Low yields in advanced economies lead capital (private capital that is) to head to emerging markets looking for yield. Emerging markets - whether scared by the crisis that followed the sudden withdrawal of private financing last time around or scared of losing export competitiveness- stockpile the private capital inflows in their reserves. And when those reserves flow back to industrial countries, they drive yields down even further, starting the cycle all over again.
That is strange treadmill the world now seems to be on.
Private capital has come back to emerging markets in a big way. More private funds flowed to emerging markets in 2005 than in 1997. And this time around, private investors are willing (strike that, eager) to buy the local currency debt of emerging markets. Yields on dollar denominated emerging market debt are now too low to be really interesting ...
But those private flows are just driving record reserve accumulation by emerging economies. And the record US current account deficits that are the counterpart to those rising reserves make the world look risky and unbalanced, and the more risky the world, the more emerging economies want to build up even bigger buffers (reserves) against any bad outcome. Tis a strange world.
Savings has been outsourced to the poorest countries. And their central banks play a huge role in the global flow of funds. They are the key intermediaries that turn private flows into the emerging world into demand for US debt. They are thus central to the debate on the savings glut.
Chapter 2 of the IMF's World Economic Outlook - the IMF's most recent paper on global imbalances - puts Ben Bernanke on one end of the debate, and Roubini and Setser on the other. Bernanke argues US fiscal policy has had essentially no impact on the US current account deficit and continued large current account deficits pose relatively few risks; Roubini and Setser argue US fiscal deficits play a significant role, and large current account deficits pose real risks. Reserve accumulation figures in to both stories. Bernanke notes it; Roubini and Setser argue that it is the prime reason why the low savings US has not experienced the usual downside of large, sustained fiscal deficits in low savings economies, namely higher interest rates.
But strangely enough - I at least actually agree with some key parts of Bernanke's analysis. Some. Not all. By the way, I am speaking for myself; Nouriel may have a slightly different view.
Bernanke's initial presentation of the global savings glut ignored that the fact that excess savings stem as much from a fall in investment in Japan and the NICs as from any rise in global savings. Yes, China's savings are way up. But at current exchange rates, the market value of those savings is not so impressive.
An aside: Lots of the global data on savings in the WEO is put together using purchasing power parity exchange rates to value Chinese savings, and that turns out to make a difference (see Jeff Frankel on the big gap between China's PPP exchange rate and its market exchange rate).
But Bernanke got one important thing right: He focuses squarely on emerging markets, and correctly emphasizes that the rise in the US current account deficit has been accompanied a surge in the current account surpluses of emerging economies, not by a surge in the current account surpluses of Japan or Europe. Japan had a surplus then and has a comparable surplus now. Yes, Germany's surplus is bigger now than then, but the rise in Germany's surplus has been offset by the development of deficits in France and Spain. The eurozone's current account surplus actually has fallen since 97.
The swing has come with the Asian NICs (largely from a fall in investment), China, and above all, from rising savings in exporters (the Middle East, Russia). Commodity exporting South America plays a role, but on a smaller scale.
I agree with Dr. Bernanke on another point: he, more than most, puts emphasis on what emerging market economies need to do as part of the overall adjustment needed to bring about global rebalancing. Let their exchange rates appreciate. Take steps to encourage consumption growth - i.e. save less. Global rebalancing does not primarily hinge on faster growth in Germany and Japan. It is more a BRICs v. US story than a G-3 story. That is not to say that faster eurozone growth and a eurozone current account deficit would not help, but I do not think that will be the main vehicle of global adjustment.
Of course, I also disagree with Dr. Bernanke on a couple of core points:
I don't think the recent acceleration in reserve growth in emerging market economies can be explained as a rational response to the 1997 crisis (in Asia) and the 2000-02 crisis (in Latin America). China had more reserves (relative to GDP) at the end of 2004 than many Asian economies had external debt in 1997 - it hardly needs to add 15% of its GDP to its reserves to maintain a solid prudential cushion. There is a wide range of possibilities between following the path that led so many emerging economies into trouble and running a 7% of GDP current account surplus and banking another 7-8% of GDP of capital inflows in reserves.
And I don't buy his argument that US fiscal deficits have essentially nothing to do with the current account deficit. Read Menzie Chinn over at Econobrowser.
Bernanke's argument is not the standard argument for why fiscal deficits do not cause current account deficits. He is not arguing that fiscal deficits have no impact because they are offset by a rise in private savings (Ricardian equivalence). He is not arguing that fiscal deficits have no impact because they raise real interest rates, and thus reduce private investment (crowding out).
Rather he argues that fiscal deficits (government dissavings) are all that have stood in the way of even lower global real interest rates as a result of the global savings glut. And the primary impact of lower global real interest rates would be higher US housing prices, higher US consumption and thus lower private savings. Not rising investment outside the US, or less savings abroad.
Personally, I think there would be a much broader range of global responses (less savings in emerging markets for one, more investment globally for another) to even lower global real interest rates if the US government decided to demand less global savings to finance its fiscal deficits. A dollar fall in the US government deficits would not be matched by a dollar rise in private US consumption/ a dollar fall in private US savings. Or a mix of a fall in private savings and a rise in investment in US housing sufficient to generate a dollar for dollar shift in the overall savings and investment balance. For Bernanke, any improvement in the fiscal deficit would be matched by an equivalent rise in the private deficit.
For a slightly different take, read Zanny Minton-Beddoes' take on these issues in the Economist. She doesn't agree with Bernanke. But she also doesn't agree with Roubini and Setser. Too bad she doesn't have a blog.