Bernanke’s global savings glut

Bernanke’s global savings glut argument is quite subtle, more subtle than I perhaps have recognized in the past. Bernanke’s argument goes beyond the "US current account deficits don’t matter since there is a global savings glut" headline that I occasionally push.

Bernanke takes his argument that there is a global savings glut to its logical conclusion. He argues that without a federal budget deficit, the global savings surplus that was invested in US government debt over the past few years would instead have been invested in other US assets. Real interest rates would be even lower, housing prices would be higher, investment in housing would be higher, and consumption in the US would be even stronger. As a result, the US current account deficit would not be much different.

The weakening of new capital investment after the drop in equity prices did not much change the net effect of the global saving glut on the U.S. current account. The transmission mechanism changed, however, as low real interest rates rather than high stock prices became a principal cause of lower U.S. saving. In particular, during the past few years, the key asset-price effects of the global saving glut appear to have occurred in the market for residential investment, as low mortgage rates have supported record levels of home construction and strong gains in housing prices. Indeed, increases in home values, together with a stock-market recovery that began in 2003, have recently returned the wealth-to-income ratio of U.S. households to 5.4, not far from its peak value of 6.2 in 1999 and above its long-run (1960-2003) average of 4.8. The expansion of U.S. housing wealth, much of it easily accessible to households through cash-out refinancing and home equity lines of credit, has kept the U.S. national saving rate low--and indeed, together with the significant worsening of the federal budget outlook, helped to drive it lower. As U.S. business investment has recently begun a cyclical recovery while residential investment has remained strong, the domestic saving shortfall has continued to widen, implying a rise in the current account deficit and increasing dependence of the United States on capital inflows.

According to the story I have sketched thus far, events outside U.S. borders--such as the financial crises that induced emerging-market countries to switch from being international borrowers to international lenders--have played an important role in the evolution of the U.S. current account deficit, with transmission occurring primarily through endogenous changes in equity values, house prices, real interest rates, and the exchange value of the dollar.

Emphasis added.

Note that the US budget deficit did not play a role in Bernanke’s presentation. To put it a bit crudely, Bernanke’s argument implies that the drain on global savings created by the budget deficit is all that has stood between the United States and an even bigger housing boom.

Implicitly, Bernanke assumes that any fall in the US budget deficit would have a big impact on world interest rates and, in turn falls in the world interest rate would have a big impact on US investment and on US consumption -- helped along by things like interest-only mortgages. In formal terms, the elasticities need to be large.

Obviously, there is a bit more to the story. At some point, the global savings glut flowing into the US would have pushed down US interest rates to the point where investments outside the US started to look attractive -- or reduced the incentive for foreigners to save. The overall impact would not have just been higher home prices, more investment in new homes, stronger consumption, lower US savings and an unchanged US current account deficit. Investment outside the US would have picked up too, global savings might be a bit lower, and the US current account deficit might have shrunk just a bit.

Plausible or not, Bernanke tells a full story -- he identifies the channels through which the global savings glut would have, in his view, generated large US current account deficits over the past few years even in the absence of large US fiscal deficits. The US is simply finding various ways to mop up the world’s spare savings - and thus is doing the world a service. Compare that with say Krugman, who accuses other countries of enabling bad policies here in the US: "Over the last few years China, for its own reasons, has acted as an enabler both of U.S. fiscal irresponsibility and of a return to Nasdaq-style speculative mania, this time in the housing market. Now the U.S. government is finally admitting that there’s a problem - but it’s asserting that the problem is China’s, not ours."

(Continues)

Bernanke -- correctly -- identifies the origins of the world’s excess savings in the world’s emerging economies. Europe may be stagnant, but European savings more or less match European investment, particularly if you take Eastern Europe into account. Parts of East Asia may be booming, but the booming bits of East Asia (China) still save more that they invest. In the rest of East Asia, there is not so much of a savings glut as an investment dearth; investment fell after the 97-98 crisis, and savings has yet to fall commensurately. The real beneficiaries of China’s boom -- the world’s commodity exporters -- have generally tended to save rather than spend their windfall.

I still don’t find Bernanke’s analysis completely persuasive, for the following reasons:

1) Attributing current "excess" savings in Asia to the legacy of the 97-98 crisis seems strange. First, the timing is off. Asian reserve accumulation surged in 2002, then surged some more in 2003, then some more in 2004 and (leaving Japan aside) looks to surge even more in 2005. I understand that emerging Asia needed to rebuild reserves/ pay down debt in the period immediately after its crisis. That explains Asia’s 2000 reserve buildup. But is the lagged impact of the crisis still driving the 2005 reserve buildup? After all, the IMF thinks Asia already has reserves to protect against everything short of the apocalypse, and Korea, which experienced the crisis first hand, clearly thinks it now has more than enough reserves even though its reserves (relative to its GDP) lag China’s. Second, China had relatively little external debt relative to its reserves even BEFORE 97-98; it had the smallest vulnernabilities and the least need to add to its reserves after the crisis. But right now China is adding to its reserves faster than anyone else ...

Neither the timing of the surge in reserve buildup nor the countries currently adding to their reserves most rapidly fit that well with the "its was the crisis" hypothesis.

2) In the Asian NICs, savings surpluses have come from a fall in investment, not a rise in savings (see the data in this IMF speech). But in Emerging Asia as a whole, investment must have surged over the past few years. China is the biggest economy in the region, and investment in China has grown at an amazing pace. Fixed investment has gone from roughly 37% of Chinese GDP in 2000 to over 45% of GDP in 2004. And, by all accounts, investment in China continues to grow faster than China’s GDP, so investment to GDP keeps on rising. In dollar terms, investment in China has surged. It has gone from maybe $400 billion in 2000 to $740-750 billion in 2004. Had China’s savings rate stayed at 39% of GDP, its 2000 level, China would have needed to borrow about $100 billion from the rest of the world to finance this kind of investment.

As it stands, China’s savings rate rose, so China was able to finance its 2004 investment entirely out of domestic savings. All inflows from abroad were just added to its own domestic savings surplus and stored away in reserves. Compare what happened in 2004 -- $200 billion plus in reserve accumulation -- v. what might have happened if Chinese savings had stayed around 40% of GDP -- a $100 billion current account deficit financed by a combination of FDI and other inflows. After 2000 their "surplus" savings in Asian NICs could quite easily have been used to finance China’s investment surge -- had China been prepared to let its exchange rate move and to run a current account deficit.

Rather than talk of a global savings glut, we really should talk about a Chinese savings glut (consumption dearth). China’s 2005 savings rate looks to be well above 50% of its GDP.

3) I don’t think China’s high levels of savings are entirely independent of a wide range of Chinese government policies, including China’s extraordinary defense of its current exchange rate peg. Indeed, I don’t see why the same market mechanisms that turned capital inflows into the US into a trade deficit would not have worked in China. China certainly seems to be an attractive destination for foreign investment: one investment bank recently estimated capital inflows to China are running at about $50b a quarter (FDI + hot money), or $200 billion a year. FDI alone is probably running at around $70b a year.

Bernanke argues that inflows into the US equity markets in the late 90s bid up US stock prices, making Americans feel richer and thus to consume more, and that inflows into the debt market over the past few years have the same effect through the housing market. Presumably similar, or perhaps different, channels would work in China as well.

Blocking this channel of adjustment is a big deal. With a projected current account surplus that might reach $150b and perhaps $200 b in capital inflows in 2005, China’s reserves -- the source of much of the surplus savings surging through global markets -- could swell by as much as $350 billion this year. $350 billion is about 3% of US GDP, and almost 20% of China’s GDP. In other words, real money.

p.s. -- Thanks to Calculated Risk and Glory for useful housing links.