"Low for Long" Policy Rates: Required for Global Economic Balance

This implied that a lot of risk-taking had to take place within this system since the mismatch between the assets the savers wanted to hold and those the borrowers issued could hardly have been wider: OPEC governments’ or Chinese private agents’ savings were – and still are – invested in local currency, mostly in short-term and credit-risk free forms, while the debt those savings financed was mainly long-term, full of credit risk, and denominated in Western currencies.

Despite this mismatch, the globalised financial system made the transfer of savings possible by taking on the risks the savers did not take. The central banks of the surplus countries by accumulating reserves took on the currency risk: they borrowed short-term in their own currency to lend, mostly short-term also, in foreign currency. They acted exactly as any foreign exchange market player does when taking a carry-trade position; the only difference was that they were not seeking to make a profit but to prevent their currency from appreciating.

The developed countries’ risk-takers took on the other risks: most of the credit-risk and maturity-transformation risk associated with the close to $4,000 billion of savings transferred from 1998 to 2007 between the emerging and the developed economies was taken on by the then risk-demanding global banking and “shadow banking” systems (see Adrian and Shin 2008).

When things turned sour, many participants were forced – or decided to – de-leverage and cut their risk-taking positions. But the mass and the nature of the risks to be carried were left largely unchanged: the Chinese and OPEC savers did not use much of their deposits to buy riskier assets and most of the borrowers did not pre-pay their debt.

This is where the lower short-term rates helped: they induced the stronger hands to take on the risks – whether credit, interest-rate or liquidity risks – that the weaker ones could not hold anymore.

Figure 1. Surplus emerging regions’ cumulated current-account balance and foreign exchange reserves
($ billions)

Note: The surplus Emerging regions consist of Asia (including the Newly Industrialised Countries), the Middle East and CIS. Sources: IMF, Thomson Datastream.