Ben Bernanke's Glut Theory

Mark Thoma quotes the Economist on Ben Bernanke's "Glut Theory":

Economist's View: Is There a Global Saving Glut? If So, Will it Persist? : The Economist begins a series of articles on the global saving glut, global investment deficit, excess liquidity, and slow expected world growth hypotheses for the persistence of low long-term interest rates, with an emphasis on world saving patterns.... [The] introductory piece asks whether Ben Bernanke... was correct to deflect criticism over the current account deficit away from U.S. policymakers. It concludes that the U.S. must shoulder more responsibility for global imbalances than Bernanke's global saving glut hypothesis allows.... [and] that rebalancing will take time and invlolve risks to the world economy....

The great thrift shift, by Zanny Minton Beddoes, The Economist: On March 10th 2005, Ben Bernanke ... argued ... the world might be suffering from a “global saving glut”. The phrase immediately caught on.... His suggestion that the causes of global imbalances lie elsewhere conveniently deflects attention from monetary and fiscal decisions.... It suggests that Mr Greenspan's loose monetary policy and George Bush's tax cuts are not responsible for the imbalances in the world economy. That may seem a little self-serving, coming from a man who has subsequently moved from the Federal Reserve to become chairman of Mr Bush's Council of Economic Advisers.

Taken at face value, the notion of a global saving glut is not borne out by the facts. “Glut” suggests an unusually large amount, as in a summer glut of strawberries. In fact, figures published in the IMF's latest World Economic Outlook show that the rate of global saving as a proportion of global output, measured at market exchange rates, has mostly been heading downhill over the past 30 years....

But Mr Bernanke's argument is more subtle. He is saying that low interest rates imply too much saving relative to the amount people want to invest, and that the... discrepancy is concentrated outside America....

A weak appetite for investment might help explain low interest rates, but not the rising imbalances between America and the rest of the world. To understand those, two other factors have to be considered: differences in countries' economic structures, and differences in policymakers' reactions to the investment bust....

To protect exports and to build up vast war chests of reserves, many East Asian governments kept their currencies cheap for years after the financial crises. Firms stayed reluctant to invest, the saving surpluses remained large and the foreign-exchange reserves piled up... a good part of the rising imbalances of the past few years can be explained by a series of investment busts—-after periods of overinvestment—-and sharp differences in the way policymakers responded to them. But particularly since 2000, two other factors have also become important: more saving in China, and the soaring price of oil....

These shifts have... had important and unusual consequences.... One camp argues that the saving glut Mr Bernanke has identified is a temporary and largely cyclical phenomenon.... But a growing group of analysts now suggests that the “saving glut” is the result of long-term structural shifts and is likely to last for years, perhaps decades.... If the “saving glut” really is here to stay, there are two main possibilities. The first is that America's consumers will continue to barrel along and the imbalances between America and the rest of the world will increase further. The second is that Americans themselves will start saving again, perhaps because the housing market falters.... With the rest of the world still determined to save too, that would send the global economy into a tailspin....

Comments

[realist]

95% of american wage earners have had flat or lower wages over the last four years. american credit card debt is at an all time high. americans have never had less equity in thier homes. gasoline and natural gas are at an all time high. property taxes are going up to pay for federal tax shortfalls. all forms of insurance are going up. 50% of jobs created since 2001 are related to the real estate sector, so, if people stop buying houses, we should be back in a recession. pensions are tanking, and many hold mortgage backed securities. that won't bode well in a housing bust. so, don't count on, "americans will start saving again, perhaps because the housing market falters".

[Ralph]

The legendary Japanese savings rate is to some extent a myth. Since the eighties when the rate was something like 14% the Japanese savings rate has halved and continues to go down. So if some people think of Japan when they speak about a global glut this tendency may have to be revised.

[Skoobz]

Prof DeLong,
When the Japanese were forced to cut short term rates close to zero it never caused a sell off of their government debt and subsequent spike in interest rates. Why wasn't there a run on JGB's? Is this because the high private savings rate happily made it's way into government bonds as an alternative to stocks and real estate, with their declining values?

And/or does the ability of the Japanese government to keep long term rates low have anything to do with the fact that the Yen is not the world's reserve currency?

[Arun Khanna]

If India liberalized its economy fully and lowered tariffs, it's capital needs for infrastructure development and FDI can soak up a big part of the worldwide savings glut.
U.S. can continue to act as the 'debtor of first resort' for central banks and investors worldwide for now. The key issue is whether U.S. dollar's role as the reserve currency for the world can be taken up by a credible alternative currency in the future, perhaps by the Euro. If yes, then U.S. cannot continue as a debtor nation for too long.

[nate]

I am a total novice at this and could be wrong...

If you see "OPEC" at site below, it is going down over recent time (OPEC is buying less U.S. Treasuries). Where is it going? Maybe the Saudi Stock Market? Is there a way to know?

http://www.treas.gov/tic/mfh.txt

http://www.ameinfo.com/financial_markets/Saudi_Arabia/

Everyone always wants to be subtle...

[realist]

six arab countries, including saudi arabia, pulled much of their money out of the u.s. market after 9/11. since that time, our s&p is up about 16%. the stockmarkets in those six arab oil producing nations is up about 400%. looks like they found a better place to invest money.

[nate]

the U.S. Russell 2000 is up around 50% since 9/11

admittedly not 400%...

[hans Suter]

Dr. Kurt Richebächer in the The Daily Reckoning:

In his testimony to Congress on July 20, 2005, Mr. Greenspan declared it quite likely that the world is currently experiencing a global savings glut. Agreeing with Ben Bernanke, he mentioned this glut as one of the factors behind the so-called interest conundrum, i.e., declining long-term rates despite rising short-term rates.

Having read a lot from the Fed’s luminaries, their inability to distinguish between rampant global credit excess and a global savings glut does not surprise us. In this view, the Federal Reserve has come to the rescue of a world where excessive saving is threatening depression by eliminating savings.

Attracted by superior rates of return on U.S. assets, investors around the world have been scrambling to pour their excessive savings into direct investments, stocks, bonds and real estate in the United States, in this way financing the resulting huge U.S. trade deficit.

While this explanation may seem to make sense, there is one big snag: Not one word of it is true. First of all, in reality, private foreign investors have drastically curbed their investments in the United States. According to the Bank for International Settlement - the international organization of the world’s central banks - Asian central banks financed 75% of the U.S. current account deficit in 2004.

First, private capital flows into the United States have slumped. Without the massive interventions by the Asian central banks, the dollar would have collapsed long ago.

Second, the dollars with which these central banks have been buying U.S. Treasury and agency bonds have definitely nothing to do with Asian savings. Evidently, the central banks are recycling the dollars, no more, no less, which they receive from U.S. trade and capital flows. These dollars have come into the central banks’ possession through their interventions in the currency markets, to prevent a rise of their currencies against the dollar.

To speak of a global savings glut as a possible cause of the surprisingly low U.S. long rates in the face of these blatant facts is truly the height of insolence and absurdity. That this opinion comes from the leading figures of the Federal Reserve is more than shocking.

True, Asian countries have very high savings rates. For China, it is reported to be as high as 45% of disposable income. But this does not necessarily imply an existing savings surplus be lent to America. The bulk of available savings in China domestically is locked up in an even higher domestic investment ratio.

Looking at the global financial system, a straightforward fact to see is that central banks have been amassing foreign exchange reserves at an accelerating pace since the early 1970s. Rising in several large waves, their main source is plainly the soaring U.S. trade deficits.

Having no use for dollars in general, the first dollar recipients in the surplus countries sell them to their banks against their own currencies. These banks, in turn, found ready dollar buyers in firms and investors around the world, wanting to acquire direct investments or other assets in the United States, at least until 2000. Since then, though, capital inflows on private accounts into the United States have drastically receded, while U.S. trade deficits have exploded. In order to prevent a rise of their currencies against the dollar, central banks had to step in as buyers of last resort.

Apparently, it is not widely realized that this big shift in dollar recycling from private accounts to central banks essentially has far-reaching monetary implications for the participating countries and even for the world economy and world financial markets. Buying dollars, the central banks credit the commercial banks in their country with interest-free deposits.

Now, the critical point to see is that the banks, on their part, regard these deposits as their liquid reserves to be used for profitable lending or investment. Inundated with liquid reserves by the dollar buying of their central bank, the commercial banks in these countries embark on faster credit expansion. Shifting the rising surplus of liquid reserves between them, they create credit for consumers, businesses and speculators many times the amount of the liquidity injection by the central banks.

Our focus in particular is on China. As in the United States, the resulting credit deluge is boosting components out of proportion to the whole economy. In China, however, the specific components are real estate and manufacturing investment, while in the United States, it is consumer-spending excess.

What the Asian central banks truly recycle is the U.S. credit excess. But in flooding their banking system through the dollar purchases with liquid reserves, they transplant the virus of credit excess to their own economies. For U.S. policymakers and economists, this is a reasonable and sustainable division of labor. The U.S. economy runs on wealth creation through asset inflation with a high rate of consumption, while China and Asia run on wealth creation through saving and investment with a high rate of investment.

We are fearful of this development, because it affects more or less all industrialized countries with high wage levels. In this way, overconsuming America is force-feeding the rapid mutation of China’s backward economy into a first-class manufacturing power. When China’s credit and investment boom started, in 2000-01, its central bank had foreign exchange reserves in the amount of $165.4 billion. Today, they exceed $700 billion.

We are wondering what is worse for the whole world, China’s further rapid manufacturing growth or a disastrous hard landing. Observing the same monetary and economic follies as in the late 1980s in Japan, we consider the second possibility highly probable.

A persistent, sharp slowdown in China’s imports strikes us as ominous. The general comforting explanation is inventory liquidation. But how to explain, then, the continuous oil and commodity boom? We suspect speculation far more than economic growth as the reason.

With all the talk about a savings glut, we feel obliged to make some remarks about the subject. First, please take another look at the Wicksell quote on the first page, stating, “The supply of real capital is limited by pure physical conditions, while the supply of money is in theory unlimited.” “Supply of real capital” is actually a synonym for available savings.

At an international conference in 1953 about savings in the modern economy, with many heavyweights in economics in attendance, the famous former chief economist of the Fed E.A. Goldenweiser gave a rare precise definition of saving. He said: “Saving means the withdrawal of sufficient resources from the production of consumption and services to have enough for maintenance, expansion and improvement of the plant.” Then, he complained, “that ever since Wesley Mitchell’s Business Cycles there has been a tendency to concentrate too much on the monetary expression of economic developments, and it has become reactionary to think in physical terms.”

From the macro perspective, “saving” provides the physical resources for the production of capital goods in that consumers abstain with part of their income from consumption. Of course, this also involves money flows, but saving’s decisive distinguishing feature is the partial abstention from current consumption to make real resources available for the production of capital goods.

It is ludicrous, therefore, when American economists claim that rising asset prices, increasing consumption, should by counted as saving. When we read decades ago that Mr. Greenspan, long before he became Fed chairman, had expressed precisely this view, he was once and for all finished for us as a serious economist.

The world economy seems to be flooded with liquidity. But there are two diametrically different kinds of liquidity: earned liquidity and borrowed liquidity. The former comes from surplus income or savings; the latter comes from credit and debt creation.

In a country with virtually zero savings like the United States, any liquidity essentially arises from debt creation. This is really fake liquidity depending on permanent, prodigious borrowing facilities, presently the housing bubble. Once this bubble evaporates or bursts, the U.S. economy loses its chief liquidity source - with disastrous effects on asset prices.

The crucial question concerning the U.S. economy is whether it is slowing or accelerating. As explained in detail, we see a lot of fudge in the recent economic data. Our main critical consideration is that a self-sustaining recovery would absolutely require a strong rebound in business investment. But that is not in sight. On the other hand, the turnaround in the housing bubble is only a question of time. A fairly short time, we think.

The consensus expects that the U.S. economy has the "soft spot" behind it and will surprise positively. We expect shocking economic weakness. All asset prices, depending on carry trade, are in danger, including bonds.

[bakho]

The corollary to saving too much is spending too little. Why do citizens of these countries consume too little? Could low wages and concentration of wealth be associated with saving too much and spending too little? By just focusing on one component (savings), a lot of odd explanations cannot be eliminated. Of course, that is a good method to deflect political problems that don’t fit the master ideology.

[gcs]

national savings need at least a three way carve up

1) households
2)firms
and
3) gubmints
take japan :

number 1 is on a fairly
even long rundown track

and three has always borrowed like wimpy

but the pivot that made before 92and after look so
diff,,,,number two has gone from borrow to save ...big time

similarly

uncle sam as our number three has been really comping for
number two going on a savings bender

[dave]

Let me ask you guys who seem to be very up to date on current economic issues, globally and in the USA:

Where do you put your money?

I'm 27, bought a house with a 30year 6%fixed rate mortgage, have a small traditional IRA from a previous company and a small 401k with my current one.

I live in New Jersey and am probably going to invest some income in NJ specific municipal bonds.

Any advice, besides to move?