Chapter

The Bernanke Shock, 2008–12

Ronald I. McKinnon

in The Unloved Dollar Standard

Published in print December 2012 | ISBN: 9780199937004
Published online January 2013 | e-ISBN: 9780199980703 | DOI: http://dx.doi.org/10.1093/acprof:oso/9780199937004.003.0005
The Bernanke Shock, 2008–12

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The second avalanche of hot money outflows into emerging markets (EMs) began when the Fed reduced the interest rate on federal funds to virtually zero in December 2008—and other industrial countries followed suit. But the outbreak of a banking crisis in Europe with counterparty risk in the summer of 2011 led to a global tightening of bank credit on which “carry traders” depend for financing hot money flows and long positions in primary commodities. So they had to sell off their foreign exchange (mainly EM) assets and long positions in commodities to get back into dollars or yen. The result is that EM currencies and commodity prices—with the exception of the price of oil—fell and remained weak through December 2011, while the dollar strengthened and the Japanese government intervened several time in the last half of 2011 to prevent the yen from appreciating. This cycle illustrates one of the main themes of the book: wide interest rate differentials across currencies make the world monetary system much more fragile whatever the exchange rate regime.

Keywords: carry trades; banking crisis; hot money flows; commodity prices; international monetary reform

Chapter.  5116 words.  Illustrated.

Subjects: Financial Markets

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