you say, they narrowed. This suggests to me that the process was driven by financial innovation in the US, which created new demand for spread product such as sub-prime mortgage debt by packaging them up as CDOs. Investors who had not previously been able to buy such lowly rated debt were now able to do so by effectively hiving off the first losses. The result was a housing and hence consumption boom in the US which drew in more imports from China, and which, given the Chinese exchange rate peg, forced the Chinese authorities to absorb more dollars. In short, the irresistible force of a financial innovation driven US consumption boom met the immovable object of the renminbi peg.

    3. Yves Smith Post author


      You are wrong about the causal chain, 100% wrong.

      China NEVER devalued massively in the 1990s. It held its peg, and the US applauded. It OUGHT to have lowered the RMB to deal with the blowback of the Asian crisis and did not. So we encouraged them in their use of a fixed exchange rate.

      Greenspan dropped interest rates to deal with the implosion of the dot com bubble. We’ve argued that was utterly unnecessary, that it was not stoked by debt and therefore would not blow back to the financial system.

      Rebel does a very nice job of dealing with the spread argument (welcome back BTW, haven’t seen you in comments for a while).

      If you are going to make economics arguments, it helps not to make stuff up.

      1. Fred Bethune


        “China NEVER devalued massively in the 1990s”

        Huh? Look at your chart. From 1990 to 1994 the yuan lost nearly half of its value.

        Look at 1993 to 1994. That’s the “massive devaluation” followed by hard peg that I was referring to. I should have said “early to mid 90s” rather than “late 90s” but whatever, it’s not even really relevant.

        Are you telling me that a renminbi that was worth 4.7832 to the dollar in 1990 and ended the decade at 8.2783 to the dollar in 2000 (most of that change happening over just a few years) was not massively devalued in the 1990s?

        1. Paul Repstock

          Fred, you should look at the chart!
          The USDX appreciated 50% from the 1990 low to the 2000 high. The USDX is a basket of currencies which includes only one currency affected by the Asia melt down, so I would not be surpised if China’s currency lost even more value than the Japanese.

          And further more, I suspect that Jesse is wrong. I think the Dollar will hit the bottom of his chart.

        2. Yves Smith Post author


          You really need to get a grip and go do some history and look at trade balances. First you said late 1990s. Then I show you wrong. Then you start caviling about the early 1990s.

          Guess what? China’s currency then was widely acknowledged to be…..drumrolll..OVERVALUED! And no one thought the peg as of 1994 was out of line. The best thinking among development economists was that developing economies SHOULD run trade surpluses to help them develop faster. So trade surpluses, within certain (not well defined) bounds were seen as a Good Thing.

          Go look at the trade stats with China. You don’t see large deficits in 1995 and 1996 (1997 you had the Asian crisis, so results then are hard to interpret). They continue to grow smartly from 1997 onward with a fixed peg. The US affirmed the use of the peg as of 1997 because the Chinese were expected to DEVALUE in the wake of the Asian crisis.

          1. Fred Bethune

            Wow. I need to get a grip? I’m cavilling? Holy self-awareness fail.

            Your whole approach here is the very definition of cavilling.
            Scratch the word “late” from my point form sketch of events in a blog comment. Does that affect any aspect of the larger argument, either way? No, it doesn’t.

            In response you make an even bigger mistake (“China NEVER devalued massively in the 1990s”) and then try to squirm out of it by making the argument about real effective exchange rates rather than nominal exchange rates (what everyone normally refers to when they say that a country “devalued”). But you’re still even wrong about that (“And no one thought the peg as of 1994 was out of line”). RMB was undervalued 1994-1996 and only became overvalued by the time of the Asian crisis:

            “”Consistent with the well-known Balassa-Samuelson effect, movements in China’s real effective exchange rate and current account balance from 1994 to 2002 suggest that the long-run equilibrium path for China’s real exchange rate has a moderate upward tilt of about 2 percent per year.

            The actual real exchange rate started out below this long-run equilibrium path in 1994–95. With the usual lag of about two years, the undervaluation was reflected in an improvement in the current account, from a surplus of about 0.8 percent of GDP in 1994–96 to a surplus of about 31⁄2 percent of GDP in 1997–98. By 1997 the cumulative effects of somewhat higher inflation in China than in partner countries had pushed China’s real effective exchange rate from below its long-run equilibrium path to modestly above it, and the collapse of a number of Asian emerging-market currencies in the crises of 1997–98 pushed China’s real effective exchange rate even higher.
            With a lag of about two years, which is common for many countries, the consequences of substantial movements in China’s real exchange rate relative to its assumed longer-run trend are reflected in movements in China’s current account, as figures 8.3 and 8.4 illustrate. Consistent with the assumed lagged effect of movements in the real effective exchange rate relative to its equilibrium path, the current account shows modest (below average) surpluses in 1994–96. The surplus expands significantly in 1997–98, reflecting, with a lag, the real undervaluation of the renminbi in 1994–96. ”
            Michael Mussa, Debating China’s Exchange Rate Policy, p. 282

  9. LeeAnne

    “Also, I should point out that I’m not writing off the role of deregulation, fraud, etc. in creating the bubble. ”

    Because, of course, ‘deregulation, fraud, etc.’ must continue.

  10. Richard


    Chairman Bernanke has thrown you off your usual perspective of what caused the credit crisis.

    Since the beginning of this blog, you have argued that had investors known what was going into these securities, they would not have bought them.

    Since the beginning of this blog, you have written 100s of postings about what was going into (or in the case of mortgages not being transferred according to the pooling and servicing agreements, not going into) these securities.

    Bernanke’s observation about China purchases US government backed securities is irrelevant to your thesis. Even with the Chinese artificially driving up the price of treasuries, had investors known what was going into these securities, they still would not have purchased them.

    All Bernanke’s comment does is to show that the Chinese were actually very good investors. They followed Warren Buffett’s advice and stuck to investing in securities that they could understand.

    1. Max424

      “All Bernanke’s comment does is to show that the Chinese were actually very good investors.”

      Yup. If China had gotten greedy, they woulda got blowed up along with everybody else.

      But they didn’t get greedy. They stuck to their plan. And when the sh+t hit the fan in the fall of ’08, China instantly reacted, and – domestically – stimulated, to the tune of many trillions, and an export nation that should have been crushed by a world-wide demand crisis came out it with a bulging $3 trillion foreign cash reserve and a growth rate — perpetually stuck? — at 10%.

      Strategy and tactics — in that order. Too smart China.

    2. Yves Smith Post author

      I thought it was implicit in the post. The Fed is still refusing to take responsibility for its huge mistakes……the biggest being thinking an unregulated financial system is a great idea and they could let inmates with state backstopping (the big banks with meaningful dealer operations, JPM and Citi alone were obvious risks before you even get to the fact that they weren’t willing to let investment banks fail post Lehman) get up to their eyeballs in risk.

      I can’t recite all my past arguments in every post, each would wind up being chapter length. But perhaps I should have had the word “deregulation” somewhere in the piece, fair point. The fact that Bernanke mentions it en passant does not change the thrust of his argument. You need to ask yourself: why is he still taking about and writing about “savings glut” if the point is not to make it sound like a primary driver? You need to look at the emphasis in his speech and the underlying paper, how many paragraphs he spends on each topic. Even if he makes the right point (as in he can’t deny the role of deregulation), it comes off like a necessary caveat, not a central theme.

      If he really believes that deregulation was the central problem, his behavior is not consistent with that. Why are he and his smart colleagues at the Fed not throwing most of their research weight into looking at that problem? (Admittedly, some of it comes from the fact that the place is lousy with monetary economists, so they prefer to study what is familiar to them).

      1. Richard

        Actually, like you, I read his paper. I really wanted to see how far he would go in blaming the “savings glut” and China for the financial crisis.

        Like the Financial Crisis Inquiry Commission report, he never made the case for why the savings glut was the necessary and sufficient condition to explain the credit crisis or how its absence would have prevented the crisis.

        Nowhere in the paper does he show that China stopped buying US government backed paper and the next day the credit crisis hit.

        Given all that you have said, it is clear that even if there had not been this savings glut, there still would have been a credit crisis.

        The necessary and sufficient condition for the credit crisis was regulators adopting the position that they no longer had to modernize and enforce financial regulations. Particularly those that applied to disclosure and making sure that investors had access to all the information they needed to make a fully informed investment decision.

        On a slightly different topic, I hope you saw BoE Deputy Governor Paul Tucker’s comments about the “sense of shame” felt by central bankers and regulators for requiring tax payers to bailout the global banking system.

      2. kievite

        “The Fed is still refusing to take responsibility for its huge mistakes……the biggest being thinking an unregulated financial system is a great idea and they could let inmates with state backstopping (the big banks with meaningful dealer operations, JPM and Citi alone were obvious risks before you even get to the fact that they weren’t willing to let investment banks fail post Lehman) get up to their eyeballs in risk. “

        That’s true and it’s important to remind that academic establishment served as the fifth column in the deregulation frenzy. This is one case when I think American suspicious attitude toward eggheads has serious fundamentals. But on the society level it looks to me more like moves in zugzwang, when no matter what course of actions you chose your position deteriorates. That does not mean that Greenspan was not a white collar criminal, but if we remember the history it was Prohibition that raised organized crime on a new level. So like Al Capone was the creature created by Prohibition, Greenspan was the creature of decline in manufacturing. I think that there are two bigger themes here then the Fed mistakes/blunders as gross as they were:

        1. Many known empires experienced financization state after their zeniths (Spain, Dutch, Great Britain are notable examples). Have we seen the apex of American economic hegemony? Kevin Phillips in Wealth and Democracy makes a compelling case we did and that the United States mirrors many of the historical aspects of previous economic powers in decline. What is most startling, all of them experienced the phase in which dependence on financial institutions was at the top because of desperate attempts to replace declining manufacturing tax base. His comparison of 17th century Spanish, 18th century Dutch, 19th century British, and 20th century American economics is quite illuminating. Another interesting point that Mr. Phillips makes is that financization can be, and has been in the past, reversed. The cost is the empire.

        2. This might be not a new crisis, but a new phase of the same crisis after long vacations caused by collapse of the USSR. I think most readers here does not understand the magnitude and consequences of this historical event. And the key driver in both phases of the crises was/is the rise of energy prices and arrival of peak oil which made the oil-based economic model of the USA and other developed nations less sustainable and espoused other economic weaknesses. This is the crucial difference between the current crisis and 1930th. The oil dependence of the current manufacturing base prevents its rebuilding on a new platform due to the the shire size of the base, as was the case with coal dominated GB and actually there is no any viable new energy source for replacing oil in transport. So it might be a semi-couscous decision to prolong the agony by trying to convert the USA into another Switzerland on the strength of reserve currency and global military position in a hope the technological progress will bail us out as it did in the past. That line of thinking is connected to the previous argument about empires. The key mechanism here is that when you cannot invest profitably in manufacturing the money automatically start flowing into finance, speculation and oversees. It takes two to tango and the Congress was an accomplice in this historic transformation. In other words the titans of finance have gained tremendous power with direct government assistance, and first of all the assistance of the Fed and SEC. Stock market became holy under Chairman Greenspan if I remember correctly. Shredding of manufacturing and rise of speculation and predatory finance naturally gave a rise to the plutocracy, or more correctly to the changes in the composition of the top 1%.

        1. Richard

          I always have a hard time talking about the ‘decline’ of the US in general.

          If I have to talk about decline, I like to talk about it in the context of our regulators capacity for adapting to changes in the financial markets and continuing to enforce regulations which ensure that investors can make fully informed investment decisions.

          What has happened over the last decade plus is the decline of the financial market regulatory system.

          The agencies that are suppose to regulate are still there. The will to do so is not.

          Some say this is the result of regulatory capture. Others say it is the result of incompetence.

          I prefer that the Obama Administration made the conscious choice not to reintroduce regulatory will and reverse this decline.

          While the Administration and Congress provide lots of lip service to being serious about addressing this issue, it is all talk. There was no need for massive amounts of legislation. What was needed was an Administration that would champion the financial market regulatory system over the banks.

          1. kievite

            Some say this is the result of regulatory capture. Others say it is the result of incompetence..

            Oscar Wilde used to say that “The truth is rarely pure and never simple.” I would rule out incompetence, other then in in a form of “acquired institutional idiocy”. But when financial sector constitutes dominant part of S&P500 the term “regulatory capture” might mean two different things:

            – indirect finance oligarchy control of the government and its key institutions. For example, Treasury connections to GS or GS connections to Treasury due to the same players in different chairs in different stages on thier life( rotating doors policy). Depenence of politicians, especially democratic, on donations from Wall Street (look at president Obama track record in this area) is another powerful factor.

            – government voluntarily embrace of speculative finance (casino capitalism) as the saver of economic growth. That means that government itself has neither will, nor desire to regulate or interfere with financial sector activities (and actually promotes US financial sector activities oversees) it as it does not want to kill one of the few sources of economic growth left.

      3. Paul Repstock

        Yves; What ‘mistakes’ should the benbernanke confess to? It was no mistake, It’s “Da plan”, Baby. Stick to Da Plan, and all will come out right in the end. Half the world and most of the people will be bankrupt, but the US dollar will again be King, so we can do it all ove again. Yipee..:(

  11. pope john

    >Foreign investors’ hunger for safe US assets helped to
    >cause the 2007-2009 crisis by encouraging banks to turn
    >risky mortgages into AAA rated bonds, Ben Bernanke, US
    >Federal Reserve chairman, argued in Paris on Friday.

    US demand for Grade A heroin helped to cause their domestic drug epidemic, argued drug baron Mahmoud “Needles” Amjab from his yacht in the Maldives. “We’d rather grow food for our people, but we’re just cogs in the machine. And you know those crazy Americans, they love to self-medicate.”

    1. Pixy Dust

      pope john
      So accurate.

      The Fed puts the cart before the ox and blames cart when ox and cart hurl themselves over the cliff.

      In the aftermath, driver cowers behind boulder and makes up any excuses that might work.

      I sure feel bad for the ox though.

  12. Siggy

    China has a population of 2.3 billion. US .3 billion. Now, whose fault is that? Or, is that a fault?

    Now China pegged their currency to the US Dollar, after all it is the world’s reserve currency. Is that a fault or a wise move by China?

    I’d say a wise move because it locks the labor arbitrage that supports an export based economy. That is, it is the basis of a mercantilist economic philosophy. Now is that a fault; or, is a wise choice that will facilitate the conversion of an agrarian society into an industrial society?

    The Bernanke isn’t simply dissembling, he’s trying to hide the fact that the global credit crisis is rooted in our profligate creation of credit money which just coincidentally happens to be the world’s reserve currency.

      1. nonclassical

        When U.S. $$ is no longer “reserve currency”, better have your own grocery store=massive inflation

  13. JB in NYC

    Q: Why are people so hungry?

    A: Because there’s too much food.

    Q: What can be done about it?

    A: Give them more food.

    Q: Won’t that make them more hungry?

    A: Eventually they will starve.

  14. steve from virginia

    Maybe it’s me but the disconnect seems obvious: the Chinese built a large currency reserve for whatever reasons and are castigated now for having lent some of it to us.

    Now the multinationals have built large currency reserves for whatever reasons and are castigated for not lending at all.

    Seems to me the reserve issue — while important — is subordinate to other structural matters such as productivity and ROI. F/X reserve is a problem for China but the problem behind that problem is demographic imbalances just like our real problem is increased efficiency of resource waste with diminishing returns.

    To some degree Bernanke is right. I give him a lot of credit as a poker player with a handfuls of nothing who has managed to keep himself in the game with timely bluffs. He clearly understands that in the short term China must divest itself of its overload of dollars for China’s sake: recycling them within the Chinese underground economy is the #1 source of hyperinflation in China right now.

    This means China must try harder to do what Krugman et al accused her of doing to cause the crisis in the first place: to repatriate dollars to the US and do so in ways that keeps them here. This must also be done to maintain dollar exchange rate stability.

    What I can say about this is neither the US nor China are trying very hard to devise a way to do this. The backdrop is that the worth of the commodity dollar is different from the exchange value which is set by swapping dollars for oil. The dollar is a defacto hard currency backed by crude oil. This is and will be so as long as crude exporters accept dollars.

    There is also a lower bound to dollar value! Nominal price of crude @ some level destroys both physical demand and crude oil nominal value increasing dollar worth @ the same time.

    This currency bound makes Bernanke more or less irrelevant as millions of the world’s drivers make monetary policy just as they are not starting to make political waves.

    America needs to come up with more goods the Chinese will buy besides automobiles. China needs to think outside the Treasury/GSE/Sovereign Wealth Fund box. Both need to embrace energy conservation because relative energy shortages are stripping capital value from all economies. China cannot waste enough fuel and do so on a large enough scale to rebalance the world’s economy.

    Expecting them to do so is suicide. We are already in the middle of peak oil. Best we start behaving accordingly.

  15. nonclassical

    “..problem lies in “changes” within securities markets”..

    here here, Yves! Thanks again for your expose’…

    again, my question at this time ivolves all the “bad paper”
    in the hands of “investment banks”, who are sitting on mountains of cash and “paper debt”-how are they “removing it from their books”, and is the FED buying quantities of it, or only small portions, at U.S. taxpayer expense of course…

  16. Jim

    I wonder if China is able to print yuan and buy hard assets, in addition to all the dollars they need to spend? Maybe that is part of the reason the world is having so much inflation?

    Some reason I think china has a much bigger ponzi sceme going on than the US. It has to be more than just spending the dollar surplus.

    1. financial matters

      They are printing a lot of yuan to buy dollars…

      Michael Pettis 2/22/10

      “””When a Chinese producer sold goods to the US and took payment in US dollars, there was an unrealized economic loss equal to the undervaluation of the RMB. This unrealized loss was passed onto the PBoC when it bought the dollars from the exporter and paid RMB”””

      “””Revaluing the RMB, in other words, is important and significant because it represents a shift of wealth largely from the PBoC, exporters, and Chinese residents who have stashed away a lot of wealth in a foreign bank, in favor of the rest of the country. Since much of this shift of wealth benefits households at the expense of the state and manufacturers, one of the automatic consequence of a revaluation will be an increase in household wealth and, with it, household consumption. This is why revaluation is part of the rebalancing strategy – it shifts income to households and so increases household consumption.”””

  17. A H

    I don’t follow the argument in this post.

    Bernanke, “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”

    Where does he blame China?

    Yves, “At the same time, other data do lend support to the notion that the shadow banking system was the main culprit in the meltdown.”

    Yes, the problem was in the unregulated banking system. Isn’t this what Bernanke just said?

    Yves, “But of course, the Fed has to continue to assert that its super low rates really have no distorting effect on the wider world.”

    You can’t assert that capital inflows have no distorting effect on the wider world, as they both do their work through the treasuries market.

    1. Yves Smith Post author

      I was tempted to put the Flip Wilson video in. This is a “The Devil Made Me Do It” argument from the Fed on behalf of the banksters.

      The argument stil makes the “savings glut” inflows the primary cause. The bad regulations were a secondary factor.

      Per Ben, if you had not had savings glut inflows, there would have been no crisis. You also needed as he acknowledges, the crappy regulations.

      But, if you follow his logic, the savings flows were the driver and as he further says led all those really creative investment bankers to do their mischief and create all those toxic products.

      Notice how the fact that the Fed deliberately created negative interest rates and kept them there has nothing to do with his story. He’s trying to make the Chinese et al. the driver for the creation of phony AAA instruments, not the negative real yields.

  18. Robert Oak

    While everything here is basically true, I don’t think Bernanke in his speech blamed China for the financial crisis. I think he blamed China for the next crisis. He says it was mainly EU areas which bought derivatives AAA rated MBSes and the like. I also think QE2 is in part about attempting to force China to float more their Yuan due to it’s supposed downward pressure on the dollar along with other EEs and their peg, because QE2 will….increase commodity prices. So, on this one, I think the blame goes to Congress and this administration for refusing to every do anything about the trade deficit and currency manipulation. They do nothing, nada, zippo, cannot even say the word “massive trade deficit”.

    1. Paul Repstock

      Blaming anyone, be it China, Europe, or Martian graymen, for buying fraudulently constructed US financial paper is so typical. This is the type of thinking which allows wingnuts to blame rape victims,on the basis of being in the wrong place at the wrong time.

      I’m very sorry, but the chain of evidence suggests racketeering and conspiracy. All of the elements worked together to defraud ordinary Americans and the World at large, for the benifit of a very few who were ‘in the know’.

      1. Robert Oak

        He is not blaming the victim on MBS/CDO/CDS/SIV fiction, mathematical model fraud. He blamed the credit rating agencies and a lack of regulation but mentions derivative model “innovation” (read fraud with math), came into existance due to fast cheap “easy money” in part by the global hunt for (cough) safe assets with high returns.

        Myself, I’m referring to China, this speech, only. I have yet to see any financial armageddon prevention from buying up $1.2 trillion in MBS fictional caca (toxic assets) and wanted a nationalization plus some sort of resolution trust from the onset.

        Talking about real economy here, real GDP, real value of assets (not nominal) and real jobs…..w.r.t. China, their currency manipulation and capital flows and possibly motives for QE2 that are genuine (no Banksters involved).

        Just referring to this speech, this problem.

  19. Pixy Dust

    No one could have see this coming. Except everyone who was called Chicken Little for pointing it out. Willful amnesia by the Fed.

    Their congressional support party of “No Compromise!” is now telling public employees to compromise. More willful amnesia. Or maybe just class discrimination. Or maybe just promoting violation of contract law. Who knows with these guys in their free-market global netherworld existence.

    China held a gun to American corporations’ heads yelling “move your factories to China because you’ll maximize profits!” Sure, yeah. More amnesia. And productive, hard working Chinese saving too much are at fault? Yeah, that’s makes sense in their parallel universe. But really, these guys make it up as they go along.

    Let’s face it, those Federal Reserve Notes aren’t even pretty. Some socialist democratic countries like Canada have had colorful holographic currency for years. Now they have healthy economies and people. Maybe art is a good thing. But try telling these cheapskates that.

    So just what is it that working Americans and retirees are getting for their labor, professional skills and services? Huh? Huh? Long ago they were told “Don’t take any wooden nickels!” Well I’ll bet those wooden nickels would be worth more than a FRN right now. But let’s get real.They just want working people and retirees to work harder and pay more for their disintegrating notes and the corporate debt obligations tethered to them. That’s all.

    As I roll my pixy eyes, I’ll never cease being amused at human folly.

  20. Nelcisco

    This the same Ben Bernanke who said on 60 minutes about two months ago that the Fed isn’t printing money, which is obvious that it is.
    Trump for president, he’ll stop the bull shit with China.

  21. Bernanke Lobby Needs more $$$$$$

    “It’s democracy in action,” Boehner said in an impromptu, triumphal news conference off the House floor just past 9 p.m. Friday, when it was clear the bill would pass. “I’m proud of this vote,” he added.

    Congress, Obama brace for showdown as government shutdown looms..

    The neo-nazi’s versus the slow-plodding retarded democrats… a fight to the death over who can bring in the most lobby bucks for the next election … BOOOOO

  22. joe

    back in 2008, he said the financial crisis was “caused by a failure to regulate the capital coming into the country due to the trade deficit.” That was testimony before Congress. The transcript is online but can’t locate it now. Remember finding the statement interesting so I looked it up after hearing it to make sure I heard it right.

  23. Opinionated Bloviator

    Cool, I wonder if the imminent currency collapse will be blamed on the “space mutants”…

  24. Tom Hickey

    Fedspeak: Foreign investors’ hunger for safe US assets helped to cause the 2007-2009 crisis by encouraging banks to turn risky mortgages into AAA rated bonds, Ben Bernanke, US Federal Reserve chairman, argued in Paris on Friday.

    Translation: China’s saving the proceeds from its export to the US in dollars caused US banks to commit massive fraud.

    OMG, these people are at the top of the command economy?

  25. Psychoanalystus

    >> the Board of Governors and the New York Fed. Everyone there, or at least pretty much everyone who gets presented to the media, seems to have an advanced form of mental illness <<

    Schizophrenia would cover them nicely, as it produces *delusions* (thoughts and beliefs that aren’t anchored in reality), along with *hallucinations* (distorted perceptions such as seeing or hearing reality in a way very different from that of most other people’s).

    It seems there are some pretty sick people running the Fed these days…


  26. anne

    Well… I have just decided to bypass retailers and buy from China direct. Great websites, great customer service, don’t have to leave home and deal with some snotty sales assistant, and any store with a brain will do the same.

    People in Australia will buy online – but most stores won’t ship to us. So if you want your store to do well – get your online store organised and ship to Australia. Oh yes – you golf shops – get with it!! Online shopping in Australia is really crap (for the most part) – and we can bypass taxes for $1000 of goods – you have a growth industry there (hint! hint! golf products!)

    Look outside the box and start doing some innovative selling around the world (like China) and stop whinning about your economy. While oil is still relatively cheap – take advantage of it. (When oil goes crazy – different story!)


  27. Jason X. Ray

    I think the Fed is missing the big picture here. The Chinese (and Europeans and Japanese) are trying to figure out what to do with their excess dollars. These are the central banks I’m talking about, not private investors. They have been buying US securities, but I guess the banks figured out that they could also get in on the goods, except that unlike the US, which is sovereign and has good credit (for now), these banks had limited amounts of true AAA securities; so, they come up with a bunch a fake securities via a bubble (technology, housing, and infrastructure next) so they can sell to the Chinese.

    The missing element here is why there are so many foreign central banks holding trillions in US dollars or treasuries. It’s too simplistic to argue ‘trade deficit’ because it overlooks why there is a trade deficit. I think the answer lies in the removal of gold-backed dollars back in the early 70’s and the subsequent free-lunch the US has enjoyed, i.e. you take our dollars even though they are no longer backed by gold and we’ll ship our jobs overseas and import tons of your goods.

    This worked in the short-term, but now these countries are overwhelmed with a depreciating dollar, so they are taking losses and are trying to figure out what to do. Buy commodities in Africa, avoid a fight the US until their internal demand increases, etc…

    The fraudulent behavior of the banks is not excused by massive trade imbalances. They are two seperate issues. Prosecute fraudulent behavior and enforce the law and you’ll prevent future occurences. The trade imbalance is a different issue entirely.

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