Yves here. It has been striking how little commentary a BIS paper by Claudio Borio and Piti Disyatat, "Global imbalances and the financial crisis: Link or no link?" has gotten in the econoblogosphere, at least relative to its importance.

As most readers probably know, Ben Bernanke has developed and promoted the thesis that the crisis was the result of a "global savings glut," which is shorthand for the Chinese are to blame for the US and other countries going on a primarily housing debt party. This theory has the convenient effect of exonerating the Fed. It has more than a few wee defects. As we noted in ECONNED:

   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.

Similarly, the global savings glut thesis cannot explain why banks created synthetic and hybrid CDOs (composed entirely or largely of credit default swaps, which means the AAA investors did not lay out cash for their position) which as we explained at some length, were the reason that supposedly dispersed risks in fact wound up concentrated in highly leveraged financial firms.

By contrast, the Borio/Disyatat paper tidily dispatches the savings glut story, and develops a more persuasive argument, that the crisis was due to what they call excess financial elasticity, which means it was way too able to accommodate bubbles.From Andrew Dittmer's translation of the paper from economese to English:

   The idea of "national savings" or "current account surplus" refers to the total amount of exports sold minus the total amount of imports sold (more or less). The "excess savings" theory holds that this excess had to have been financed somehow, and so presumably by countries in surplus, like China.

    However, for the US in 2010, the total amount of financial flows into the US was at least 60 times the current account deficit, counting only securities transactions. If this number were correct, then inflows would be 61 times the current account deficit, and outflows would be 60 times the current account deficit. The current account deficit is a drop in the bucket. Why would anyone assume it had anything to do with the picture at all?

    Moreover, if the "savings glut" theory was correct, we would expect there to be certain historical correlations between the following variables: (a) current account deficits of the US, (b) US and world long-term interest rates, (c) value of the US dollar, (d) the global savings rate, (e) world GDP. There aren't (see graphs). You would also expect credit crises to occur mainly in countries with current account deficits. They don't (6).

    Suppose we look at a more reasonable variables: gross capital flows. What do we learn about the causes of the crisis? Financial flows exploded from 1998 to 2007, expanding by a factor of four RELATIVE to world GDP, and then fell by 75% in 2008. The most important source of financial flows was Europe, dwarfing the contributions of Asia and the Middle East. The bulk of inflows originated in the private sector.

    If we look instead at foreign holdings of US securities, Europe is still dominant, but China and Japan are a little more prominent due to their large accumulations of foreign exchange reserves. Still, the Caribbean financial centers alone account for roughly the same proportion as either China or Japan). Other statistics provide a similar picture.

    So what caused the crisis? Clearly, the shadow banking system (mainly based around US and European financial institutions) succeeding in generating huge amounts of leverage and financing all by itself. Banks can expand credit independently of their reserve requirements) - the central bank's role is limited to setting short-term interest rates. European banks deliberately levered themselves up so they could take advantage of opportunities to use ABS in strategies, many of which were ultimately aimed at looting these same banks for the benefit of bank employees. These activities pushed long-term interest rates down. Short-term rates remained low because the Fed didn't raise them as long as inflation didn't appear to be an issue.

Keep in mind that this is not a mere aesthetic argument. If you believe the Bernanke argument, you'll argue that China needs to let the renminbi appreciate faster and provide more safety nets to its populace so they can shop almost as much as Americans do. If you accept the Borio/Disystat analysis, it means you need to regulate financial players and markets far more aggressively.