For several months now, learned discussions about the international financial system have been dominated by the theme of global savings glut. As formulated in several speeches in Spring 2005 by Ben
Bernanke, ex-Governor of Federal Reserve and current chairman of Council of Economic Advisers, “(…)over the past decade a combination of diverse forces has created a significant increase in the global supply of saving--a global saving glut--which helps to explain both the increase in the U.S. current account deficit and the relatively low level of long-term real interest rates in the world today.” The theme has been extensively debated by international finance official pundits and assorted analysts and academics. It has now practically become the conventional wisdom and provided the conceptual canvas for the discussions at 2005 Annual meeting of the World Bank and the IMF. IMF dedicated to the topic a full chapter of its authoritative
World Economic Outlook. The widely read survey of the world economy
published at the time of the meeting by the thinking people’s weekly, the Economist, dissects in erudite detail “the great thrift shift.”
Quite a shift, indeed. In politics and in Internet time, ten years is an eternity but some of us old timers do remember that just ten years ago, the dominant theme was that of global savings shortage. In 1995, the same IMF World Economic Outlook stated that the question of whether global savings will be sufficient to fund growing world economy was becoming paramount as the pressure on savings was increasing. World Bank has extensively researched the prospects of global savings shortage and warned that without fiscal consolidation, especially the reform of social security systems, “global real interest rates could rise well above already high recent levels of about 4 percent.” In any case, Zia Qureshi, World Bank economist,
warned the same year that “[the] international capital markets will tend to remain tight in the coming decade.” Based on those imposing sources, John Makin, economic guru of the conservative US think-tank, American Enterprise Institute, flatly
asserted in 1995 that the US cannot afford a 4% growth.
His fears were unwarranted. US economy continued to grown quickly for the rest of the decade. Not only global capital shortage did not materialize but capital markets actually became looser and looser and were able to accommodate major infusion of funds in all markets segments: equities, bonds, emerging markets as well absorb such major shocks as the LTCM debacle in 1998 and Nasdaq meltdown in 2000-2001.
What happened? According to the explanation offered by official sources, such as Prof. Dr Hermann Remsperger, Member of the Board of the Deutsche Bundesbank, in 1999
speech to central bankers, the savings shortage was averted by the sagacious action of governments, which tightened their fiscal belts, both in the US and in the EU. With all due respect to Herr Professor, this explanation is far from satisfactory. For one thing, the fiscal discipline did not last and in the early 2000s both EU and US governments returned to their usual profligacy. Yet, it was precisely at the time where their deficits were reaching record levels that the long-dated government bonds issued by the same governments were increasing in price as their yields declined dramatically. It is these low interest rates (both real and nominal) that constitute the best known symptom of the savings glut.
With fiscal rectitude no longer operative as explanation, learned analysts look for an alternative. Ms. Beddoe, in the Economist’ survey of the thrift shift, provides an impressive example of such explanation, taking the reader on a whirlwind global tour of major economies. Yet for all its brilliance and agility, the demonstration is utterly unconvincing, because self-defeating. The situation among countries surveyed varies so much that it is difficult to draw any general conclusions. If it is true that the fiscal profligacy of central government causes both low savings and current account deficit –the conventional charge against the US - then Japan, where the budget deficit and government debt have been considerably higher in the last ten years than either in the States or in the EU, should have seen a reversal of its long-standing current account surplus. Yet it did not. At least in Japan, higher government debt led to lower savings. In Europe on the other hand, increased budget deficit entailed higher savings (“Ricardian equivalence”). Two do not a trend make but they do suffice to seed doubts about a existence of casual links between savings rate on the one hand and the government budget and current account balances on the other.
The problem goes considerably deeper. What is in question is the very notion of savings and its measurement. Basically, savings are defined by the prevailing economic theory as a residual, the difference between income and consumption. These savings are then channeled, more or less efficiently, by financial intermediaries into investments. This definition and associated measurements raises a whole raft of questions, most important of which is that of reality check. It is a long-standing practice of economic theory to simplify reality on order to develop meaningful generalisations. Nevertheless, such simplification should not be carried out ad absurdum into the fantasy land. Unrealistic assumptions combined with powerful statistical techniques and data-crunching computers create what system analysts call GIGO: garbage in garbage out. Conventional definition of savings may have been applicable in the era, when most people worked in large factories and offices, being paid salaries on a regular basis, when financial institutions were pure intermediaries between lenders and borrowers, and when distinction between current expenditure (or consumption) and investment was easy to make. However today, a large and ever growing proportion of the population are, in Charles Handy’s words, portfolio workers, gaining their revenues from various sources and with varying degrees of regularity. On the expenditure side, they increasingly spend their earnings on intangible artifacts and services for which they may or may not pay directly. In a similar vein, standard measurements of trade, current and capital flows and balances assume that trade of goods is the primary determinant of balances, that firms are basically national and financial institutions are pure intermediaries and agents of other firms. These assumptions result in two widely shared myths about global macro-economy: the myth of low saving rate of US households and the myth of unsustainable current account deficit. I am using the word myth, rather than say a statistical illusion, advisedly in a sense of a deeply held belief having only a tenuous link with facts and reality. Let's take the two myths in turn.
According to the official data, US savings rate, never really impressive compared to say Japan's or Belgium’s, has actually turned negative. Thus, US consumer is not merely profligate but truly dissolute. This view is so widespread that few people question how does it square with the massive asset accumulation by US households. Not only the US boasts the largest equity market in the world but it also has by far the highest rate of direct individual participation in these markets. US mutual funds and other forms of collective savings dwarf those of EU (despite EU having a larger population). Nearly half of the US workers own an investment retirement account. And the level of home ownership in the US, which is as good indicator of the propensity to accumulate durable assets, is – at about 60% of all households - quite comparable to that of Japan, Germany or France. So, it would appear that while seemingly behaving like reckless squanderers, US households did actually manage to accumulate sizeable assets, a large share of which have been highly productive. This apparent paradox can be easily explained by what US households did not do: they did not put their money into well-defined savings accounts held by the banks the way their Japanese and German counterparts do. As the Economist acknowledged in its saving shift survey, the measured drop in the US savings rate can be almost entirely explained by a combination of financial innovation and capital gains, the first making the second possible. Financial innovation means that household money is no longer channeled primarily through banks but through other intermediaries. This makes the flows much more difficult to measure. But, as we live in a “measure or die” world, there is a tendency to rely on old measurements, even if they are not just inaccurate but squarely misleading. Zvi Griliches, Harvard professor, who died in 1999 and who was an authority on economic measurement, wrote in 1995 that the share of economy measured with a degree of accuracy by official statistics has fallen from 50% to 30% between 1947 and 1990. Weaknesses are the most pronounced in the areas which are most dynamic and trend setting such as financial services or information technology.
[1] Thus, it is safe to assume that the share of economic blank sports has further increased.
One often heard argument in support of the “weakness” of US savings is the large and growing current account deficit. After all, if the domestic savings were large enough, it would not be necessary to import such large amounts of capital. Those who read this blog so far, can anticipate my view on current account “deficit”: a statistical illusion, due to faulty measurement data. In this case, measurement problems are even more serious and far-reaching. It is not only that financial flows dwarf traditional trade flows (by a factor of hundred) and are therefore largely independent of those, or that financial flows are heterogeneous yet so fluid and interconnected that it is quite difficult to dissociate speculative and parasitic movements of short-term hot money from the productive and constructive long-term direct investment, or that financial innovations make them elusive and constantly evolving. It is also that financial institutions that handle the financial flows are more than mere intermediaries. They are global giants, masters of the universe, who manage these flows in function of their strategies of return-on-assets optimisation. Add to that the fact that some of the multinational businesses, which are classified as non-financial (such as GE, IBM or Microsoft) are very large financial players (for instance, GE is the largest capital equipment financier in the world). Thus broadly defined US financial institutions are simultaneously large exporters and importers of capital. They are the dominant players, both quantitatively and qualitatively, in the largest financial centre outside the US, the city of London, and play an active role in all other nodes of geofinance, Paris, Frankfort, Tokyo, Singapore, Hong Kong and so on. They handle the surpluses of oil-producing countries, advise central banks of large product exporters and steer less-visible yet huge and growing flows of private investments. Whether, as a result of their interaction, US current account shows a deficit or a surplus is incidental and largely irrelevant.
For more than two decades now, the widely and loudly proclaimed conventional wisdom has been that the financial situation of the US is not sustainable and the painful day of reckoning is near. Global trade was supposed to grind to a halt, global depression set in, followed or succeeded by hyperinflation. Despite a succession of crises, apocalyptic scenarios did not come to pass.
[2] The main reason for this is that they reflected a flawed view of the economic reality. US dollar today bears no resemblance to the UK pound in the thirties, any more that the global economy today resembles the world economy of the thirties. Thus the dollar is not condemned to a secular decline and, as hedge funds know only too well, its value is as likely to go up as to go down. There is no more savings “glut” than there was a savings “crunch” ten years ago. US consumer behaves more rationally as his counterparts in other parts of the world. In any case, he appears better prepared, both financially and conceptually, to handle the challenge of globalisation, demographic imbalances and misguided public policies. The true savings/investment policy challenges are not in the US but in Japan and Germany:
· How to introduce financial innovation and mobilise huge mountains of unproductive cash lying in postal savings and in landbanks?
· How to give Japanese and German consumer greater confidence in the future?
The persistence of the global savings discussions demonstrates that official guardians of the global monetary system and media pundits (often interchangeable) remain as clueless as they were in the 1980s and 1990s. The true enigma of savings discussions is how so many bright and well-informed people can get so wrong for so long. Of course, this is not the case for everybody. Alan Greenspan, for those who take the trouble to read his intricate writings, understands well the dynamics of the new economy and its interactions with global financial systems, and acted on the basis of his understanding. Unfortunately, he is leaving early next year. His departure raises a real risk of misguided policies and, more than the imaginary threat of inflation, may explain the recent nervousness of financial markets.
