Some in the emerging markets, most notably Brazil’s finance minister, has claimed the unorthodox easing by the Federal Reserve in particular, but other developed countries more generally, are fueling destabilizing capital inflows.
Bernanke delivered what appears to be the most comprehensive official response to such criticisms. He did acknowledge that international capital movement is volatile and that the accommodative monetary policy in US and other developed economies, shifted interest rate differentials more in favor of emerging markets and likely spurred private capital flows.
Yet he argued that capital inflows into emerging markets was driven by other considerations than just interest rate differentials. He specifically cited growth differentials as another factor that attracted flows to the emerging markets.
Bernanke also suggested the risk appetite of investors also shaped asset allocation decisions. Here he referred to the risk-on, risk-off matrix, often shifting in response to developments in Europe.
Bernanke bolstered his argument by citing research by the IMF and others that conclude that the monetary policies of the advanced economies was the dominant driver of private savings into the emerging markets. He noted that capital flows into emerging markets have slowed over the past couple of years even as monetary policy in the advanced economies continued to ease.
Many emerging market countries want to have currency valuations that economists argue are below fair value. Under-valued currencies attract some foreign capital flows anticipating currency appreciation. Moreover, Bernanke argued that the weak currency strategy of some developing countries left them vulnerable to inflation and more sensitive to the monetary policy of other countries.
He tried turning the tables. Brazil’s Finance Minister Mantega opined the US was selfish in pursuing monetary policy without taking into account the impact on others. In effect, and of course more diplomatically, Bernanke argued the real selfishness and beggar-thy-neighbor policies is not the easing by the US and other advanced economies, but by the reluctance of many emerging market countries to allow their currencies to appreciate. Allowing currency appreciation would increase the ability of emerging market countries to sustain growth while supporting the recovery in the advanced economies.
Lastly, Bernanke argued that even if there are costs for developing countries from the easy monetary policy of the US and other advance economies, there were also benefits. Part of the reason many developing countries are slowing is that their exports to the US and Europe have decelerated. Easier monetary policy is supportive of stronger economic growth and therefore of stronger demand. This should stimulate trade and underpin growth in emerging markets.
Distilled down to its essence, Bernanke’s argument is that monetary policy easing in the face of weak domestic economies is not the equivalent of a currency war. The fact that some emerging market countries insist on having under-valued currencies is part of a currency war and such policies can be associated with costs, such as greater sensitivity to inflation and limitations on the independence of their own monetary policy. There are various drivers of capital flows to emerging markets and those capital flow do not appear to be correlated with US or European monetary policies.
Bernanke’s argument should draw investors’ attention to those emerging market countries, like Mexico or Poland or Turkey, that typically do not resist currency appreciation. Lastly, in it interesting to note that the Brazilian real has been largely flat for the past three months, with the US dollar mostly confined to a BRL2.00-BRL2.05 trading range, seemingly unaffected by the Fed’s QE3+ or the ECB’s OMT.