My Blog

April 6, 2008

As I have mentioned many times on this blog I am one of those who sees the great global imbalances of the present period as largely a consequence of a global savings glut, and as the biggest saver China is one of the most important players in this process.  As the system is currently undergoing a great deal of stress, it is going to be forced to change one way or the other, and there is no reason to believe this change must be benign, either for the world or for China.

How does the savings glut work?  In recent years we have seen a combination of a structural savings glut (mercantilist policies in a number of countries, especially in Asia, have included a rigid currency regime which exports high domestic savings) and a cyclical savings glut (commodity exporters, especially oil exporters, have seen export earnings grow much faster than imported consumption).  The combination of these two has resulted in a vast building up of foreign currency reserves among the saving countries.  The accumulation of foreign reserves is largely the consequence of accumulated trade surpluses, which because they imply total consumption that is less than total production, is the way in which domestic savings – forced or otherwise – is exported to the rest of the world.

In a system in which most countries of the world are tied together by trade and capital flow links, a savings glut of course does not mean that there has been a net increase in global savings.  It means that excess savings in one part of the system will automatically lead another part of the system into excess consumption so as to keep the overall system in balance.  With its very flexible financial system, its deep pockets, and the high credibility of its financial markets (not to mention the eagerness of many of its citizens to increase consumption), it is no surprise that the US economy and financial system have been the great equilibrator, running the significant trade deficits over the past several years needed to match the mercantilist and commodity-export-related surpluses of those countries with surplus savings.

But falling house prices and slowing demand are forcing the US to increase its own savings rate and so to reduce its ability to balance the excess savings abroad – we can see this by noting the rapidly declining US trade deficit.  A world of excess savings, in other words, is being forced into an adjustment in which the savings of its largest economy is set to grow – and it cannot be a good idea to increase savings in a world that is already experiencing a savings imbalance of this sort.  

Of course this adjustment cannot happen in a vacuum, and either the excess savers must cut savings and increase consumption, or another very large and credible economy must take up the US consumption slack.  The former certainly does not look like it is happening, and in fact it cannot happen as long as the excess-savers’ central banks keep intervening in the markets to keep their currency values low – their intervention is the very process by which high domestic savings are exported to the rest of the world.

So the latter is happening.  Europe is being forced to absorb an increasing share of the savings imbalances as the US reduces its share.  As I have often written here, I am very skeptical about whether Europe has the financial or economic flexibility, or the political flexibility for that matter, to replace the US as the great equilibrator.  But what is the alternative?  Even if global savings are eventually reduced by declining commodity prices, I see little evidence that the mercantilist savers are bringing their consumption levels up quickly enough to enable the global economy to regain some balance.

That suggests to me that at some point, perhaps quite soon, European trade imbalances will be high enough to cause significant problems at home.  Either Europe will react by trying to limit imports, or the euro will crash against the dollar, sending the role of equilibrator back to the US, or mercantilist savings will decline sharply and maybe even reverse.  As I see it these are the only three likely options to restore balance.  Neither is likely to be benign, but I guess the trick is to figure which of these is likely to be the less damaging and work towards that direction.

Meanwhile, and as an aside, Friday’s South China Morning Post has a story on QDIIs, a subject I have covered a lot in this blog because QDIIs act as a sort of proxy for speculative interest and they indicate one of the ways in which China is trying to diversity the exporting of its excess savings.  China’s QDII’s, which are funds specifically designed to allow Chinese investors to invest abroad (capital controls prevent foreigners from easily investing in China and Chinese from easily investing abroad) seem to be under continued pressure from disgruntled investors who are fed up with the losses they have taken.  An article titled “Mainland funds deny QDII cash pressure,” has this to say:

Beleaguered mainland fund managers have denied they are facing pressure from investors who want to cash out of their qualified domestic institutional investor products in Hong Kong.  The QDII scheme, which allows mainlanders to invest in foreign markets such as Hong Kong through approved funds, has come under close scrutiny after Minsheng Bank was forced to liquidate a product late last month after the net asset value fell by more than 50 per cent.

“We don't feel redemption pressure,” the article quotes Zhang Houqi, the deputy president of China Asset Management, as saying.  China Asset Management was one of the first mainland fund houses to embark on the QDII scheme.  The story goes on: “Analysts said QDII funds were being forced to increase their cash positions before potential heavy redemptions since the first batch of buyers wanted to cut losses.”

When managers are busy assuring the market that they don’t feel redemption pressure, that is usually a sign that there is redemption pressure, isn’t it?  After all it is not hard to think of the name of one or two banks who recently told us that they were not under liquidity pressure, only subsequently to find that indeed they were.

If there are sufficient redemptions in the next few weeks or months that force these funds to liquidate, I suppose we will see a jump in the already high monthly increases in central bank reserves, as money which previously left the country (and so relieved the PBoC from mopping it up) returns to the perceived safety and relative high returns of Chinese bank deposits.

Comments (8) for "The savings glut is looking ...

The question is whether the mercantilistic spirit is limited to government, or is rather a cultural behaviour. In the case of Japan one would be tempted to assume the latter. However, this tendency may change quickly as inflation destroys bank-deposits. And as people in general become less prone to save, this transforms to the national level (declining trade surplus). Whereas the savings of the Japanese could for a long time be absorbed by internatinal markets (USA), the Japanese felt that they have real value saved, whereas in fact the value of their surpluses accumulated over decades are effectively being inflated away by Bernanke. The Chinese private savers feel the inflation at home and should react to it by increasing consumption. The world cannot absorb Asia's savings glut any longer, but inflation turns up quickly enough to make savers understand that they really are not saving any value. As long as Japan was alone the process was slow, now it is quick. By Stefan, Tallinn - 4/6/2008 1:48 AM

Isn't the argument between a "savings glut" and a "consumption glut" a chicken/egg question--a Heller-esque Catch-22? Suggesting that the supply curve dominates the demand curve is a bit like a tail wagging the dog. "I snuffed 30 grams of cocaine, but it's the dealer's fault for making it so cheap." I cringe whenever I hear someone imply that America is doing the world a favor by running a whale of a deficit in the current account. Stephen Roach put it in the best terms: http://www.morganstanley.com/views/gef/archive/2007/20070604-Mon.html By matt - 4/6/2008 2:53 AM

Matt, I guess on my part I cringe when I hear someone imply that we need to figure out who to blame for the current imbalances. I am not sure that an attempt to try to understand the dynamics of these imbalances, which are huge and certainly need to be understood, is the same as deciding who is doing the world a favor and who is harming the world. The fact is that there is a huge amount of net savings within some countries and a huge amount of net consumption within others, and it is unlikely that both of these occurred simultaneously for purely domestic reasons to the extent that they coincidentally balanced perfectly (and balance they must). By the way, one of the reasons I am not looking to see who to blame is because, as I have said many times in this blog, in my opinion the current imbalance harms China more than it does the US for two reasons. First the very cheap RMB needed to maintain these mercantilist policies has resulted in an exchange of subsidized Chinese goods for overvalued US and European paper, which implies a wealth transfer from a very poor country to a group of very rich countries, and second because the US economy and financial system are far more flexible than those of China, the adjustment, when it comes, will be less painful for the US than for China. As for Roach's argument, that there is no global savings glut because there has been no net increase in global savings, I think it has been dismissed quite a long time ago as missing the point. A global savings glut never meant that net global savings would rise. In an open financial system increased savings in one part of the system necessarily will cause reduced savings in another part of the system. That is why the trade imbalance must occur. With the US as the "residual" economy, thanks to its huge size, openness and flexible financial system, a huge increase in savings in one part of the world necessarily will cause a reduction in US savings, along with a US current account deficit required to match the current account surpluses generated elsewhere as a consequence of the higher savings. Roach himself notes this but doesn’t follow through when he says: "According to IMF statistics, in 1996 the advanced countries of the developed world accounted for 78% of total global saving. By 2006, that share had fallen to 65%. Over the same decade, the developing world’s share of global saving has risen from 22% in 1996 to 36% in 2006. Put another way, the rich countries of the developed world – which made up 80% of world GDP in 1996 – accounted for just 43% of the cumulative increase in global saving over the past decade. By contrast, the poor countries of the developing world – which made up only 19% of world GDP in 1996 – accounted for fully 58% of the cumulative increase in global saving over the 1996 to 2006 period, or approximately three times their weight in the world economy." Such a rapid increase in developing world savings must be accompanied either by sharp slowdown in world consumption and growth or by a reduction in developed world savings. By the way some very smart people, with whom I think I am in agreement, now believe we are at risk of switching from the latter to the former as the US increases its savings rate. Stefan, I shy away from cultural arguments because they tend to “explain” what has happened in the past but historically they have never been much good at predicting future behavior (for example the US used to have a very high savings rate – could it have been cultural, the consequence of living in a frontier economy? – and then it switched to a low savings rate). I don’t know why the Japanese saved so much but in the case of the Chinese I suspect it has to do with very weak social safety nets, weak health care systems, and perhaps even political and social uncertainties. I don’t get the impression that rich, secure Chinese are any shyer about consumption than rich Americans or Europeans, although I admit I have never seen good numbers on the topic. I do agree with you that a period of inflation should reduce Chinese savings, at least at the household level, as the value of bank deposits is eroded. Ironically it might be inflation generated by the combination of high savings and mercantilist policies that may caused savings to decline. By Miochael Pettis - 4/6/2008 1:08 PM

Very interesting entry and comments. If the US is forced to increase its savings rate and so cannot act as a residual for Asian and OPEC savings, please explain how this could cause a reduction in global growth. By David Chen - 4/6/2008 1:21 PM

China saving investment gap will/is coming down fast due to following factor: some cyclical,some structural 1. Demographics, absolute labor forces will peak in 2010, the rural surplus labor at prime work age probabaly peak even earlier. 2. Rising government consumption,especially fiscal spending on public goods-education, medical, pension. If China growth further slowed and government aggressively push for fiscal expansion, this would lower surplus savings by a few PPT to GDP 3. Coprorate earnings growth probabaly peak out cyclically By isaac - 4/6/2008 4:00 PM

Isn't there no such thing as a savings glut, which implies that some people save too much? What happened was the central banks of the world created too much money. In the 1970s much of the money was consumed, but this time the Asian economies stuffed much of the inflated money supply into their reserves. By 8 - 4/6/2008 8:38 PM

David, a forced increase in US savings that isn't matched by a reduction elsewhere would mean that production exceededed consumption and the balancer would have to be an increase in investment. Since the increase in investment didn't come voluntarily, it would probably show up as an increase in inventory which, once it had reached certain levels, would entail a cut in production and worker layoffs. That would cause an even further reduction in global consumption. By Michael Pettis - 4/8/2008 12:39 PM

Ah, the lump of consumption theory! A savings glut in one area does not have to lead to increased consumption elsewhere; as you admit, it can lead to increased investment, and I would argue that the US would be wise to invest more in infrastucture, education etc rather than stockbuilding. I dare say that the GDP-weighted world population is ageing, in which case increased global saving is rational, and the problem is more an investment dearth than a savings glut. By RebelEconomist - 4/10/2008 5:57 AM