By Steven K. Beckner

PARIS (MNI) – Federal Reserve Chairman Ben Bernanke warned Friday
that capital inflows into emerging market countries are “imposing
notable challenges” and called for collective efforts to create more
balanced and sustainable global economic growth ahead of a meeting of
Group of 20 finance ministers and central bankers who will have such a
rebalancing at the center of their agenda.

Bernanke rejected charges that the Fed’s accommodative monetary
policy is causing hot money flows into emerging markets and creating
negative spillovers and instead put the onus on those countries to
adjust their own policies, especially their exchange rate policies.

At the same time, though, he acknowledged that the United States
and other advanced countries need to increase their national savings
rates by reducing deficit spending.

Bernanke, in remarks prepared for a conference on global financial
stability sponsored by the Bank of France, blamed large trade imbalances
on a “two-speed” global recovery and said the world’s policymakers need
to “reshape the international monetary system” to achieve more
“balanced” and “sustainable” growth.

That is precisely what Bernanke, Treasury Secretary Timothy
Geithner and their counterparts are scheduled to discuss at two days of
meetings here. And the Bank of France conference was obviously timed to
put forth the views of the world’s leading central bankers on that
issue.

Appearing with Bernanke was Bank of France Governor Christian
Noyer, Bank of England Governor Mervyn King, Bank of Japan Governor
Masaaki Shirakawa, European Central Bank President Jean-Claude Trichet
and Bank of China Governor Zhou Xiaochuan.

Although Bernanke did not devote much time to U.S. monetary policy,
his remarks amounted to a tacit defence of Fed accommodation.

“The global financial crisis is receding, but capital flows are
once again posing some notable challenges for international
macroeconomic and financial stability,” he said. “These capital flows
reflect in part the continued two-speed nature of the global recovery,
as in the emerging markets is far outstripping growth in the advanced
economies.”

“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,” Bernanke noted, adding,
“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 flows 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,” he
observed.

But Bernanke vigorously countered charges that monetary
accommodation in the “advanced countries” such as the U.S. is solely or
even mostly responsible for causing such “negative spillovers.” As he
has before, Bernanke echoed Geithner in placing much of the blame on
rigid exchange rate policies in some emerging market nations. Although
he did not mention G20 member China by name, there was little doubt that
he had that country in mind.

The Fed chief, whose speech was accompanied by a paper on capital
flows co-authored by three Fed economists, conceded that “policymakers
in the emerging markets clearly face important challenges,” but said
their concerns “should be put into perspective.”

“First, these capital flows have been driven by many factors,
including expectations of more-rapid growth and thus higher investment
returns in the emerging market economies than in the advanced
economies,” he said. “Indeed, recent data suggest that the aggregate
flows to emerging markets are not out of line with longer-term trends.”

“Second … emerging market economies have a strong interest in a
continued economic recovery in the advanced economies, which
accommodative monetary policies in the advanced economies are intended
to promote,” Bernanke said.

“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
adjustment, monetary and fiscal policies, and macroprudential measures,”
he continued.

“Finally, it should be borne in mind that spillovers can go both
ways,” he went on. “For example, resurgent demand in the emerging
markets has contributed significantly to the sharp recent run-up in
global commodity prices.”

“More generally, the maintenance of undervalued currencies by some
countries has contributed to a pattern of global spending that is
unbalanced and unsustainable,” Bernanke added. “Such imbalances include
those not only between emerging markets and advanced economies, but also
among the emerging market economies themselves, as those countries that
have allowed their exchange rates to be determined primarily by market
forces have seen their competitiveness erode relative to countries that
have intervened more aggressively in foreign exchange markets.”

Bernanke concluded with the same kind of exhortation that has been
included in past G20 statements and, indeed, G7 communiques before them.

“Our collective challenge is to reshape the international monetary
system to foster strong, sustainable growth and improve economic
outcomes for all nations,” he said. “Working together, we need to
clarify and strengthen the rules of the game, with an eye toward
creating an international system that more effectively supports the
simultaneous pursuit of internal and external balance.”

“To achieve a more balanced international system over time,
countries with excessive and unsustainable trade surpluses will need to
allow their exchange rates to better reflect market fundamentals and
increase their efforts to substitute domestic demand for exports,” he
said.

“At the same time, countries with large, persistent trade deficits
must find ways to increase national saving, including putting fiscal
policies on a more sustainable trajectory,” he continued. “In addition,
to bolster our individual and collective ability to manage and
productively invest capital inflows, we must continue to increase the
efficiency, transparency, and resiliency of our national financial
systems and to strengthen financial regulation and oversight.”

Echoing his familiar “savings glut” theory for why U.S. long-term
interest rates were so low in the run-up to the housing boom and bust,
said that “over the past 15 years or so … many emerging market
economies have run large, sustained current account surpluses and thus
have become exporters of capital to the advanced economies, especially
the United States. These inflows exacerbated the U.S. current account
deficit and were also a factor pushing U.S. and global longer-term
interest rates below levels suggested by expected short-term rates and
other macroeconomic fundamentals.”

Bernanke’s paper finds that Asian and Middle Eastern countries, as
well as European investors, invested heavily in the United States
because of “a strong preference for very safe and liquid U.S. assets,”
especially Treasury and agency securities.

“The preferences of foreign investors for highly rated U.S. assets,
together with similar preferences by many domestic investors, had a
number of implications, including for the relative yields on such
assets,” he said.

“Importantly, though, the preference by so many investors for
perceived safety created strong incentives for U.S. financial engineers
to develop investment products that ‘transformed’ risky loans into
highly rated securities,” he continued. “Financial engineering
resulted in the overwhelming share of private-label mortgage-related
securities being rated AAA.”

But capital inflows did not in and of themselves lead to the
financial crisis, according to Bernanke. He said “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.”

Leaving out any role for the Fed’s easy money policies of 2003-04,
Bernanke blamed other government policies and private industry
practices, including “misaligned incentives in mortgage origination,
underwriting, and securitization; risk-management deficiencies among
financial institutions; conflicts of interest at credit rating agencies;
weaknesses in the capitalization and incentive structures of the
government-sponsored enterprises; gaps and weaknesses in the financial
regulatory structure; and supervisory failures.”

Nevertheless, he drew lessons from the crisis for capital inflows:
“In reflecting on this experience, I have gained increased appreciation
for the challenges faced by policymakers in emerging market economies
who have had to manage large and sometimes volatile capital inflows for
the past several decades.”

** Market News International **

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