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Alan Greenspan argues that the fall in long-term rates stems from an increase in "perceived" economic stability, which reduces the risk of lending out ten-year money.
According to estimates prepared by the Federal Reserve Board staff, a significant portion of the sharp decline in the ten-year forward one-year rate over the past year appears to have resulted from a fall in term premiums. Such estimates are subject to considerable uncertainty. Nevertheless, they suggest that risk takers have been encouraged by a perceived increase in economic stability to reach out to more distant time horizons. These actions have been accompanied by significant declines in measures of expected volatility in equity and credit markets inferred from prices of stock and bond options and narrow credit risk premiums.Greenspan, though, put a lot of emphasis on the word "perceived," and ended with a small warning.
History cautions that long periods of relative stability often engender unrealistic expectations of its permanence and, at times, may lead to financial excess and economic stress.
The emphasis on "unrealistic expectations" seems right to me.
A lot is changing in the world. China and oil. The US, India and nukes. Less investment in the US (it you take out investment in residential housing), Japan, the Asian NICs (where investment never recovered from the 97-98 crisis) and even the Middle East (at least relative to oil revenues) -- pretty much everywhere other than China. Greenspan certainly put far more emphasis on the fall in investment than Dr. Bernanke.
Since the mid-1990s, a significant increase in the share of world gross domestic product (GDP) produced by economies with persistently above-average saving--prominently the emerging economies of Asia--has put upward pressure on world saving. These pressures have been supplemented by shifts in income toward the oil-exporting countries, which more recently have built surpluses because of steep increases in oil prices. The changes in shares of world GDP, however, have had little effect on actual world capital investment as a percentage of GDP. The fact that investment as a percentage of GDP apparently changed little when real interest rates were falling, even adjusting for the shift in the shares of world GDP, suggests that, on average, countries' investment propensities had been declining.To the list of big changes in the world, I would add more: the US has outsourced savings to an unprecedented degree for a major economy.
Softness in intended investment is also evident in corporate behavior. Although corporate capital investment in the major industrial countries rose in recent years, it apparently failed to match increases in corporate cash flow. In the United States, for example, capital expenditures were below the very substantial level of corporate cash flow in 2003, the first shortfall since the severe recession of 1975. ... Japanese investment exhibited prolonged restraint following the bursting of their speculative bubble in the early 1990s. And investment in emerging Asia excluding China fell appreciably after the Asian financial crisis in the late 1990s. Moreover, only a modest part of the large revenue surpluses of oil-producing nations has been reinvested in physical assets. In fact, capital investment in the Middle East in 2004, at 25 percent of the region's GDP, was the same as in 1998. National saving, however, rose from 21 percent to 32 percent of GDP. The unused saving of this region was invested in world markets.
That of course is why I would be reluctant to bet on "economic stability' over a ten year horizon.
Forecast out US trade and transfer deficits at current levels (6.5% of US GDP in the first quarter) and ten years out the current account deficit would be around 10.5% of US GDP -- as US net external debt would have risen by more than enough to produce net interest payments of 4% of US GDP. Think net external debt of 80% of US GDP, a 5% nominal interest rate and no gains from intermediation -- i.e. the US does not earn more on its gross assets than it pays on its gross liabilities.
That by the way is a conservative estimate. While I have not run updated my model to reflect the end 2004 net international investment position (a bit lower than expected), I also get net external debt of WELL over 80% of US GDP by 2015 with a sustained 5.75% of GDP trade and transfers deficit. A 6.5% deficit would generate more external debt.
As these charts at Econobrowser show, over half of net investment in the US economy is now financed by savings from abroad. So far outsourcing savings has worked to keep US interest rates lower than they other wise would be. But i at least would be uncomfortable betting that this will always prove to be the case -- many external borrowers have to pay a premium to attract savings from abroad, particularly if they want to borrow in their own currency.
Over time, foreign savings will not just finance a large share of investment at the margins, but also account for a rising share of all savings invested in the US economy. Historical relationships might break down. Let alone relationship -- rising trade deficits, growing gross external liabilities and falling US long-term interest rates -- that only manifest themselves rather recently.
Things do change. Ten years ago, the Asian tigers were booming. Southeast Asia and the Asian NICs together ran a large current account deficit. Ten years before than Japan was on top of the world ...