The Shanghai stock market was up 4.5% in very nervous trading today but down 16.3% since its recent peak at 3478 on August 4, and still trading at more than 30 times earnings. All this turmoil is triggering all sorts of worried comments about the sustainability of the fiscal stimulus package and whether it has already reached the end of its effectiveness (it hasn’t – the government still has credit and fiscal firepower, and will use it if growth slows down significantly in the next few quarters). It also makes it harder, but probably more useful than ever, to focus on the bigger picture, and this entry is definitely big picture. It also turned out to be a very long piece, as these big-picture pieces tend to.
The topic is whether or not the global imbalances that have led to the current crisis were in any way “caused” by the Asian savings glut, and besides arguing why I think this may be the case, I want also to argue that getting this argument right is far more important than many seem to realize. Mohamed Ariff, executive director of the Malaysian Institute of Economic Research, indirectly suggests why in a good OpEd article in today’s New Strait Times:
China is seen as the beacon of hope in these days of gloom and doom. This has led some observers to think China will lead East Asian economic recovery and thereby spearhead a global economic turn-around. But this faith in China as saviour may be misplaced.China’s imports from the rest of East Asia consist mostly of raw materials, intermediate products and components and parts, the bulk of it turned into manufactures for exports. China’s imports of consumer products from the region account for no more than a small proportion.
China’s imports from its neighbours have plummeted in the wake of the slump in China’s own exports, although the Chinese economy is growing at seven to eight per cent, because China depends largely on domestic production for its own consumption, which does not spill over to the rest of the region through trade.
I started writing this because while googling around looking for something else, I stumbled early this week upon a blog by LSE’s Danny Quah with the intriguing title “Where in the world is Asian Thrift and the Global Savings Glut?” I later found that like mine, his blog is carried by Nouriel Roubini’s RGE Monitor. I also subsequently discovered by a weird coincidence that on Saturday I am sharing a panel with him in a conference at the Guanghua School at Peking University, where we will be discussing the “Reconstruction of Global Finance”.
The whole “savings glut” debate is a controversial one because almost from the start it has degenerated into a fairly silly argument about who to blame for the global imbalances and the subsequent crisis – or more specifically and more excitingly, whether the predator was wholly the foolish American consumer or the beetling Chinese saver. Three months ago Brad Setser discussed all this in one of his blog entries that (inevitably) drew more comments than most, and as usual he provides a concise and enlightening discussion on the subject which you might want to read. He is a proponent of the hypothesis, but nonetheless pretty fair-minded.
Professor Quah weighs in on the other side of the savings glut debate although, unlike most others in the debate, he seems not terribly concerned about assigning full blame to any of the major parties. It is neither excess US consumption nor excess US savings that solely “caused” the imbalance, in other words, because necessarily both sides are required for it to exist.
Except for the possibility of trade with outer space, the US deficit has to be matched dollar-for-dollar by trade surpluses in the rest of the world. Correspondingly, therefore, the rest of the world has been saving—consuming less than it has been producing—and accumulating dollar claims against the US as a result.
In this description, however large the global imbalance, a savings glut—wherever or however it might arise on Earth—has no independent existence. It makes as much sense to say the world’s excess savings caused enthusiastic US consumers to flood into Walmart to buy $12 DVD players, as to say US consumer profligacy made hungry Chinese peasants abstain even more and instead plow their incomes into holdings of US Treasury bills.
When two variables have always-identical magnitudes, obviously neither can usefully be said to cause the other.
Who are the predators?
This is correct, but as an aside, the discussion about enthusiastic American consumers forcing the Chinese to save, or hungry Chinese savers forcing Americans to consume, typically uses colorful but totally inappropriate images to describe the dynamics of the this process. For example, I often hear opponents of the Asian savings glut hypothesis say, voices dripping with disbelief, that the savings glut hypothesis insists that the poor American consumer rushed out to buy another DVD player because terrible China forced him to borrow the money and buy the DVD player. How could that possibly happen?
Well, that’s not how it would have happened. In any large country, there are millions of households able and interested in increasing savings or in increasing borrowing. Specific policies or financial conditions will determine at any given time changes in the behavior of some of these individual households, so that at the macro level, and only at the macro level, the country will have seen an increase in savings or an increase in consumption.
It is not every household that rushes out to consume when consumption rises, and this never happen because predatory savers force an otherwise unwilling consumer to buy. So if it had indeed been rising Asian savings that drove the US consumption binge, policies aimed at constraining Asian consumption and boosting Asian production (which cause savings to rise) will have initially led to a rising Asian trade surplus and US trade deficit, as the tradable goods sector in Asia expands and the tradable goods sector in the US contracts.
This surplus would be recycled into the US via purchases of highly liquid securities. If the Fed failed to respond to this increase in liquidity by raising interest rates and contracting money (and contracting the tradable good sector), the financial system would have to accommodate the rising liquidity as it has always done throughout history – by growing financial balance sheets and taking on more risk. In that case the conditions for consumer borrowing will have been made increasingly easy, and those households who needed or were predisposed to borrow under easier lending conditions, and pressure on the parts of banks to extend credit, will do so.
As long as there are some households willing, however appropriately or foolishly, to increase consumption, the easier availability of consumer credit will cause them to increase consumption – this has happened many times and in many countries, and has nothing to do with a predisposition to excess consumption. Furthermore as recycled liquidity boosts household wealth by boosting the value of homes and investment portfolios, the rising wealth of each individual household will have an impact similar to rising income – and with it consumption will rise.
So the point is the not very controversial suggestion that a surge in domestic liquidity in the US can easily cause US consumption to rise. If that liquidity surge was “caused” by the recycling of a large and growing trade deficit, then it is easy to see how at the macro level US consumption would rise in response to a surge in Asian savings.
Similarly, the proponents of the Asian savings glut hypothesis wonder in disbelief how an American consumer deciding to buy a DVD player could have possibly “forced” poor Chinese peasants to cut their already minimal consumption and increase their savings. But there was no force. A sudden explosion in binge consumption in the US would divert production from China, and as China increased the share of its output dedicated to exports, total production would not immediately be matched by total domestic consumption (Americans bought some of it) and the Chinese savings rate would necessarily increase – whether at the household level or at the corporate or government level.
The interest rate argument
The point is that sarcastic comments about predatory American consumers forcing dim-witted Chinese households to save more and consume less, or predatory Chinese savers forcing helpless American households to borrow and consume, may be good debating tactics but they are misleading and explain nothing. At the macro level either event – higher Asian savings leading to higher American consumption, or higher American consumption leading to higher Asian savings, or even a combination of the two – is perfectly possible.
So why should we accept the Asian savings glut hypothesis? One argument that I first saw proposed by Brad Setser was that if the imbalances had been driven by US consumption, and therefore US borrowing needs, the consequence should have been an increase in US interest rates. Had they been driven by excess savings, US borrowing rates would have probably declined.
In fact during most of the relevant period US interest rates did decline, even leading to the US Fed several times complaining about its inability to control domestic long-term rates. So that pretty much settles it, right? But Professor Quah dismisses this argument:
Many other factors could, of course, have driven down short rates: US monetary policy responded to national economic downturns in 1991 and 2001. Through the 1990s inflation rates worldwide converged and fell, together with short-term interest rates set by central banks everywhere. The burst of the dot-com bubble in March 2000 saw the NASDAQ index decline 77% in the following 18 months, prompting action by the US Federal Reserve. Japan’s monetary policy during its decade-long recession drove nominal interest rates there to zero.
Although he is right, this is not a completely satisfying dismissal. The same savings glut that pushed down US interest rates could easily have pushed down global interest rates, especially in a world that was seeing rapidly rising capital flows that in many cases were aimed at “arbitraging” (absolutely the wrong word, of course, but one widely used in the markets at the time) interest rate differentials. After all it is often the case that, especially during periods of large international movements of capital, increases or reductions in US interest rates (or in British rates during the globalization period at the end of the 19th Century) are matched by changes in foreign interest rates.
Still, the fact is that his response does show that the interest rate argument is not final. There might be other perfectly good reasons that explain the decline in US interest rates.
The bilateral trade argument
Quah’s main argument against the savings glut hypothesis, at least as far as his blog entry, seems to be that it could not have been a rise in Asian savings that drove the global imbalances because had it done so, much of the imbalance would have rested between Asia (or China, more specifically) and the US. The strongest piece of evidence he presents is a chart that shows the US bilateral trade balances between the US on one side and China, developing Asia, the EU, and oil exporters on the other. I have reproduced the graph below, but if you can’t see it well, just click on Quah’s blog (blocked in China, so China-based readers will need to use a proxy), and click on the graph itself for an enlargement (I wish I was clever enough to do things like that).
As the chart shows, the US trade deficit rose nearly as quickly, or even more so, with those other regions as it did with China and/or developing Asia. It wasn’t just a US-China phenomenon or a US-Asia phenomenon, it was a US-everybody phenomenon.
Quah’s argument seemed to be a powerful one at first, and I had to think about it for a while or else I would have to find myself deserting from the “savings glut” camp. In the end, however, I think his argument it turns out not to be very satisfying and I still think it runs against a timing story that better explains the imbalances. I’ll say more on that later, but it seems to me that in a “globalized” world, if the Asian savings glut hypothesis is true, not only would rising bilateral trade deficit between the US and other countries outside of developing Asia be possible, but they would even be almost necessary.
Why? Because we have to be careful about misreading bilateral trade numbers. It is the aggregates that usually matter. I don’t have the data in front of me, but I believe that Europe did not run significant and rapidly growing aggregate trade surpluses during this period. If that’s the case, then a growing bilateral surplus with the US is perfectly consistent with the savings glut hypothesis as long as you assume that trade is international and that any specific product can be produced and assembled in many countries – which is of course a pretty unremarkable assumption.
So, for example, if rising Asian net savings “caused” rising American net consumption (in the way described above – no sarcasm, please), it would mean that money recycled from Asia into the US caused the US trade deficit to rise as it was intermediated by the financial system into consumer financing, even as it caused Asian trade surpluses to rise.
It’s the aggregate balance that matters
But, and this is the important point, the trade did not need to occur only at the bilateral level. If rising Chinese savings was intermediated into rising US consumption and this bilateral relationship was resolved, to take a concrete example, by Chinese exporters producing shoes and American consumers buying shoes, the trade would not have had to occur directly between the two. When Americans shop for shoes, they don’t care which country saw net savings rise, and when Chinese sell shoes they don’t care whose economy saw an increase in net consumption. China could have produced shoes, sold them to a designer in Italy, where they would be packaged and branded, and then sold to American consumers.
In this simple case, Chinese excess savings would have “caused” Americans to borrow money and buy the shoes, and so China would run a trade surplus, the US would run a trade deficit, and Italy would be balanced. But Italy would nonetheless show a bilateral surplus with the US and a bilateral deficit with China.
Excess US consumption, in other words, would still have been “caused” by excess Chinese savings in this case, but global trading and processing networks would have the bilateral trade imbalances, and their countervailing obverses, spread out though the world. Many countries would run surpluses with the US and deficits with Asia, but at the aggregate level they would balance out at close to zero, and the US would be left with the sum of its bilateral deficits and Asia with the sum of its bilateral surpluses.
The point is that there is nothing in the Asian savings glut hypothesis that requires that all trade imbalances occur at a bilateral level and only between the participating countries – that the deficit/surplus imbalances occur between the US and Asia. It only requires that the US, as the equilibrator to rising Asian savings, have a large and growing trade deficit and Asia have a large and growing trade surplus. If other regions also have large and growing aggregate trade surpluses that fed into the US deficit at the same time, that would perhaps be the problem Quah says it is, and either would need to be explained or would create problems for the hypothesis. But they didn’t.
With one big exception, of course. Oil exporters did see not only rising bilateral trade surpluses with the US, but they also saw rising aggregate surpluses. Does this somehow weaken the savings glut hypothesis? Again no, because those surpluses reflect one thing only, rising oil prices, and in an environment of rapid US and Asian growth, we would expect oil (and other commodity) prices to rise. In fact the savings glut hypothesis would predict that as long as the recycling was occurring efficiently, both countries would grow quickly and high commodity prices would be not only possible, but in fact highly likely.
So as I see it, this is how the arguments and counterarguments stand:
1. The argument that declining US interest rates proves the correctness of the savings glut hypothesis is wrong. Declining US interest rates are suggestive but not final. Other things could have explained declining US interest rates during this period, and of course there is easily a possibility of feedback loops in which any initial decline in US interest rates could, by increasing household wealth (via rising asset values) increase consumption and the US trade deficit, leading to Asian recycling, and so on to more lower interest rates.
2. The argument that rising US bilateral deficits with many regions around the world disprove that the savings glut hypothesis is also wrong, and much less suggestive. On the contrary, if the hypothesis is correct and if trading is truly globalized, we would expect US bilateral deficits to be high with nearly everybody. At the aggregate level, however, we would not expect anyone except the high-saving Asian saving countries to run large trade surpluses.
3. There was also an argument that I associate with Morgan Stanley’s Stephen Roach – a very smart man who by the way disagrees strongly with the hypothesis – since he was the one who first made this argument to me, over a lunch at Peking University two years ago. According to Roach there has been no significant increase in global savings during the savings-glut-hypothesis period, which pretty much demolishes the idea of a saving glut.
I disagree because the hypothesis doesn’t imply in any way that global savings have increased. In a closed economic system, unless investment has increased commensurately, an increase in savings in one part of the system must necessarily come with a reduction in savings elsewhere, and this was exactly the point of ascribing the current trade imbalances to a forced rise in Asian savings. Rising Asian savings “forced” declining US savings by causing the US financial system to accommodate growing domestic liquidity by taking on risk (again, no sarcasm please – you might disagree but in itself this is not implausible).
Timing the flows
So where does that leave us? Before answering, I think there is another thing to think about here, as I wrote earlier in this entry, and that is the timing issue.
In a June 4, 2008 entry, much of which is reproduced here, I mentioned a very interesting paper by German economist Jorg Bibow of the Levy Economics Institute of Bard College (The International Monetary (Non-)Order and the “Global Capital Flows Paradox”). In it the author considers the “paradox” of high and rising capital flows from developing to developed countries during the past decade. This is a paradox because most economic theory (and history) suggests that developing countries are net recipients of investment, not net providers.
Bibow rejects the Asian savings glut hypothesis, but my understanding of his paper is that he agrees with much of what I understand the theory to be but rejects it on much narrower technical grounds – he claims that the saving glut hypothesis is based on the “fatally flawed” (his words) loanable funds theory. However his narrative (to be horribly post-modern for a moment) of events seems very close to my own.
What interests me most is the data he provides in his paper (and you can see the accompanying graphs by following the link to his paper). First off, Bibow discusses the evolution of the US current account deficit over the past fifty years.
Basically, according to the data quoted in Bibow’s paper, the US current account has been within a range of a surplus of 1% of GDP and a deficit of 1% of GDP for most of last fifty years with two exceptions. The first exception occurred in the mid-1980s when the US current account deficit rose to nearly 3.5% of GDP in 1986-87 before declining sharply and running into a small surplus in 1990. The second exception began technically in 1994, around the time of the Mexican crisis, when the US current account deficit climbed to around 1.6% of GDP, before it began to decline again, but it really took off in 1997-98, when it raced forward to peak at around 7% of GDP in 2007.
As an aside I should add that there was an acceleration of the growth rate of the deficit around 2004, if I remember, and I have a pretty strong suspicion that this had something to do with the financing of the Iraq war. As I have pointed out before, US asset markets and consumption often boom during unpopular wars, like the Vietnam War, which tend to be financed not with taxes but with money creation and debt, and often these two things lead to great markets – for a while.
If the US trade deficit was driven simply by an out-of-control US consumption binge, it is a little hard to see why it would have followed a pattern of general stability marked by two surges – a small one from 1984-88 and a very large one after 1997. If it was driven by Asian savings, this pattern becomes a little easier to understand – or at least, what amounts to the same thing, we can posit a more plausible story to explain it.
The narrative
I will ignore the 1980s surge because this post is already too long, but again one can tell a very plausible story based on Japanese trade policies and domestic savings. The post-1997 surge is much larger and more interesting. 1997 was, of course, the year in which several Asian countries, after years of tremendous growth and what seemed like invulnerable balance sheets, experienced terrifying financial crises and viciously sharp economic slowdowns, which profoundly impressed Asian policy-makers and has affected policy decisions to this day.
Since the main cause of the crisis seemed to be the sudden reversal in the early 1990s of current account surpluses into substantial deficits, along with highly unstable balance sheets in which large external obligations were mismatched with domestic assets and “hedged” with extremely low levels of foreign reserves, one of the main (if mistaken) lessons policy-makers learned was the need to run current account surpluses and to amass large foreign currency reserves to protect countries from a repeat of the disastrous crisis of 1997.
These countries, consequently, but into place “mercantilist” policies in order to achieve both goals – persistent trade surpluses and large amounts of foreign currency reserves. This (I think plausible) story is reinforced by another graph Bibow reproduces. The global capital flow “paradox” to which he refers in his title is the fact that developing countries are exporting capital to rich countries. According to his data, developing countries have almost always been net recipients of private capital flows – which is what one would have expected from most economic theory and history.
They have generally been net providers of official capital as far as foreign currency reserve accumulation goes, but for most of the last fifty years reserve accumulation on average was significantly less than net private inflows, so developing countries were net recipients of capital. (For much of the 1980s the balance on both was zero or close to zero, and I suspect that this reflects negative private flows to Latin American and others among the 32 defaulted or restructuring LDCs, as they were then called, netted against positive private flows to Asia.)
It is only in 1998 that reserve accumulation among developing countries begins to take off and by 1999 it exceeds net private capital flows to developing countries. This is when the “paradox” of net capital flows from developing to developed countries begins. Except for a small decline in 2001 net flows from developing countries surge almost in a straight line to around $700 billion annually (combining $1.2 trillion of reserve accumulation versus $0.5 trillion of net private flows).
I am sure there can be other competing explanations for the timing of these flows, but I am very impressed by the fact that Asian savings, as expressed in reserve accumulation, surge after 1997, as does the US trade deficit, although exacerbated by the second surge around 2004. Given the virulence of the 1997 crisis and the tremendous shock it provided to Asian policy-makers (and policy-makers in developing countries elsewhere), it seems to me that a very plausible argument can be made that it was the effect of 1997 that caused the shift in developing-country policies that led to the surge in savings and the corresponding increase both in trade surpluses and reserve accumulation.
The surge in the US trade deficit after 1997 is also more easily explained by a shift in Asian trade policies and currency regimes than by a shift in US consumer preferences. Of course that doesn’t mean that nothing relevant happened in the US. US monetary policy was clearly too accommodative, and especially in reaction to the Iraq war, so that it exacerbated the conditions created by the Asian savings glut. If anyone is still looking for which country to blame, my understanding of the creation of the imbalances suggests that you can blame almost anyone you like and there is a good chance that you’ll be at least partly right.
Why does this matter?
The issue of what drove what is not simply of academic interest. The consequences for the world of a system in which imbalances were driven by a sudden and self-perpetuating explosion in US consumption, which then forced higher savings onto Asian countries, are very different from a system in which imbalances were driven by a sudden and self-perpetuating increase in Asian savings, which then forced higher consumption onto non-Asian countries.
Deciding whether or not the savings glut hypothesis is correct is important not just because it allows us finally to decide which country really is the evil predator, the US or China. It matters for a very different reason.
If it was an explosion in US consumption which drove the global imbalances, then we are likely to see a fairly benign resolution to the crisis for everyone, except maybe the US. After all in that case the imbalances were driven by US consumption excesses, and since those excesses are, like it or not, going to be resolved by the need for US households to repair their badly-damaged balance sheets, the imbalances too will be resolved, and in a way that is mostly benign for everyone except recovering US households. This process may be postponed by current US fiscal policy, and especially by recent policies that subsidize consumption, but it will only be postponed, not derailed.
And just as Americans can no longer binge consume, their binge consumption will no longer force Asians to save such a high and rising portion of their income. Asian growth, and especially Chinese growth, will be much more balanced.
But if the global imbalances were driven by a surge in Asian savings, Asian and Chinese growth will still rebalance, but the rebalancing will be much more difficult. Why? Because too-high Asian savings, caused in large part by post 1997 policies that encouraged differential growth between consumption and production (as I discuss here, for example), have until now been matched by too-low US savings rates. As long as the two imbalances balanced, the world economy could continue functioning without too much distortion.
But now if we can expect net savings in the US (and perhaps in many other parts off the world) to rise, we need to see a rapid change in those policies that encouraged too-high Asian, and especially Chinese savings. In that light there was an interesting and worrying OpEd article in today’s Financial Times by the Peterson Institute’s Fred Bergsten and Arvind Subramanian:
The Obama administration is increasingly signalling that the US will not continue to be the world’s consumer and importer of last resort. The clearest statements came last month from Larry Summers , White House economics director, in a speech at the Peterson Institute for International Economics and in an interview with the Financial Times. The US, he said, must become an export-oriented rather than a consumption-based economy and must rely on real engineering rather than financial wizardry. Tim Geithner, the US Treasury secretary, and other top officials have spoken similarly of rebalancing US growth.
If the US really is serious about this shift towards higher savings, and if the primary source of the imbalance was the Asian savings glut, and not an original US consumption “glut”, this means that in the future US policies will be in direct conflict with still-current Asian policies, and unless the US is unable to accomplish these goals, Asian countries will need to force through an adjustment in their development policies as quickly as possibly. Asian and especially Chinese officials have acknowledged the need to increase consumption more quickly.
But for now this adjustment in policies that encouraged too-high Asian, and especially Chinese, savings does not seem to be happening. “The optimal choice is to expand household consumption,” PBoC governor Zhou Xiaochuan said in a speech last month. ”That is, however, easier said than done. While the current income structure cannot be dramatically changed in the short term, the second-best choice is to maintain and expand investments.” He is almost certainly right, at least except for his last statement.
In fact as I have argued many times (for example here, and here), I suspect that most of the Chinese fiscal stimulus is exacerbating the imbalances – both by boosting current and future production and by creating conditions that will constrain future consumption growth.
In that case there has been no significant rebalancing yet towards more rapid consumption growth taking a greater share of Chinese production – just a frenzied attempt to keep current growth rates high by boosting investment, which will almost certainly lead to capital misallocation and rising non-performing loans, and clearly unsustainable attempts by the Chinese government artificially (and unsustainably) to boost short-term consumption by subsidizing it heavily with government debt (something the US seems to have been doing too) which has the effective consequence of reclassifying fiscal expenditures as household consumption.
The end result? Planned increases in investment in China eventually become forced increases in investment – rising inventory – that ultimately must lead either to writing inventory off or closing down production facilities in the future. This is, by the way, just another way of stating the excess capacity problem.
Perhaps what we need is a real return to Confucian roots. I recently read this quote from Lao-Tzu: “The sage does not hoard. Having bestowed all he has on others, he has yet more. Having given all he has to others, he is richer still.”
Thank you for the thorough discussion of the issue. Very informative. I don’t see how so many people who otherwise accept basic BOP accounting identities as ordering principles of the universe have such a hard time accepting the basic mechanisms described above. Anyway, this post provides the underpinnings as to why I am betting on deflation. Gracias.
This is the best explanation I have ever seen of the crisis. I hope our policymakers read this carefully.
[...] Read the rest of this great post here [...]
Quah’s blog was posted on Sunday, which given the time difference means the earliest you could have read it was probably Monday. Since then you managed to write this piece? I am hugely impressed.
Had not at all appreciated how much Lao-Tsu had anticipated Keynes. His attack on liquidity preference ‘The sage does not hoard’ and that investment creates saving and not vice versa ‘Having given all he has to others, he is richer still’ completely admirable.
It was driven by U.S. borrowing, which was a result of very low interest rates courtesy of the Federal Reserve. Had there been no inflation, interest rates would have increased and the borrowing would have slowed.
Chinese high savings are to some extent a result of their currency policy which depresses the value of Chinese currency. Furthermore, the massive fixed asset investment directed by the government is directing a large amount of the economy away from private hands. High real estate prices are also a problem, since it requires a lot of savings to buy a home. Government funds its budgets with land sales and has an interest in high prices.
The mess was created by the world’s central bankers and interventionist bureaucrats and politicians who decided which sectors of the economy would receive an advantage: exports, housing, etc. The best medicine would be for these politicians and bureaucrats to go away and allow the market to clear the excess capacity. Chinese want to consume, but their government prevents them. Americans want to save, but their government counteracts them.
[...] Yet another discussion on the Asian savings glut hypothesis, and why it matters – Michael Pett… [...]
“In that case there has been no significant rebalancing yet towards more rapid consumption growth taking a greater share of Chinese production – just a frenzied attempt to keep current growth rates high by boosting investment…”
And similarly, in the US no rebalancing toward Mr. Summers’ desired export economy. And there won’t be. I don’t know what Mr. Summers is thinking.
China (a country of 1300 million) has hoped to develop an industrial economy on the basis of a 1960’s Japanese model (a country of 130 million) and a saturated US consumer market. Who could have thought that might have worked? In a previous perhaps too glib comment, I mentioned your observation that it was the US productive sector that was required to make adjustment to mercantilist policy. There is a causation question even in that. But going with that premise – we did it. We have out-sourced, and off-shored and smashed our business models horizontal to enable ourselves to survive in that atmosphere. There seemed to be a comparative advantage in doing so.
How to rebalance? US banks are in what a former president once called, “deep do-do”. Unless those Chinese savers are ready to invest in US industry capital will be found wanting. And who’s going to make that investment in the face of mercantilist policy? And there is still the comparative advantage question. But there is another difference. China is not Japan and it’s not 1960. Japan took the long route doing the marketing and building brands – Sony, Toyota, Honda. China contracts production to established names. We’ll be lucky if those savings continue to go into govt. debt. But it’s not going into Corporate debt. No way. Can we leverage that into industry? Will it require a governmental industrial policy to do that? I think I know how that would be seen. We’re allowed to have a banking policy though.
You have been over and over how difficult it will be for China to increase internal demand. But it’s pretty clear to me that it is China who must shoulder the larger burden in rebalancing. To me it would seem much easier to reposition those Chinese manufacturers than to rebuild a US manufacturing industry. And we must hope that US manufacturing can fill a few demand gaps. Health care technology, workplace safety equipment, pollution control technologies come to mind. History (and Chinese import/export data) suggests that won’t happen either.
So, this time it appears the major adjustment must come from US demand. Next we talk about decoupling. Chinese industry is repositioned to domestic demand and US demand becomes irrelevant. Global trade falls, markets become fragmented…
Why is the US trade deficit accounted to excessive consumption and not simply to a lack of domestic production? The idea, that Americans were forced to consume by Asian savers doesn’t sound right, but the distruction of Ameriacan munufacturers through currency manipulation seems quite plausible too me.
“Similarly, the proponents of the Asian savings glut hypothesis wonder in disbelief how an American consumer deciding to buy a DVD player could have possibly “forced” poor Chinese peasants to cut their already minimal consumption and increase their savings. But there was no force.”
Well, if a country, say China, has high tariffs for imports and pegs its currency to its main export target, say the US, you get very close to a force.
The tariff punishes consumption from abroad. The peg requires purchases of US debt.
To me, it sounds like the Chinese government has forced these savings upon their poor peasants.
The US is responsible for letting credit go to consumption and into asset bubbles. It could have gone more into investment and they would have had a brighter future. Now it absolutely *has* to go into investment.
I remember Quah making these or similar comments months ago – so it is not new fare but it is of great interest.
There is something wrong in the state of Denmark now in Asia, especially when the following statement is considered:
“…China’s imports from its neighbors have plummeted in the wake of the slump in China’s own exports, although the Chinese economy is growing at seven to eight per cent…”
Does anyone else find this incongruous?
It implies incredible national civics are being applied/mandated in China that despite the quick return many have experienced imports of good that such a boom in normal times would prompt is not occurring now as everyone, with great sobriety, forestalls imports.
But I don’t think such an emergency order on imports has been accepted or applied in China and I suspect the drop in imports to China reflect the true growth in China.
My “gut” says China now has at least a 10% output gap in current versus potential GDP – no matter whether that leads to positive nominal GDP or not.
The “savings glut” is a thesis which starts with an unfortunate value laden choice of words, with the steadfast proper tones of “savings” mixed with the hedonistic wicked “glut”. Savings is savings. Period. It is an accounting identity and not a qualitative concept. There can be no doubt that the large national savings in China has long historical precedence and I think has nothing to do with the very large US dollar reserves that China has accumulated. There is a mistake to see a countries reserve position as a national “savings” – it is simply a residual or a result of trade where the currency of exchange has not been converted to the domestic currency.
As long as China does not convert their trade receipts into Yuan, they will have an impact of the USA flow-of-funds in US dollar terms. Again that is simple accounting. Following that logic it is obvious that there were “excess” dollars that had to be absorbed into the US economy. Unless the Federal Reserve is “sanitizing” those dollars, it is inevitable they will have to find a liability. And it is logical that if an asset has to be created in short order to accommodate a sudden rise in these US dollars, those assets which can be re-hypothicated or can attract very high “loan to value” ratios will be significantly impacted. Ergo the housing bubble.
China cannot convert these reserves into their domestic currency as it would impact the domestic currency, forcing the Yuan to levels where terms of trade are no longer attractive to those China exports to – Ricardo made this all clear long ago. If the currency is not at realistic levels, this becomes a critical issue as the currency no longer provides information for Chinese administrations as to the true quality and nature of the Chinese economy. Massive “hollowing out” of the Chinese economy will likely develop until a dramatic day occurs where the piper is paid. The current asset price rally (even with the decline the last two weeks) may be the start of a bubble and perhaps the beginning of the “end game” in this final accounting. Jane Jacobs did a great job explaining this when she discussed China’s predecessor, Japan, in their exporting mechanisms in the 1980s in her “Cities and the Wealth of Nations”. It might be reasonable for countries to pursue this trade policy as China has for the last decade, with the idea that real domestic growth will fill in this hollowing out and then full convertibility of the currency can be allowed for by then the information the currency level provides will not shock. But so far no country in history – right back to Athens as the first trade exporter with a national trade policy, has ever achieved a soft landing when this strategy is deployed. More often than not it has led to a very hard landing and extreme stress domestically (if the country is trite in size) or extreme stress domestically and internationally.
In fact I think this is why the USA “allowed” this rigged currency to fuel large trade imbalances with China. The concern for international tensions was considered and what would be required if China was forced to pursue a mostly domestic growth answer to their transformation to capitalism. It might be said that even now, the costs of the resulting boom bust waves from China trade, or whatever impact that had on the current USA economy, is cheaper than the military buildup and investment required by the USA otherwise. The massive costs of the housing bust is still smaller than the costs of 3 more aircraft task forces in the Western Pacific and another 100,000 troops in Korea and Japan and a final elimination of the North Korea problem. I also think the current route of international security and progress via trade and globalization – no matter how unbalanced the currency levels may seem, are still the right answer. For in the end it is China that will pay the full cost, not the USA or the other OECD countries.
Hey Michael, Lao-Tzu isn’t traditionally thought of as being part of Confucianism. In fact, the two are frequently direct opposites in Chinese culture.
Michael,
I have a question, about another facet of the imbalances.
Concurrent with the rise in trade imbalances has been a big rise in income inequality, particularly in the U.S., but also in China and much of the rest of the world. Leaving aside the moral dimension entirely, there is a point where income distribution becomes so skewed that the money available for investment by the wealthy overwhelms the amount available for consumption by the many.
In the U.S., this seems to have created a combination of increasing debt financed consumption by the many, and increasing investment in financial instruments and overseas firms by the wealthy.
In China, too, the skewing of incomes increased imbalances.
I guess my question is, without these pronounced income imbalances, and all else equal, would we be in the same situation? Put another way, if median income in the U.S. stayed the same as a percentage of GDP, might not the same amount of consumption may well have been possible with no increase in debt?
On a related note, you might find a recent post by Calculated Risk that illustrates most of the rise in U.S. consumption relative to GDP over the last 40 years is attributable to the absurd increases in health care spending here. But you can see a bulge in other consumption expenditures in 1998-1999.
http://www.calculatedriskblog.com/2009/08/health-care-spending-and-pce.html
“I suspect that most of the Chinese fiscal stimulus is exacerbating the imbalances”
I would argue the same is true in the US. 125% LTV refis, cash for clunkers, cash incentives for homebuyers, etc.
There is a British phrase, “hair of the dog”, which means ‘curing’ a hangover with a drink. I think this is an appropriate description of the US (and Chinese) policy response to the crisis.
[...] Yet another discussion on the Asian savings glut hypothesis, and why it matters (Pettis) [...]
That was a very good read. Thankyou.
There are two points I would like to make. Firstly, obviously the huge addition of productive capacity by China and others over the last decade with devastatingly cheap cost bases has clearly had an effect on monetary policy as practised by western central banks. And obviously low inflation has fed into low rates and a massive increase in money supply and the ability of consumers to borrow both with very loose strings and at cheap rates.
The basic underlying massive deflationary force being felt in low prices and lower wages is also being seen in serial asset bubbles in short order as central banks fail to grasp how to manage monetary policy in such an environment.
Secondly, the point you make about China and the US is of course analagous to any creditor-debtor relationship. Money supply is increased when loans are made and people rightly worry about burgeoning debt. But that money ends up somewhere else – and if people are over burdened on one side, someone, somewhere else must be accumulating it. So the balance is not just between nations but between banks or depositors and borrowers and at the most basic level between the increasing accumulation of money by the rich and the rest. We will hear a lot more about the word ‘BALANCE’ in the next few years.
Regarding the low interest rates… and I’m not saying anything new here:
1) Low long-term interest rates take their cue from the long-term risk-free rate (government bond yields)
2) Govt bond yields are a function of the market’s buying and selling of govt bond yields
3) From 2002-2008, the central banks of Asia, Russia, the oil exporters, and a host of other emerging mkt countries are well known to have purchased an extraordinary, unprecedented volume of US treasury bonds. Like, astronomical… it’s hard to put into words how huge these purchases were
4) These US treasury purchases, after a certain point, were uneconomical. At first, ok, they wanted to build up their reserves for the sake of currency defense, in response to what happened in 1998. However, after they had way more reserves than they needed, they kept robotically purchasing treasuries for uneconomic reasons (the private sector had stopped purchasing them in 2004 or so?)
Why would these governments robotically amass ever-low-yielding US treasuries that they didn’t need? We all know the answer – their currency regimes dictated that they do so. In order to keep their currencies pegged to the dollar (more specifically, to slow their currencies’ appreciation against the dollar), these countries were required to sell their local currency and buy US dollars, and then they had to park those purchased US dollars into the safest investment possible – US treasury bonds
Michael, I think you’re over-thinking this! I know what I’m saying is nothing new, what are the gaps in this simple explanation? Is pointing a finger at currency regimes just too politically untenable?
This isn’t the first time unsustainable currency policies have led to a crisis, and (unfortunately) it probably won’t be the last.
And just to emphasize (since this is another thing that people take the wrong way)… it is not the exchange rate levels that cause the crises/imbalances/etc. It is the dynamics that the exchange rate regimes put into play that cause trouble:
1) Exchange rate regime forces EM country to sell local currency and buy dollars, and park those dollars into low-risk US assets (ie recycle the money back into US)
2) So, money floods into the US, and US does not efficiently handle the influx of money. Glut of money in US eventually finds its way to bad investments
Everyone is at fault – the EM countries for running unsustainable currency regimes which forced too much money into the US (and built a system that was over-dependent on US over-consumption), and the US for not efficiently handling the influx of money into the country (by perhaps tightening money supply)
Prof Pettis,
Thanks for informative article & blog. I am late to your blog, but have learnt a lot.
I have a question. What actions did Asian policymakers take in 1998 (and after) that increased the reserve accumulation? What changed that lead to $700 billion annual accumulation?
If it is already answered, please can you direct me to it?
Thanks.
Professor Pettis,
I have been following your blog more and more. Your posts and most of the comments are outstanding. The open way you write, answer the comments and respect different opinions gives a nice free community feeling. Thanks.
I would like to point out that there is a fundamental cause for the imbalance. China, and other countries, produces for less. This is true not only for final consumer goods but for investment ones also. For example, China today is the larger producer of solar panels.
This means that whatever the direction, US businesses will try to be supplied by China and other economies with equivalent “advantages”. In other words, the Asian savings glut is correlated not to one but both sides of the US and Europe economies, consumption and also investment.
This comparative advantage is not shared by Chinese workers, potential consumers, but by investors, managers and their government. If so, it would vanish, destroying not only their export engine but their economy.
This exposes an unprecedented world structural crisis in which the US and Europe are on the weak side. Anything they do cannot match the advantages and ability China and some other countries have to produce consumer and investment goods as needed, at lower cost.
Also, one cannot underestimate the power of USD 2 trillion reserves. With it, the Chinese government can manage its share of the crisis for at least the next 5 to 7 years. And time is in its favor.
Due to the size of its population China cannot pursue in the long run the GDP growth model and will need to adjust its economy to a sustainable development. But this is another story.
Christopher.
Exceptionally well written and well reasoned post professor, both in explaining your position and refuting some of the weaker arguments out there.
The term “mercantilism” comes close to explaining the imbalances, but the true motives go much deeper than just trying to accumulate monetary reserves. Most Asian nations have been striving to keep employment levels high and China has been focused on making its companies and industries more competitive.
Primarily this has been done by keeping Asian currencies weak and the mechanisms for this have been readily available since Bretton Woods. However, China has also had a big focus on infrastructure and other forms of support for industry (tax benefits, grants, subsidies, etc.).
While the longer term growth of imbalances with China and Developing Asia appear similar on Quah’s chart, it takes a closer look to see how the trade gap with China was accelerating much more rapidly through the last few years. More than just being a source of cheap labor, China is becoming one of the most skilled and efficient manufacturing nations.
The long term concern, in my mind, is that the whole world has too much capacity. Excessive consumption in the US masked this for awhile, but the global contraction is based on it. China has had the least trouble adjusting, partly because its industry is more competitive, and partly because the economic system is geared toward protecting the productive forces rather than the financial sector.
Simply increasing consumption doesn’t solve the overcapacity problem because resources will be too scarce (including the atmosphere as a resource for storing carbon). It’s also hard to do without distributing incomes more broadly and the trends go against that during an economic contraction.
Renewable energy and energy efficiency are necessary for allowing a rise in consumption that is both affordable and sustainable. Of course China recognizes this and is doing what it can to help Chinese businesses become the world leaders in these areas.
“and unless the US is unable to accomplish these goals”
I think US will NOT BE ABLE to accomplish these goals – US consumer savings are off-set by the govt deficit these days..when/how do you think the govt deficit will come down for aggregate saving to increase? I am betting that it will be near impossible to accomplish theses goal in the next decade.
On the contrary, Mr. Ross, it would appear that Lao-Tsu anticipated Say’s law and the idea that capital investment is necessary condition for income generation. This is in stark contrast to Keynes. Don’t forget that China is a profoundly capitalist country on which socialism was imposed, not the other way round.
One more time Michael, the trade deficit and socalled savings glut was produced by an excess of credit in the United States. You might read The MOnetary Sins of the West by Jacques Rueff. Being the US is the reserve currency, the financing of trade occurs without the money actually leaving the country, unlike most other countries. Rueff was afraid that the actions of the US during the 1950′s and 1960′s was going to precipitate another great depression, due to the gold standard and the fact the US was taking liberties with its reserve status. China could actually acquire treasuries, use them to collateralize yuan and for all practical purposes keep the money in the country. The only use for American money besides monetary collateralization is to acquire American goods or commodities in world trade. In short we are looking at a Wall Street and Citi corp created bubble, of course with complicity from Alan Greenspan.
I like reading your site because you raise these great questions, especially the fictions that underlay the global trade imbalance and what is sure to be a really tough time over the near term in China. Being China is still a communist style country, its measure has very little to do with utilization and a lot to do with production of things the market might not need like surplus manufacturing and business capacity. I believe the real significance will show up in the mining business worldwide, where there will be a massive collapse, but there will be reprecussions in international money flows, as I sense that there will be an attempt to pull out of China by many once it becomes clear how bad the mess is going to become.
typo, possibly? Last sentence in excerpted para currently reads:
“self-perpetuating increase in Asian savings, which then forced higher consumption onto Asian countries. ”
should read:
“self-perpetuating increase in Asian savings, which then forced higher consumption onto non-Asian countries. ”
from:
“Why does this matter?
The issue of what drove what is not simply of academic interest. The consequences for the world of a system in which imbalances were driven by a sudden and self-perpetuating explosion in US consumption, which then forced higher savings onto Asian countries, are very different from a system in which imbalances were driven by a sudden and self-perpetuating increase in Asian savings, which then forced higher consumption onto Asian countries. “
Michael, what are your views on changes in global savings preference? What is the economic effect if consumers, businesses and governments world-wide (on aggregate) decrease their preference for present consumption and increase savings? Would the equilibrium state move to a lower interest rate, higher investment point? Would unemployment be higher?
Very interesting about fiscal policy postponing the correction, rather than fixing it. This is what many believe, but somewhat difficult to explain. Nice job with this post.
If Asian “savings glut” had forced the Fed to keep the interest low, it would have been reflected in the effective fed fund rate from 1998-present. But the Fed did not cut interest rate drastically except during the periods from 9/11 to 6/2004 and from 3/2008 until now.
http://www.federalreserve.gov/releases/h15/data/Monthly/H15_FF_O.txt
The IMF shock solutions to the Asian Financial Crisis are a big part of this desire for a savings buffer. No one wants to go the way of Suharto or have the ethnic riots (largely anti-Chinese) that Indonesia had. The humiliations imposed by Western finance have not been forgotten.
The IMF is a much weaker institution now, and really, all international organizations are. The likely collapse of greenhouse emissions talks will make that even more clear.
Very interesting analysis. I’m a financially non-technical person, so pardon me if this question is dumb, but wouldn’t one response be for the US to become protectionist in regards to finished goods? This would help push Chinasia to eat their own production and reduce their savings.
Piaw Na, thanks for the correction. That was sloppy on my part because I was just assuming that all major Chinese philosophers either belonged to the Legalist tradition or to the Confucian tradition, and since the Taoist Lao-tzu was certainly not a Legalist…
The decisive argument against the ‘savings glut’ theory is precisely the one quoted by Professor Pettis from Stephen Roach: ‘According to Roach there has been no significant increase in global savings during the savings-glut-hypothesis period, which pretty much demolishes the idea of a saving glut.’ Stephen Roach is factually accurate. There has been no increase in the global savings rate.
Professor Pettis’s reply to Stephen Roach is: ‘I disagree because the hypothesis doesn’t imply in any way that global savings have increased. In a closed economic system, unless investment has increased commensurately, an increase in savings in one part of the system must necessarily come with a reduction in savings elsewhere, and this was exactly the point of ascribing the current trade imbalances to a forced rise in Asian savings. Rising Asian savings “forced” declining US savings by causing the US financial system to accommodate growing domestic liquidity by taking on risk.’ (emphasis added)
But the world economy is not ‘closed’ in the relevant sense that there is a fixed cap to the savings rate. If savings were rising in Asia, most of which it must be recalled is used to finance investment and therefore growth in the Asian economies themselves, the US could have also raised its own savings rate – with the result that world savings would have increased. The US is not forced to lower its savings rate because Asia has a high savings rate.
The reason Asia is right to have a high savings rate is evident. After division of labour (technically reflected in growth accounting as a rise in ‘intermediate products’) fixed investment is the most important lever of economic growth not only in developing countries, such as China, but in developed economies as well. As Dale Jorgenson, the world’s leading expert on productivity growth, notes: ‘investment in tangible assets is the most important source of economic growth in the G7 nations. The contribution of capital inputs exceeds that of total factor productivity for all countries for all periods.’
In order to finance a very high level of economic growth the Asian economies necessarily had to have a very high level of fixed investment, which in turn requires a high savings level – as investment can only be financed by savings. If the US pursued policies which led to it having a far lower rate of investment, and therefore a far lower rate of growth, than the Asian economies that is a problem created by the US but not Asia. It is undesirable from the point of view of both world economic growth and world social welfare that the rate of growth of Asia’s economies should slow down to that of the US.
Regarding the latter point it is worth quoting another paper of Professor Quah : ‘Between 1981 and 2005 the number of people in the world living on less than PPP [Parity Purchasing Power] $1.25 a day fell from 1904 million to 1400 million, a reduction in world poverty of 504 million people. Over this time, the East Asia and Pacific region saw its population in that low-income bracket decline from 1088 million to 337 million: This is a reduction of 751 million, and thus 50% larger than the worlds decline overall. In fact, in China alone, the number of people living on less than PPP$1.25 a day fell from 835 million to 208 million, a fall of 627 million, already itself greater than the entire worlds poverty reduction.’
He therefore concludes: ‘From the perspective of global growth and income distribution, the economic successes of East and Southeast Asia are striking: Poverty alleviation in China alone has recently accounted for 100% of that for all of humanity.’
In short it was the US which chose to respond to high savings and investment rates in Asia by having a low savings rate itself – the responsibility does not lie with the Asian economies because the economic system is not in the relevant sense ‘closed’. The problem, therefore, was the low level of saving in the US, not the high level of Asian saving. The consequence of the high savings and investment rates in the Asian economies, in the first place of course China, was a high rate of economic growth and a huge increase in world social welfare. It is consequently highly undesirable that the Asian economies should reduce their investment and savings levels downwards towards the US level.
[...] Yet another discussion on the Asian savings glut hypothesis, and why it matters Michael Pettis [...]
John Ross,
From being a regular reader who never comments I see that I am becoming a more frequent commenter, and always for the same reasons.
The first part of your comment again fails to understand the dynamics that Pettis describes, and Pettis might not know that even Stephen Roach has abandoned that argument long ago. Excess savings in one part of the system do not require total savings to go up. If they did, there would be no imbalance and no distortion outside the saving country. They are distortionary precisely because they force countervailing measures elsewhere. You are ready to blame US monetary policy for forcing adjustment elsewhere in the world, but you cannot conceive of policy elsewhere as forcing adjustment in the US. Isn’t that just a form of Orientalism – the assumption that only Western policies matter, while the rest of the world must sweetly and dumbly accept its fate? If the Chinese trade surplus is the biggest ever seen in the history of the world, as Pettis asserts (and even if it is merely among the biggest), why could that not have been a consequence of Chinese policies, and why can that not cause benign or malign adjustments elsewhere, especially in very flexible open economies?
The second part of your post seems totally irrelevant to me. To argue that there could not have been oversavings and overinvestment in Asia (bad) because of the poverty reduction that took place (good), is like saying that there could not be a sub-prime crisis in the US (bad) because many low-income American families who had never been able to own homes before were finally able to (good), or that the debt-fueled policies of Mexico in the late 1970s were not bad because for a while Mexican economic growth rates were extremely high. Besides being wrong in all three cases, in fact the former statement is even more questionable than the two latter statements because simply pointing to two events and assuming one caused the other is easier to justify in the latter cases.
Even assuming that there couldn’t have been overinvestment for those reasons, the over-savings argument implicitly defines over-saving, as you yourself acknowledge in other comments, as savings that exceed investment. In China, by 2007, savings exceeded investment by nearly 10% of GDP. Even if all that investment was sustainable, never misallocated, and fully justified, why does the system require a massive trade surplus? To put it another way, why did Chinese investment require a savings glut? If wages and interest income had been permitted to rise, so that China’s net savings were lower and Chinese growth more fairly distributed to the poor rather than to the rich, why would that suggest to you that there would have been less poverty alleviation in China? I would argue the opposite. Had savings and investment been better matched, not only would Chinese growth be healthier and more sustainable, but Chinese wealth would be better distributed and the poor better off.
MarcoPolo, I like your cynicism about US export growth. I share it. In spite of what Pettis says I think it will be tough to change this
JMQ, I am not sure of the numbers but Pettis says it was rapid consumption growth, not slow GDP growth, that caused the rising US trade deficit. If that is true, then the problem was financial I think.
Bob_in_MA, that was a really interesting piece. Thank you for posting it.
Ross, you use the argument that “investment is good” as a pretty big crutch to justify a lot of non sequiters. Probably everyone agrees that there is no serious and sustainable growth without investment, and it is annoying that you keep pulling this out as a great revelation. But this does not mean that all investment is good, nor that any condition that accompanies rising investment is optimal, and especially that policies that exchange the undervalued product of those investment for overvalued foreign products or assets benefits the Chinese.
The Savings Glut Hypothesis is so simple minded that it is really scary that someone with the stellar economic credentials of Ben Bernanke could have proposed it. But it would take an exhaustive study of globalization of economies and finance over the last 40 years to fully explain it. MP started a pretty good outline here, and I could even add some points, but like MP says, it’s getting kind of long.
As far as re-balancing goes, the only way I can see it happening is for a sort of de-facto de-coupling to take place. The US, Japan, and Europe are on more or less equal footing from a competitive standpoint, but China and to a lesser extent the rest of the EMs are getting to the point where the developed world cannot compete. The only thing keeping developed world corporations competitive is outsourcing manufacturing (or technical services in the case of India..IBM is doing great) and trying to retain finance, maybe design, sales and marketing. But the Chinese want out of that bottle.
So if the Chinese won’t let their currency re-val up, then the debtor developed world needs to stop buying. Couple ways to do that…increase personal savings rate has been a popular one lately. But then there is the National Savings Rate. That is the one where the government raises taxes. Doesn’t seem like there will be enough money to go around tho.
Also, I don’t think China can really boost domestic consumption without a substaintial minimum wage law. So the ball is in their court again here.
Then I’ve got one more obvious question. If there is a savings glut, then why is Ben printing up money to buy $300B in treasuries, $1.25T in MBS, and 200B in GSE bonds?
I guess the answer is we blew away a bunch of money with popping asset bubbles. But shouldn’t someone come up with a hypothesis about how this happens?
As you start off by saying, when two variables always have the same absolute magnitude, it’s not possible to say one is causing the other.
In historical context, I think you should leave it at that. Americans have had a preference for present consumption implying a very high subjective discount rate, while the Chinese have been more future-oriented, looking forward to the anticipated “Chinese Century,” and have had a low rate of time discount.
Everything else follows. And frankly, I can’t see how turning China into an American-style consumer society is going to help humankind transition to sustainable growth.
A few quick comments –
One way to establish causality of the imbalances is to determine what was the primary metric that prevented the imbalance from being rectified for an extended period of time. That is, why did the imbalances did not correct themselves and what prevented it from being corrected…
The only answer to that question is the Chinese currency policy. If chinese currency was allowed to appreciate, we neither would have had trade balances of the magnitude that we did have nor would we have the hoard of bonds in the Chinese officialdom.
The other action that could have prevented the imbalance was withdrawl of the pro-consumption interest rate policies of the Fed. This gives you a clue as well. Even when they started tightening, it did not have the necessary impact due to the currency policy and its corollary bond hoarding policies of the Chinese policymakers.
Therefore, if Chinese currency policy was the cause of the imbalance, it implies that the mechanism of action for the imbalance was the higher savings and lower consumption that such a policy causes. IN other words, if chinese currency was allowed to depreciate, imports would have been cheaper and consumption would have increased in china and vice versa in the US.
Secondly, your point about how all of this is going to end is absolutely correct. Take a step back…In the last 4 decades in the world, we have added more production capacity than we have increased consumption, primarily due to EM countries becoming more of an integral part of the global production system. If you accept that and also the fact that that consumption in the biggest consumer economy is going down and investment in the biggest investment economy is going up, that can not be a good solution for the imbalances. It will further increase the investment/consumption imabalnce in the world.
Ultimately, all of this is pointing to the fact that we are still going down the slippery slope of deflation…the current rebound is a mere stopping point before we slip further down. Globalization and peace will be the final victim of the current round of bad policy making.
I hope I am wrong on all of this.
“Rising Asian savings “forced” declining US savings by causing the US financial system to accommodate growing domestic liquidity by taking on risk (again, no sarcasm please – you might disagree but in itself this is not implausible).”
This, and given the hypothesis that the 1997 Asian crisis led to a mercantilist policies, we should see a discontinuity in the US savings rate at that time. Yet looking at the NBER savings chart, there has been a pretty steady decline in the US savings rate since the early 1980s. There is a steeper decline around this time, but it returns the decline to a steady path since the 80s.
This then should heavily discount the 1997 mercantilist policies as the (primary) starting point. Looking at it more holistically, those mercantilist policy makers would look at the declining US savings rate and institute such a policy to take advantage of the declining US savings, *and* get a war chest to boot.
So the question then becomes, why has the US savings rate declined over the last 25 years, and who would be expected to fill the gap since by the equilibrium statement it must come from somewhere?
Way too much text based on a simplistic premise. One would infer from your analysis that there is a perfectly frictionless pipeline connecting the US and China, and that trade flows in either direction based on the purchase/save decisions of the citizens on each endof the pipe. But that of course is nonsense. The US has a ridiculously open market for imports from China and elsewhere, while China has one of the most closed markets on Earth. Witness their stimulus plan and contrast with ours. Great hoopla about the US insisting that US tax dollars be spent, in small part, on US steel products. The China program specifies that 100% of the stimulus money be spent on Chineese made goods, unless there is no Chineese product available. Witness the restrictions on imports of American films — 5 per year, which must all pass muster with a government censor. Of course American media content is freely available in actuality to Chineese consumers — they just don’t pay us for it. There are many many other examples of Chineese (and other Asian) barriers to US made products and Services (Insurance and banking are two). So blame the Chineese government for the imbalances. They, along with a flacid US response, caused the problem.
“Cedric Regula
Then I’ve got one more obvious question. If there is a savings glut, then why is Ben printing up money to buy $300B in treasuries, $1.25T in MBS, and 200B in GSE bonds?
I guess the answer is we blew away a bunch of money with popping asset bubbles. But shouldn’t someone come up with a hypothesis about how this happens?”
Here is some clue on the potential cost of bailing out those Wall Street crooks!
http://www.bloomberg.com/apps/news?pid=20601087&sid=aQEI97EY.fs0
U.S. Rescue May Reach $23.7 Trillion, Barofsky Says (Update3)
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By Dawn Kopecki and Catherine Dodge
July 20 (Bloomberg) — U.S. taxpayers may be on the hook for as much as $23.7 trillion to bolster the economy and bail out financial companies, said Neil Barofsky, special inspector general for the Treasury’s Troubled Asset Relief Program.
The Treasury’s $700 billion bank-investment program represents a fraction of all federal support to resuscitate the U.S. financial system, including $6.8 trillion in aid offered by the Federal Reserve, Barofsky said in a report released today.
“TARP has evolved into a program of unprecedented scope, scale and complexity,” Barofsky said in testimony prepared for a hearing tomorrow before the House Committee on Oversight and Government Reform.
Treasury spokesman Andrew Williams said the U.S. has spent less than $2 trillion so far and that Barofsky’s estimates are flawed because they don’t take into account assets that back those programs or fees charged to recoup some costs shouldered by taxpayers.
“These estimates of potential exposures do not provide a useful framework for evaluating the potential cost of these programs,” Williams said. “This estimate includes programs at their hypothetical maximum size, and it was never likely that the programs would be maxed out at the same time.”
Barofsky’s estimates include $2.3 trillion in programs offered by the Federal Deposit Insurance Corp., $7.4 trillion in TARP and other aid from the Treasury and $7.2 trillion in federal money for Fannie Mae, Freddie Mac, credit unions, Veterans Affairs and other federal programs.
Treasury’s Comment
Williams said the programs include escalating fee structures designed to make them “increasingly unattractive as financial markets normalize.” Dependence on these federal programs has begun to decline, as shown by $70 billion in TARP capital investments that has already been repaid, Williams said.
Barofsky offered criticism in a separate quarterly report of Treasury’s implementation of TARP, saying the department has “repeatedly failed to adopt recommendations” needed to provide transparency and fulfill the administration’s goal to implement TARP “with the highest degree of accountability.”
As a result, taxpayers don’t know how TARP recipients are using the money or the value of the investments, he said in the report.
‘Falling Short’
“This administration promised an ‘unprecedented level’ of accountability and oversight, but as this report reveals, they are falling far short of that promise,” Representative Darrell Issa of California, the top Republican on the oversight committee, said in a statement. “The American people deserve to know how their tax dollars are being spent.”
The Treasury has spent $441 billion of TARP funds so far and has allocated $202.1 billion more for other spending, according to Barofsky. In the nine months since Congress authorized TARP, Treasury has created 12 programs involving funds that may reach almost $3 trillion, he said.
Treasury Secretary Timothy Geithner should press banks for more information on how they use the more than $200 billion the government has pumped into U.S. financial institutions, Barofsky said in a separate report.
The inspector general surveyed 360 banks that have received TARP capital, including Bank of America Corp., JPMorgan Chase & Co. and Wells Fargo & Co. The responses, which the inspector general said it didn’t verify independently, showed that 83 percent of banks used TARP money for lending, while 43 percent used funds to add to their capital cushion and 31 percent made new investments.
Barofsky said the TARP inspector general’s office has 35 ongoing criminal and civil investigations that include suspected accounting, securities and mortgage fraud; insider trading; and tax investigations related to the abuse of TARP programs.
To contact the reporters on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net; Catherine Dodge in Washington at Cdodge1@bloomberg.net.
Last Updated: July 20, 2009 15:01 EDT
Hi Dr. P.,
I know I’ve mentioned this controversial idea here in the past, but the logic seems inescapable to me, so at the risk of becoming boring, I’ll repeat it one last time.
Assumptions:
1. China needs to continue to over-produce for political/economic/social-stability reasons.
2. It is difficult/unwise to make drastic structural changes to the financial system. Therefore it needs to function in a way that is similar to how it works today for some time into the future.
3. The US is unable or unwilling to continue in the current savings & consumption relationship due to balance sheet problems.
If the above are true, it seems there are only two possible outcomes. Either China goes through a difficult period of reduced output (negative growth), causing politically intolerable widespread unemployment.
Or, somehow China writes off the debt – in a way that repairs the US consumer balance sheet and allows the US to continue to over-consume and China to overproduce. Probably as a very large, high-level diplomatic agreement package.
I know this is a counter-intuitive solution. But it allows the (admittedly) dysfunctional system to continue until imbalances can be worked out over time.
Possibly China can find an alternative consumer base to replace the US consumer and absorb it’s overproduction. But the US consumer is tried and true. And the alternatives, especially to China, are not great.
Here’s an idea: The US ‘sells’ some territory to China, for some arbitrarily high price. This gives China a face-saving way of writing off the debt while gaining some nominal asset.
Guam for sale, anyone? Taiwan? Hawaii? (Alaska?!)
Armando:
Some eye popping numbers from Barofsky, but that is obviously a bunch of crap. The US would do a Argentina or Zimbabwe long before they could borrow or print that kind of money.
But he does raise the issue of Fannie and Freddie, and I think the future of those entities has been under discussed lately. They are supposed to get private investment to make loans, not be supported by Fed or Treasury funding. If not, then we have completely nationalized the mortgage industry, and probably housing by association.
On whether the 1997 Asian Crisis caused mercantilism, I’m not sure Asia really had a choice in that one. They needed to build CB reserves, and also the IMF said “make it so.”
Plus the US made it easy. The confluence of the tech, Internet and telecom boom of the later 90s made the US economy one of the strongest in the world. A stock market boom plus an arguably relatively tight monetary policy resulted in a very strong dollar(dollar index hit 120 vs 80 today), especially vs. the afflicted Asian currencies. I feel sorry for anyone still in US manufacturing during that period. And of course putting cheap Asian stuff in our CPI calculations helps keep US inflation low. Never mind US healthcare and education went up 10X since the 70s.
But over the long term, starting with an emerging Japan, Asian economies have always been “protectionist”, and always pursued “export driven” models. I believe that pretty much meets the definition of mercantilism.
Here is a link of latest Peter Schiff on the debt ceiling. Peter Schiff was among the first economist that have seen the housing mess since 2005 while all the so-called experts were telling everyone on TV that the economy is fine and dandy!
http://www.youtube.com/watch?v=X_EHncb_s_4&eurl=http%3A%2F%2Fforums.bharat-rakshak.com%2Fviewtopic.php%3Ff%3D2%26t%3D4551%26start%3D2440&feature=player_embedded#t=55
“So the question then becomes, why has the US savings rate declined over the last 25 years, and who would be expected to fill the gap since by the equilibrium statement it must come from somewhere?”
-Mac
I’m not sure about the 2nd part of your question, but the first part surely had to do with easy consumer credit. Look at the chart that CR has posted here:
http://www.calculatedriskblog.com/2009/06/consumption-down-saving-rate-increases.html
…and then compare it to consumer indebtedness compared to GDP here:
http://www.calculatedriskblog.com/2005/02/recovery-built-on-marshland-of-debt.html
I think Dr. Pettis’ previous statements are spot-on about increasing consumer indebtedness in the US being *necessary* to prop up employment and GDP. If Greenspan had kept interest rates higher than they were we wouldn’t be in the debt mess that we’re in now, but unemployment would have much higher and GDP… well we might have turned Japanese in 2001.
Lovely discussion. I know this comment will be moderated and if it’s not appropriate for a Chinese blog I hope you will delete it with enough explanation or edit it so that I won’t make the same mistake again.
There are a couple of burrs under my saddle and I want to get this out. And then if it seems silly, well it’s internet, just flame me.
In the comments above there are mentioned several market distortions that could lead to trade imbalance; exchange rates, open/closed markets, etc., etc. I take that together as what Professor Pettis is calling “mercantilist policy”. Each of us seem to have our favorite mercantilist policy to gripe about. Mine is property rights.
China never needed an industrial economy. I don’t know why they think they do today. Europe and the Americas needed industry because Europe and the Americas didn’t have the population necessary to farm the land they had. China always had abundant labor. And Chinese agricultural methods were adequate by the Ming Dynasty. Productivity per acre (hectare) has traditionally been better on small plots (yes, there are examples today where that doesn’t hold). Productivity per man/hour…well nothing tops a tractor. Property rights followed agriculture. Hunter gatherers don’t need to own property. And in those _ primitive _ societies they often don’t. Agricultural societies need to confer harvest rights to those who make the investment in planting. Industrial economies need to confer development rights (patients) to developers. Witness the great difference in the concepts of property rights east to west. I don’t know Chinese, but somehow “intellectual property” doesn’t translate. And it’s not just piracy, but a completely different understanding. Perhaps one of you with a better understanding will want to take that up.
My point is that the west wishes to import labor, which has always been limited there. And wishes to export technology. The imbalance is caused because technology includes development costs which go unrecognized as property. There can be no balance. It’s a one way street. Having been one of the foremost advocates of globalization, I am so sorry that it took me so many years to see this.
One of the greatest barriers to trade is the knowledge on the part of the west that if you are to sell technology you must recover your development cost on the first transaction because it is a sure thing your first product will be taken apart, reverse engineered and within a very short time be sold back into your western markets as your competition.
Last thing I want is to start a trade war. I wrote above about horizontal business models. That’s the way we import that labor. Or, if you prefer, the way we lower the labor component of production. That’s done. It would take years to turn that around. And without it, or you could say without a strong dollar, no more business model.
Mac’s point, that household savings in the U.S. was declining since the early 1980s, is definitely true. I think it was much an increase in debt load as a decrease in savings, but that amounts to the same thing. Household debt went from about 65% of disposable income in 1975 to about 140% in 2007.
This increase in debt levels, sinking savings and rising income inequality all progressed concurrently for 30 years and it seems likely they are all related.
But the Asian model was used by Japan, South Korea, Singapore, Taiwan, etc., for quite a while before the 1998 crisis, so it isn’t clear there isn’t relationship.
Mac & Bob
Re: Household debt load increasing since 1980
We in the US may not be savers, but we certainly are investors. Reagan’s tax exemptions for retirement “savings” (I use the “” because most of that went into speculative investments via money managers) must have been part of that. And we have leveraged ourselves to max that out. Included in that was real estate which was thought of as a fail safe investment.
Professor,
Do you see a sharp correction occurring anytime soon in the Shanghai or Hand Seng indices?
And longer term, do you think the Chinese authorities will turn credit loose that is aimed at the everyday common Chinese folk instead of banks and stock speculators? This is a critical step if they are ever to grow consumer spending.
Professor Pettis: A terrific posting.
The parallels with the famous Keynes and Ohlin debate on the “German Transfer Problem” are striking.
Policy makers have clearly learned from the the 1930s and initial reactions have been far less perverse than feared.
Where I disagree with your story is on East Asia’s “excessive” build up of foreign reserves. The 1997 financial Tsunami devastated balance sheets with excessive short-term, US$ liabilities. This time around East Asia has bounced back far more quickly than the pessimists predicted due to better balance-sheet positions.
Hence, while the future of the world economy is difficult, you may underestimate the Chinese economy’s capacity to adapt and change. An amusing example of how unwanted inventories for export are being shifted to domestic consumption was published in the NY Times last week.
This described a start-up of a business student in Peking that has mobilised the entire campus. This internet site lists consumer items at huge 75+% discounts (skirts, boots, TVs, digital cameras, portable telephones,etc. produced for Western markets) with technical details and photos. Orders from stores and individuals are filled from unwanted factory inventories and delivered to specific delivery points, with a payment system similar to Ebay or Paypal. Business is booming!
This is one example of how Say’s Law and a pragmatic “Capitalist” society with a socialist government has been able to find “out of the box” solutions. Others will surely follow, regards James
Sorting out what caused the current crisis is important, but using a framework of internally consistent macro economic identities will get us only so far. Ironically, about eight years ago I ran into Dani Rodrik in the Kennedy School forum while I was carrying a recently purchased copy of Michael’s book, The Volatility Machine, which Dani had very favorably reviewed. At some point in our conversation, he shook his head and said something like, “You know, the world economy is just over-determined”. The current crisis has many explanations; many are plausible; some may be correct. It’s important to identify cause from correlation. The identities are ex-post relationships. The flows that result in them adding-up are determined by behavior interacting with policy imposed constraints (the closure rules). I think everyone agrees on the importance of the identity framework and constraints. And we also agree (and the data show) that after 1997, reserve balances grew substantially in Asia and later in to petro-countries. And we know that the tri-lemma constraint (which gives us insight into the implications of policy choices regarding exchange rate flexibility, capital account openness, and monetary policy) shows clearly a post-1997 move in Asia toward policies required to either build up reserve insurance and/or aggressively support export led growth. We also know that during the same period the US saving rate fell and, as the identities lead us to expect, the current account balance worsened. What led to what?
Bibow says, “To begin with, there can be little doubt that the global boom was sponsored by highly expansionary U.S. fiscal and monetary policies.” (p 16). We all agree on the identities, so the theory that explains the recent configuration of the identities involves a disagreement about the main impulse: U.S. liquidity resulting in a consumption boom that in the context of China’s currency policy caused a huge build up of reserves OR, or what exactly? The other story seems to take the Asian reserves as given, i.e. ex-post they are there in the capital surplus of the Asian BoP, so therefore since they start the story as a given, the US saving rate has to fall, which is the mirror image somehow of the consumption boom. This is not convincing to me for the following reasons.
First, Bibow’s graphs show a pretty steady 15 year fall in the US personal saving rate. American’s (I am one) have a think for debt (I don’t). Public sector debt is more variable, so the current account deficit sometimes masks the private saving trend.
Second, there has been dramatic financial innovation in the US, leading to the rise of the shadow banking system and securitized lending. A new paper (nber 15223) by Gorton and Metrick, “Securitized Banking and the Run on Repo”, shows the dramatic rise of mortgage related issuance, an increasing portion of it being asset-backed, beginning in 2000. They both rise 5-6 fold over a 3-4 year period. In a paper called “Financial Crises and Bank Liquidity Creation” (Oct, 2008), Berger and Bouwman develop a measure of “abnormal liquidity creation” that does a pretty good job of explaining crisis episodes in the US, without resort to conditions in foreign capital markets. “Liquidity and Financial Cycles” (BIS no 256) by Adrian and Shin show how recent financial innovation has led to liquidity cum leverage based financial cycles. Reinhart and Rogoff’s now-famous “This Time It’s Different” paper (2008,VOX and other sources) is consistent with all this. So I think is Philippon’s very interesting paper”Why Has the U.S. Financila Sector Grown so Much? (NBER, June 2008)
I think the strong hypothesis is that the financial innovation combined with financial system deregulation and Fed policy choices reinforcing these innovation, set off real estate and other asset booms. This spilled into the real economy causing acceleration of declining private saving rates i.e. a consumption boom. The post 1997 changes in Asian reserve accumulation policy dovetailed these independent forces, already underway, in the US financial and ultimately goods markets. Through the leverage producing processes explained by Adrian and Shin, we entered an explosive cycle. The resulting imbalance between opaque long-term assets held on balance sheets financed by short term repo financing is at some scale very unstable. I don’t think the so-called Asian Saving Glut really can explain this, except perhaps a role it might have played in keeping interest rates low during the explosive stage of the leverage cycle. But at that point in the leverage cycle the dynamics seem to be both internally sustaining in both directions. By this I mean that liquidity is behaving well outside the reigns of central bank control.
I think Bibow’s paper (s), and the others mentioned above, tell a strong story. They help us sort out the strong ideas from the weaker ones in the potentially over-determined world economy. The global saving glut “camp” (as Michael puts it) has to come up with a better game.
It is important to sort this out as best we can so that some mutual understanding can serve as a basis for policy reforms that both deficit and surplus countries can buy in to.
Richard Goldman
Let’s just call some proportion of all of this mercantilism. The difference between the tigers and China is that China is a continental economy, and the scale factors that have been at work are far stronger than they ever were during the the 1990s. So anyway, if the exchange rate is pegged, or heavily managed, and productivity in China (in both the tradeable/non sectors) is higher than than in the US and other major trading partners – as it clearly has been, then wages are repressed by definition. Poor workers subsidize foreign consumers, and somehow manage to save. The implications of the term “savings glut” is not quite right, but over time what this contributes to is a monetary mechanism between the liquidity center – the US Fed – and the PBOC that enables this loop to continue. Imbalances can’t be unilateral. There is lots of talk now about underinvestment in the US, a proposition that is a bit cheeky to me given that excess household investment in real estate and the trappings thereof was a big contributor to the current mess. Excess investment enabled excess consumption, and I would propose that the monetary relationships globally contributed to the excess investment. The consumption side of this in the US and Europe(don’t forget that the figures for Europe are far uglier than those for the US) is entirely the fault of a irresponsbile consumer behavior. Linking the savings glut to over-consumption wrongly leaps over the multilateral financial and investment relationships as a necessary intermediate step. With a government that promoted the idea that “deficits don’t matter”, it is no wonder why no one was watching while consumers were spending away their future income with glee.
Thinking ahead. small point:
I think your movie numbers are off. The Official limit on foreign films is more like 20, and last year more than 50 were shown in chinese cinemas. This year i think the number could be higher. It may not be a democracy, but Chinese people often get what they want!
Having said that , having a quota at all (even if ignored) is obviously a policy aimed at closing the market.
Bob_in_MA, I need to think about it more but my first response would be that if median income in the US had been higher, ceteris paribus, there would have probably been less borrowing and lower gross savings just as you suggest, although the net savings would be the same. Clearly matters have been made worse in both countries by increasing income inequality. In the case of the US because it resulted in higher gross debt levels (although probably also lower net savings), which have an adverse financial distress impact, and in China by lowering savings.
CG (and Livingstone), as I have argued many times before, we tend to focus only on currency regimes and trade tariffs as determinants of trade balances, but I think there were a lot of policies that affected trade, and limiting the discussion to the currency not only limits the effectiveness of the discussion, but it also causes us to misunderstand the impact of other policies. Also, remember that after the Plaza accords, when the yen surged against the dollar, the Japanese trade surplus with the US also surged. This was because to reduce the impact of the currency revaluation the Japanese authorities channeled even more subsidized financing into the manufacturing sector..
Harikg, I have discussed some of these policies before, for example in the June 4 entry.
Christopher, yes, but WHY does China produce for less? As you implicitly suggest, it is not enough to say that it produces cheaply because of low labor costs since other countries have equal or lower labor costs, and Chinese production is just as cheap in areas that are capital intensive, not labor intensive. For example a friend of mine that heads the Chinese sub of a European chemicals company complains that even though China does not have nay of the natural advantages – it has no advantage in sourcing raw materials and it is way behind in the quality of its technology – Chinese chemical companies are still making cheaper chemicals. Why? Because there are many effective production subsidies.
The most obvious is extremely low borrowing costs – very important in an industry as capital-intensive as chemicals – but they also benefit from low labor costs and restrictions on unionization, from low environmental requirements, from a cheap currency, which reduces local costs relative to foreign costs, from very good infrastructure, and from government-directed activities. Some of these low costs are for “good” reasons, in the sense that they are productivity enhancing (good infrastructure being the most obvious) and others are less good because they effectively represent a tax on households the proceeds of which are used to subsidize producers. It is this effective subsidy, I suspect, which will make it difficult for China to continue increasing productivity efficiently.
By the way I am not sure anyone is underestimating the power of the $2 trillion in reserves. On the contrary, I think too many people overestimate it. Reserves are great to protect a country from a balance of payments crisis or from an external debt crisis, but China suffers from neither. If China has a problem, like the US in the 1930s it will be a problem of domestic banks and domestic overproduction, and just as the fact that having the highest reserves in history in 1928 did not help the US much, China’s reserves today won’t help it much. In fact the accumulation of those reserves is part of the problem.
Mari, you may be right, but that assumes that the USG is able and willing to borrow huge amounts for an awful long time.
Thanks Lark. I corrected it.
Belisarius, if the world decides to raise its savings rate, without increasing its investment rate commensurately, it will only be able to do so with a contraction in global GDP. There are many ways this can happen, and I can’t go into all the scenarios, but in the aggregate if we all buy fewer things, one way or the other we will all have also to sell fewer things.
Drew, in fact the US could become more protectionist, and that might even create a short-term boost in GDP growth, but most economists agree that a sharp contraction in global trade, which would almost certainly be the result of a more protectionist US, would cause much slower global GDP growth. That says nothing about how that slower growth would be shared, but in general it is pretty safe to assume that all of us, to varying degrees, would come out worse.
John Ross, I agree with JohnT that your interpretation of Stephen Roach’s argument misses the point – a savings glut in one part of the world does not imply a sharp rise in global savings at all. It seems to me that almost no one bothers using that argument against the Asian savings glut hypothesis any more. I also agree with Glenn’s point that you too easily confuse “investment is good” with “capital is not misallocated”.
Benign, I am not sure that anyone is suggesting that the only alternatives for China are to continue with the lowest consumption rate in the world or for it to adjust toward having the highest consumption rate in the world. I am sure there are some reasonable levels in between.
Livingstone, yes, when you look at trends in savings, investment, and consumption on a global level, it is hard to figure out how to get all the numbers to balance in a benign way. But balance they must.
Thinking Ahead, I am not sure I would ever assume that “there is a perfectly frictionless pipeline connecting the US and China” and it is a totally unnecessary assumption for any of my arguments. Thanks for pointing out that it is nonsense, but I am not sure there is anyone in the world who would think otherwise.
Dave G, I am not sure the proposal is counterintuitive and controversial so much as impractical, unnecessary and unlikely. Countries don’t usually write off their entire foreign currency reserves willingly and China, as one of the poorest countries in the world, is not likely to forgive $2 trillion in debt just so that the US can keep running a large trade deficit and China accumulate the debt again. Also, besides the fact that it would be as politically impossible for the US to sell part of the country as it would for China or anyone else, there is absolutely no need for the US to do so. Its debt levels are well within the range of other rich countries (and much lower than some) and the US economy has a history of very rapid change and adjustment to adverse conditions.
Chan-lee, great story, and one that underlines something I want to write about in a future posting. There is a long history of bubbles in the US economy, and every bubble, when it implodes, leads to tons of hand-wringing and worries about decline, but many years later the collapses of these bubbles were often recognized as the beginnings of a new series of rapid change and productivity growth. I don’t want to get into this now, as it really requires a much longer posting, but the social benefits of the collapse of overinvestment cycles depends to a very large extent, I think, on the liquidation process.
If overbuilt networks and capacity are forced into rapid liquidation, the process leads to a collapse of prices that can create the basis for a future explosion in productivity growth (after all it took the foolish expenditures by the likes of GlobalCrossing and Qwest, and their subsequent liquidations, to create the conditions for cheap, high quality internet access that has spurred the Aamazons, Googles and Ebays of the world). If not, the excess capacity is merely dead weight for the economy. The story you give is an example of the former process. Let’s hope we see a lot more liquidation of excess capacity in China. That can eventually create a whole new source of growth.
Richard Goldman, thanks for your contribution to this discussion. Of course you are right that it much more complex than any model can capture, and there are serious reservations about any simple explanation that has yet been developed (in fact it is always easier to show why competing models are wrong than why our own preferred models are right). Still, the various explanations create fairly stark differences in policy proposals, and what worries me is that policymakers in the main economies may be working at cross purposes. My basic thrust is to argue we nmeed far more and far better policy coordination between the major economies, and I think this is a logical conclusion from any model that accepts that at least a significant “cause” of the imbalances where mercantilist polices imposed partly in response to the Asian crisis.
Lum lum, I think you are falling into the trap of assuming that the imbalance was all caused by one factor (side) or the other. It is very possible that there was both irresponsible behavior on the part of US households and on the part of Chinese policymakers.
An excellent post by Michael.
Incidentally, in my book, Fixing Global Finance, I also make the argument that if the imbalances had indeed been driven by US spending, the symptom would include high real interest rates in the world and probably higher measured inflation in the US (as domestic prices of non-tradeables were driven up). In other words, this is a “crowding out” hypothesis. The argument that excess savings in the rest of the world was the driving mechanism is consistent with the evidence of low real interest rates and low inflation everywhere. In other words, excess US spending was “crowded in”.
Martin Wolf
The direction of causality which you propose, that excessive saving by elsewhere caused insufficient savings in the US, thereby creating the global imbalances, simply does not make chronological sense – and particularly as regards China.
US savings, after being constant for most of the post-war period, began to fall sharply after 1981 – at which time they were 20.9% of US GDP. By the 1st quarter of 2009 US savings were 11.5% of GDP. In particular the decline of US saving was inaugurated due to tax cutting by the Reagan administration, coupled with large increases in government expenditure in the military field, which led to the huge budget deficit.
As US investment did not fall in line with US saving, the US balance of payments deficit also first appeared after 1981. The temporary recovery of the US balance of payments in 1991 was primarily due to US investment falling, and not US saving rising, and the US balance of payments moved into permanent deficit after 1991.
At that time China was in essential balance of payments equilibrium. China’s balance of payments surplus did not emerge until 2005, a point you rightly make in Fixing Global Finance (p84). This was 24 years after US savings began to decline and the US balance of payments moved into deficit.
Unless one believes in causation from the future, which evidently you don’t, a process which started in China 24 years later cannot have ‘caused’ a decline in US saving which began 24 years previously, nor can it have caused the renewed deterioration of the US balance of payments which occurred after 1991 – that is 14 years previously.
This is particularly clear when the reasons for the inauguration of the decline in US savings are so evident.
This is a terrific discussion – the main essay and then the comments afterwards.
I did not do a good enough job going over it above, but I am surprised how few (I dont think any) of the comments are considering how the USA global security calculations go into this current situation.
As I said prior – even with the housing boom and bust, it has been to date and will be shown to be over the long run cheaper to allow China’s exporting system to continue and to allow China’s reserve accumulation. Cheaper in terms of the other alternative in maintaining a USA security presence in Asia that would offset Chinese expansion of interest in the area. The interests of China for a much less propserous country as they would not have the present trade exports.
The deal is simple: the USA allows China to cook the books even to the detriment of immediate USA trade and commerce as long as the USA does not have to have 2 more aircraft task forces in the Pacific and as long as the USA can avoid a Cold War like build up of USA security interests in the Asia.
I think te current trade approach is also a more thoughful and civil approach, especially when considering the USA trade management and foreign policy in regards to Japan in the 1930s and 1940s. That trade policy killed millions and destroyed much in national treasure for all in the area – and the USA.
The Chinese reserves and resulting “savings glut” and the impact on flow of funds in the USA is basically a USA defense and security issue.
China should be mindful of this and understand general USA electorate support is required and be respectful in areas, no matter how “populist” they may be, for humnan rights and the likes of “global warming”. If China loses the currently dispassionate focus of the USA electorate and instead causes ire – the trade advantage could be legislated away and then the USA will revert to hard assets in the Asian area for defense.
As Michael Pettis appropriately says, discussions of this savings glut question too easily fall into a blame game debate. Let me try to explain, therefore, in technical terms what I see the problem to be and why I think the question remains an open one, despite Michael’s careful analysis. Although I disagree with Michael on the endpoint of his reasoning, I endorse strongly the view that the global imbalance issue is extremely important.
Turn now to the substance. The verbal “Who are the predators” argument is interesting but doesn’t really help determine causality. And let’s be clear – causality is what this problem concerns.
So before we try to unpack the question in multi-varied ways, we should just recognize that, technically at least, we are dealing here with a relatively standard problem: There is a demand schedule and a supply schedule for global capital; disturbances perturb these schedules in different ways and at different times. Usually, economists look at price outcomes to see where the dominant disturbance is – this is the standard identification procedure in such systems – Setser and Wolf (and before them Bernanke) look at interest rates and say that a declining interest rate can be consistent only with the driving disturbance coming from the supply side of international capital.
I had said in my November 2008 blog entry that that standard identification procedure can be confounded when yet other disturbances affect this global market for capital. So, for instance, actions by central banks, following the then-accepted understanding on inflation, would have lowered interest rates independently of whether yet other shocks to the system came from the demand side or the supply side.
I then said that conditional on such auxiliary, independent moves – by central banks or whoever else, that are important but not central to the question of causality – we can examine the contemporaneous collection of bilateral trade deficit statistics to see which was more reasonable: a cluster of correlated shocks on the supply side, or a single sequence of shocks on the demand side ending up simultaneously perturbing the entire set of bilateral trade deficits. Occam’s Razor led me to conclude, tentatively, that the latter is the right explanation, i.e., a persistent sequence of disturbances emerging from US markets drove the collective outcome in global imbalances.
I do not think about blame here – I think only of identifying causality and the sources of disturbances.
Yet others in this commentary have already referred to role played by the de facto reserve currency/safe haven that is the US dollar. I did not bring this up in my original blog posting but I do agree that there is a natural tie-in of those ideas with the analysis I presented – as with too the important facts that John Ross has injected in this discussion. There is a great deal more to say here but this comment on Michael’s blog item has already gotten way too long. I hope to provide an independent post on these other matters soon.
Martin Wolf
“Crowding out” vs “crowding in” needs much more than a free market explanation, as I’m sure you are aware, and also sure that you expanding on in a lengthier book format.
The poor Chinese worker did not choose to work for peanuts(or rice , I guess) so that the PBoC could accumulate huge excess reserves and re-cycle them into treasuries and GSEs.
The peasant in Saudi Arabia didn’t tell the Saudi Royal family to re-cycle excess dollars into treasuries.
This holds true for most of the rest of oil producers, commodity producers and EM tradeables exporters.
So this is solely due to government and central bank policies.
And most of these countries are pegging to the Dollar(reserve currency) and they print equal amounts of their own currencies in the process, then generally buy “zero risk” treasuries or GSEs(once upon a time). The US exported inflation to these countries, and they have been busily sterilizing the dollar inflows. It makes sense this has resulted in a “Global Glut of Liquidity”, if you add all the freshly printed foreign currency. With the Euro coming of age as an alternative reserve currency, Europe “benefited” from this dynamic as well.
This all seemed to work from an inflation perspective because of the underlying growth of global productive capacity, at a low price. But then again we did change how inflation is calculated, and we do underweight much of the US economy when computing the CPI. So by definition, if the Fed uses inflation as a key indicator to formulate domestic monetary policy, and we make the calculation look more favorable, then the Fed runs looser monetary policy relative to what it was the past. Then they try to exclude growing bubbles from monetary policy. Haha.
Then all this liquidity flowing to the US(reserve curency w/ zero risk government debt) had to be transformed to consumer credit. GSEs was the most direct route, but selling treasuries means the government doesn’t need to raise taxes, so we can’t ignore the GDP boost we get from that.
Then the dollar dropped most the whole time, so private foreign investors should have been disuaded by poor returns. But they had ZIRP and QE in Japan, so they were an easy mark, and the rest of the participants were CBs with a different agenda other than investment returns.
Once the housing bubble got started, then there was HEW to put money in the consumers pocket. This helps finance the trade deficit, and it all comes back to the USG eventually anyway.
Then we started securitization of everything from credit card debt to mortgages of all varieties. Then we got phony ratings on the debt from the rating agencies, which greatly helped propel sales. Then let’s not forget the low risk fixed income US investor. They were starved for returns and went “searching for yield” to quote the financial press in the first part of the decade. Many found junk camouflaged as low yielding investment grade debt.
Many more instances of financial engineering of low interest rates in the US abound. The carry trade by banks funded by low interest savings was good thru about 2004. ZIRP in Japan and near ZIRP in Switzerland fueled a cross currency carry trade to treasuries. The US Treasury under issued new long term debt and moved to shorter term financing, largely because their customers are CBs and that’s what the customer demanded. That of course kept long rates down on all debt. I find it very funny that Bernanke didn’t see that one.
So any idea that that has anything to do with a market economy with real people participating, at least ones that haven’t had their minds twisted by government policy, is pretty far from the truth.
I have a couple of ideas that people will probably ignore here at the end of a very long thread – never mind.
First, I wonder about the policy response implied in both the Asian Glut and American Overconsumption theories. If you’re arguing that it’s the fault of American overconsumption, then presumeably your preferred response is to reduce US consumption. If you were an Asian exporter, is that something you’d really be hoping for?
There are a lot of triumphalist noises coming out of China now, people saying that China’s still achieving high growth while exports to the US have declined, proving that China doesn’t need US consumption. If that’s really the case, then why are so many subsidies (e.g. export tax rebates) for exporters being increased? Is the Chinese government really confident that they no longer need exports to drive growth?
The other explanation, Asian glut, seems to imply a rather friendlier solution – a gradual change in policies in China to support higher consumption. Just improving the banking sector would help, and today there’s news of water prices going up. This seems much less scary than asking the Americans to stop buying Asian stuff.
Second, I wonder if I can try the old undergraduate essay standby: there’s thesis and antithesis, so could I suggest one kind of synthesis.
The US and Asian economies developed in very different situations. The US does growth all by itself. Consumption – the ultimate end of all economic activity – occurs within the US, and technological progress is also homegrown. Asian economies developed in a way such that they create growth *given* an inexhaustible consumer elsewhere in the world. The US’s economic configuration means that it is very open to imports and capital flows, and this allowed the “Asian glut” to cause US overconsumption. Of course, there are many ways that this could have been stopped. If the US government had adopted policies similar to the Asian exporters, it could have created high levels of savings and more investment. But then the world would be a different place (a more slowly-growing place). And the fact is that the US is not that kind of a country/economy.
So, there are clearly causal factors on both sides: the openness of the US economy + the development policies of Asian economies. The US position was sustainable in a world which comprised only other developed economies and small developing ones. Now that there is a very large, very poor economy in the form of China, the game theory of the situation changes a bit. The US may be forced to reconfigure its economy to protect itself from these imbalances occurring over and over. But it seems likely that a commitment on the part of developing economies to not treat the US as an inexhaustible resource would be less wasteful.
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I got this from Peter Schiff and which he squarely place the blame on Greenspan for the whole mess. He lower the interest rate greatly in order to stimulate the USA economy so it flood the entire market with cheap money. It lead to several bubble, 1st the DOT.COM bubble in which NASDAQ went to 5000 and then back to 1500 so in the process eliminating 2 to 3 trillion of dollar in equity.
After the 9/11 attack and combined with the DOT.COM bubble blown up, the Fed has to lower interest rate to keep the economy humming and avoid a recession. However, it fueled the housing bubble first, then the commodity bubble (oil barrel at $140). It was the Fed decision to lower the interest rate that cause the problem in the first place and now the Fed is keeping the interest rate even lower and printing money like there is not tomorrow and I wonder who are they going to blame next?
Peter Schiff pretty much predicted this entire mess long time ago.
Look at the link
http://www.youtube.com/watch?v=zdVP_sgCETo
Here is an excerpt from Peter Schiff
http://www.europac.net/externalframeset.asp?id=60&type=schiff
Monday, June 30, 2003 12:23 PM
Greenspan adds fuel to the fire
With his latest interest rate cut Alan Greenspan adds additional fuel to the fire burning away the foundation of a U.S. economy that has already been weakened by too much debt and too little savings and production.
During the Fed-created boom of the 1990’s, many investments were made based on false signals which the Fed’s easy money policy sent to the markets. By lowering interest rates and expanding money supply, the markets responded as if true savings had been increased, and time preferences for money had been extended. In addition, as foreigners temporarily diverted their savings into U.S. assets, additional false signals were sent to the markets, enabling further malinvestments.
When the equity bubble burst in 2000, the market began cleansing itself of the excesses of the boom. However, Greenspan’s irresponsible rate cuts interfered with the market’s natural corrective process by postponing liquidations and creating additional misallocations of capital. The recession, in actuality the cure for the illness that infected the economy in the 1990’s, was cut short by the Fed, allowing the disease to spread throughout more sectors of the economy, particularly housing. In its efforts to mask the symptoms, Greenspan has done irreparable harm, as the disease is now so advanced that it may be terminal.
Cutting rates is part of the problem, not the cure. In order for the economy to truly recover interest rates need to rise, more businesses need to fail, individual balance sheets need to be repaired, capital needs to be re-allocated, bad debts need to be written off, investors need to lose even more money, real estate prices must be allowed to fall, and workers need to be laid off (human capital needs to be re-allocated to more productive uses as well.) All of the preceding may sound harsh, but that is what needs to happen and that is what will happen. The Fed cannot stop, but merely postpone, this process, and in so doing make the ultimate correction that much more severe. The same holds true for the Federal government, as more deficit spending will only delay and exacerbate the problems. Moreover, if the Fed persists on this course to its ultimate conclusion, hyperinflation will destroy the dollar, leading to problems of far greater magnitude than those listed above. And based on the bond market’s reaction to last week’s quarter point rate cut, the Fed might be forced to get “unconventional” sooner than it thinks.
“Christopher, yes, but WHY does China produce for less?” You say “The most obvious is extremely low borrowing costs…”
But this begs the question why does it have low borrowing costs? It seems to me you miss out the significance of the legacy of the planned economy. Accepting with the OECD that a fully market economy only began functioning from the mid-1990s onwards, this meant the newly functioning Chinese capitalist economy inherited a mass of means of production and consumption (i.e housing, roads, ports etc.) at no cost. Hence, the labour/capital ratio was very low and the rate of profit high. The reason borrowing is cheap is because the price of money is cheap because profits are high.
Thanks for all the very interesting comments, and especially for interventions by Martin Wolf and Danny Quah, who are among the most thoughtful analysts of the global imbalances.
It is probably unnecessary for me to say that I find Martin Wolf’s point persuasive and that I think John Ross’s point about timing much less convincing. If one assumes that only China has ever followed the types of policies I have discussed and which led to equilibrating outcomes in the US economy, then the fact that there have been earlier bulges in US trade deficit and contractions in US household savings might be problematic, but I think this isn’t the case. As I have argued in many previous posts, I think the so-called Asian development model, of which China serves as the steroid-fueled example, depended on mobilizing savings and generating trade surpluses, and in practice because of the role of the dollar and the flexibility of the US financial system and economy that meant that the US was nearly always the equilibrator. Far more important to me, from a timing perspective, was the post-1997 surge in central bank reserve accumulation, which reached unprecedented levels and which needs to be explained. I am not politically correct enough to assume that policies instituted by developing countries are merely reactionary and have no external implications.
George Robertson, although I am willing to believe in an implicit or explicit security arrangement with Japan during the Cold War, I am not sure I agree that there is such an arrangement with China. At any rate I don’t think changes in the US savings rate are likely to be determined solely or even primarily by security factors.
Professor Quah, I suspect that in the end we will all conclude that there were multiple factors – I suspect the financing of the Iraq adventure played an important role – and I look forward to your next post. To repeat my main concern, there are two main components about the current global adjustment that are affected by this analysis. First, there seems to be a forced adjustment in US household consumption and savings rates that is likely to continue for many years. Second, Chinese fiscal and monetary policy responses to the crisis, in my opinion, may be reinforcing the existing development model, so that if the savings/consumption imbalance is home-grown, and not caused externally, the adjustment to a change in US consumption will be made all the more difficult.
Thank you, Professor. Lesson learned, an economics blog is naught without its accounting identities. I’ll refrain from the obnoxious and unsubstantiated earlier comments. I just re-read your April 25th post which I somehow had already forgotten. I apologize for that too. Indeed US consumption has peaked as %GDP. The consumer is tapped out. Banking problems will keep credit tight. Monetary policy & stimulus pushes on a string as long as that bank credit is tight. Housing, commercial real estate, and construction have their own excess inventories to adjust (and as we both know that’s actually worse in other places) which will keep bank credit tight and before that adjustment is complete the boomer demographic will depress those needs further. US employment and wages show no sign of improvement and the US has also, like China, implicitly transferred future household income to fund public debt reducing future consumer spending. There’s a further risk that pushing on that string will raise commodity prices and costs adding still more pressure. US household consumption is being forced to adjust. This on top of an already saturated US market. The Chinese face a dismal prospect for their export industries.
US businesses, on the other hand, are in a more favorable position. The US has not much invested in China and preferred to simply source from Chinese manufacturers. The US can match its procurement to demand more easily than China can match its production to demand. That disparity is going to be important pretty soon for its impact on what we are going to be calling “trade tensions”. Causality going forward, correcting the imbalance, will reflect that dynamic. Chinese savers may not have been “forced” to lend to over-extended US consumers, but they will be forced to adjust to lower demand. The only think I can think of which could change these identities would be a sudden and global realignment in the value of the dollar, perhaps a non-negligible probability given the potential of helicopters, but more likely also to exacerbate the imbalances than to ameliorate them.
Michael: “First, there seems to be a forced adjustment in US household consumption…”
Michael, while that’s true, all official policy seems to be geared at increasing that consumption. I think you have commented that the U.S. seems to be addressing, or at least acknowledging, its side of the imbalance more seriously than China. But if you look at many of the policies being implemented here, they are meant to increase consumption and investment through increases in household debt.
Two of the obvious symptoms of the credit bubble here were that 40% of homebuyers in 2005-2007 put no money towards a down payment, and car loans were often for 110-125% of purchase price so the buyer could pay off the unpaid balance on the loan used to buy the car they were now trading in.
Now, 50% of new mortgages are FHA loans, which require just 3.5% down. But first-time buyers will get a 10% tax credit (up to $8,000), which can be applied toward the downpayment. So those buying the average, post-bubble starter home/condo are putting no money down, and many will end up getting cash back.
With the cash-for-clunkers program, the vast majority of buyers turned in vehicles that had no outstanding debt payments, for new ones carrying new loans, and still walked away with some cash.
The U.S. government is actually paying the household sector to increase its debt load. Is this so different from China subsidizing the building of more ships, to keep up the demand for steel?
I have yet to see any serious discussion here of what is a manageable debt load for households, and how do we get there? I feel we will get there in the same way the Chinese will arrive at reasonable level of steel production: very painfully.
I am going to have to agree with Cedric. It was neither the savings glut or the consumption binge that caused this. Any complex network has to be able to withstand large disturbances. It was the prevention of homeostatic responses that allowed the perpetuation of the imbalances to continue to crisis proportions. No one had the guts to say say this is to much of a good thing. So, in full agreement with Cedric “this is solely due to government and central bank policies”.
Well – last kick at the can regarding the primacy of the geo-political security issues in finding “causality” in economic results, especially in regards to the current world economic crisis and China.
Every major war or conflict the USA has fought had their roots in either terms of trade or protecting mercantilist ventures abroad. Even The Revolutionary War is obviously a mercantilist trade dispute – but it had staying power due to the ideological underpinnings. I don’t think anyone would debate this view on American history, but to perhaps make an argument that that trade issues were a co-primary (can I have such a word?) causality.
One doesn’t have to even debate the primacy of this variable when reading Asian history, as the primacy of trade and commerce for being the root for all conflict in the area for the last 3 centuries leaps out at one immediately. We don’t even need Niels to reveal that to us in Asia, for in Asia we have the Dutch, the Western powers exploiting China with exclusive and forced trade concessions, the establishment of Hong Kong as a trade factory, the Japanese-American War (WW II) which one can easily see the start in the Root-Takahira Trade Agreement where at first Japan and the USA were partners in the exploitation of China but later set the stage for Pearl Harbor. Then the strategy for a “defeated” Japan to use soft power and security arrangements with the USA to rebuild their industrial base, a policy that led directly to their crash in 89. Then China to use the current industrialization and growth policy based on trade.
Japan did not have an implicit security arrangement with the USA during the Cold War but an explicit well defined security agreement. Few would argue that the nature of that security arrangement defined the economic policy the two countries pursued in relationship to each other; Japan was allowed to use a rigged currency and exporting industrial policy in return the USA gained security from Japan with their agreement to be non-nuclear, the allowed presence of the troops in Okinawa, support of the Korean policy, and later the benign support of the Viet Nam policy.
Why has a sudden massive sea change now occurred with the China’s current economic policy in regards to the 3 centuries long historical record and despite the centrality of China to USA security concerns in Asia (and vice versa)? Do you really think folks at the Fed, Treasury, and State are not well versed in the historical record and fully cognizant of the “real” terms of trade with China and what the results would be in the end? Bernanke, though he was circumspect and subtle, outlined that China trade policy with the USA as the main causality for the current economic status of the USA. How could the USA leadership not be fully aware that the end of an allowed mercantilist framework would result in bubbles and busts in the USA – or whatever asset the US dollars created by this trade funded; especially when many now in power and defining USA policy were participants in the OPEC oil-dollar recycling crisis to the LDCs and later the Japanese boom and bust? I think it is given that it is realized by Chinese and American leaders that China trade policy is the same old same old.
Why would such a dismal economic results be sought by Chinese and American leadership? Because it is preferred to the alterative to which it forestalls or prevents. With so much history showing the obvious primacy of Asian trade policy in terms of USA security objectives, shouldn’t one then come to the conclusion that not only is this “savings glut” well understood by leadership in both the USA and China but was anticipated, and despite the current outcome it is preferred to the alternative as demonstrated by the long bloody history. The “savigs glut” is policy and was the intended results.
I think the long running Asian historical record shows that that the current Chinese-American trade policy is intended policy, that the results are sought, and this is a de facto “agreement”, or treaty, between China and the USA. I personally find it a far more enlightened and humane policy than prior policy which dominated the long term historical record.
It is not economic science which should be deployed in considering the Chinese trade policy and the “savings glut” – but history and foreign policy analysis.
Or, I think we could easily rid ourselves of the “savings glut” and force “fair” terms on Chinese trade in a flash. That could be accomplished next week. And the resulting effect would be to eliminate this “bubble economy” pattern in the USA.
But if we were to “fix” the problem without providing an alternative, then war would be the results. If the “correct” economic fix was applied, then the question resulting would be is would war with China be via proxy in, say, Africa or directly.
This should be a very real concern for economists who so quickly go “tut tut” and assign moral qualities to proliferate American consumption or to “mendacious” currency levels maintained by China. Those “tut tut” concerns are trivial in context to the “beast” that has so far been successfully been kept chained down in the basement.
I always admired Danny Quah for his “twin peaks” work on income distribution and analysis of the impact of globalism. Quah did not take the easy road, where most of his peers went down, talking about the iniquity of the rich Western powers (usually the USA) in exploiting the LDC via globalism. Quah honestly pointed out the indisputable good globalism was achieving for the poor world wide – that it was an indisputable good, though of course could and should be improved. But he insisted on responsibility in economic analysis in terms of accepting the empirical record and the impact of changes in economic policy.
Something along those lines should be applied to the analysis of current Chinese trade policy.
Well this debate has certainly got legs. Most impressive all around! The FT has swept into action on China’s economy the last two days, including mention of the new 4 character phrase “guojinmintui” – the state enters and the private citizen (Sector) retreats. I would recommend the IRON ROOSTER article from the FT to anyone who hasn’t seen it yet.
As a shift in topic focus, and perhaps to poke Professor Pettis towards another entry, there are rumours and proposals swirling here in Beijing about various (between 2 and 4) changes from the CBRC – including CAR, tier 2 classification, provision coverage punishments and risk assets. I can’t help but see it as quite a large policy offensive against the lending that has been going on Dec – June. Many banks will be forced to tighten lending, be more strict on recovering loans and implement rights issues to meet new regulations – if they are brought into effect. Will this bring forward the appearance of NPLs?
I long thought that the Asian Savings Glut hypothesis has to be amended with a Western Investment Drought hypothesis.
What we could see in the past 20-30 years was a collapse in Western investment because the industry was relocating to Asia.
Naturally there was an investment boom in Asia parallel.
The collapse in investments has just become apparent this spring with the collapse in residential investment in the US.
However I think that residential investment should not really be accounted as “investment” as it does not increase output in the long term. Residential housing is just a special consumer durable good.
From this point of view, Western investment probably collapsed after the dot com crisis. The Infocom revolution of the 90s was anyways only temporary reversing the long term trend from the beginning of the 1980s, i.e. industry relocating to Asia.
What happened afterwards was that savings went into financing consumption.
But whereas financing investments creates future growth, financing consumption only moves growth from the future into present.
So I think that the way out from this crisis has many paths. The point is that investments (not housing) has to recover in the West. Because only output enhancing investments can create growth.
1. The low price of savings spurs an autonomous technological revolution e.g biotech or alternative energy that raises the investment ratio in the West.
2. Asia starts to put a net demand of consumer goods into the world system instead of net supply of consumer goods. This provokes a boom in the consumer goods industry in the West. Quite unlikely IMHO
3. Asia performs an internal demand led growth, which increases its net demand for natural resources. This provokes a boom in the energy industry everywhere.
4. Business as usual. Asia continues to pump net supply into the world and the West cannot come up with new innovations.
The world would see alternating periods of reflation and deflation, miniature versions of the 2008 crisis repeated on and on.
George Robertson,
I think you are probably right in determining that the result of balanced (thus reduced) trade between Asia and the West could be war. Most probably a cold war. However I think that decision makers are not influenced by this constraint.
They are more likely constrained by democratic elections which form the economic policies in the way of maximizing consumption.
Asian political systems have somewhat different feedback mechanisms and they tend to be optimizing for industrial output.
And there is the underlying fundamentum of labour abundancy in Asia, which puts Asia into a position of competitive advantage for investments and industrial activity.
Michael Pettis
In dealing with my reply to Martin Wolf you refer to two issues – one on saving, one on investment.
Regarding saving you argue that, while agreeing that China could not have been responsible for the origin of the US balance of payments deficits, as China’s large surplus did not begin until 2005 and the US deficit started in 1981, the policies of other Asian states were responsible. But this ignores the very clear causal origins of the decline in US savings. The Reagan administration through the combination of tax cuts and very large increases in government expenditure (mainly military) moved the US budget into large deficit. Unless there had been a corresponding increase in either household or company savings (for which no compensating US policies were adopted), or a radical fall in investment, then this decline in savings could only be absorbed by the international sector – that is by the US balance of payments moving into large deficit (as occurred). But this decline in US savings was clearly inaugurated by internal processes in the US, not by trends in Asia
Regarding investment you state: ‘I also agree with Glenn’s point that you too easily confuse “investment is good” with “capital is not misallocated”.’ It is certainly possible to have situations where capital is overall misallocated and even very high investment produces very low growth. Countries pursuing import substitution strategies (Argentina, the USSR, India prior to its reforms) classically suffer from this problem. But what is at stake is not a distinction in principle, which is recognised, but the actual factual situation with China. The distinction between ‘good’ and ‘misallocation’ is one that can measured quantitatively for the economy via productivity – most comprehensively via total factor productivity. The major studies show total factor productivity in China is either ‘respectable’ (Alwyn Young) or high (Jorgenson). In either case high investment is an entirely rational (i.e. a ‘good’ and not ‘misallocated’ investment) policy because it produces high economic growth.
The final issue relates to the national accounting identities – whose frequent appearance in this discussion is due to the fact that they are the only way to maintain clarity on the quantitative relation between domestic and international balances. There is a point in your reply to Belisarius, related to both savings and investment, which is unclear as it appears either intended as an extreme innovation in economic theory, which therefore should be justified, or as a misformulation which should be corrected so it can be clearly understood. You write: ‘if the world decides to raise its savings rate, without increasing its investment rate commensurately, it will only be able to do so with a contraction in global GDP. There are many ways this can happen, and I can’t go into all the scenarios, but in the aggregate if we all buy fewer things, one way or the other we will all have also to sell fewer things.’
But world (i.e. total) savings, by definition, are necessarily equal to world (i.e. total) investment (a disparity is naturally possible nationally). It is therefore impossible for the world to raise its savings rate without raising its investment rate commensurately. So what are the ‘many ways this can happen’? Your formulation may have been intended to refer to the possibility of lack of effective demand leading to a decline in both investment and savings, or some other point, but it will still necessarily remain the case that world savings and investment are equal. I assume that your statement was simply a misformulation, in which case the discussion is proceeding within a common economic accounting framework, or are you really arguing that world saving and world investment can differ – in which case we are into a totally different level of difference not regarding China but regarding the whole of economics? As the current discussion is excellent and clarificatory it would seem important also to have clarity on this point.
One point of great interest in the discussion is that made by Bob_in_MA. I have commented here previously that, contrary to frequent but inaccurate assertions in sections of the press, consumption has increased as a proportion of US GDP during the financial crisis. Bob_in_MA’s is the clearest outline I have seen anywhere of some of the detailed mechanisms by which this occurred.
Bob_in_MA, yes, one of the consequences of the crisis is that everybody reacts to the adjustment in the imbalances by trying to slow the adjustment as much as possible, so while China invests more the US encourages more consumption. I guess this is a natural policy reaction to what would otherwise be a brutal adjustment process, but of course there is always a risk that it effectively postpones the needed adjustment and makes it harder. In the case of the US, much of fiscal policy, as you note, may be aimed at slowing the contraction in household consumption. My instinct is that temporarily boosting production in China may be more harmful to long-term prospects than temporarily boosting consumption in the US, but I would need to work out exactly why.
Glenn M, I think you are right, and that there were many opportunities – none of which were taken – by monetary authorities both in China and the US to put an end, or at least slow down, the self-reinforcing monetary relationships between the two that led to such extremes, but when the party is raging no one likes to take the cocaine away until someone gets a heart attack.
Houhui, yes I saw that article and note that the minority worrying is now increasingly becoming widespread. Obviously I, and probably you too, am/are not surprised. I do address the increasingly wary bank regulators in today’s posting.
John Ross, I am not sure my proposal represents an extreme innovation so much as a fairly well-understood accounting identity, and I suspect that if you weren’t still playing this silly and very tedious game of “gotcha” you would have tried to understand the statement within its context, and probably would have managed to do so. If the savings rate rises, and GDP declines, total savings can rise, stay they same, OR decline, depending on how fast the savings rate rises and GDP declines. This is just arithmetic. Please don’t expect me to play this sill game every time you propose it.
Lemiwinks,
I like it, but we already do make a distinction between investment in tradable sectors and investment outside tradable sectors such as housing. One of the major criticisms of IMF & World Bank, etc. (Too long ago for me to remember the specifics.) of Thailand & Korea in the 90’s was how much investment was going into real estate. But a lot of that had been going into housing a rapidly urbanizing population. Like in Hanjin City. So, there’s a level at which you can think of that as a necessary component of production. Prof. Pettis is surely right that the Asians took a lesson from that. Contrast that to the housing investment made in the US.
The Western Investment Drought, as you call it, is also interesting. We locate factories near the resources they require. Pittsburgh comes to mind; located on a good river system where ore can come from the Great Lakes, coal from the Appalachians, and lime which somehow I remember as being necessary to the process. Improvements in communication, to use the word in the French sense, have created new possibilities. Now we have spent 2 decades off-shoring our industry to locations that had an abundant labor resource. And we’ve gone one further. We have created “flat” business models in which several business entities handle the SAME component of production. Example: Dell Computer. Production itself becomes a commodity and you can often source your production more easily and more cheaply than if you were to do it yourself. Why should I capitalize a factory when I can source my production so easily? We don’t save just on labor. We save also on capital costs. So, there’s a limit to how much and where tradable sectors investment will recover in the west.
So, what I’m trying to do is to highlight this view in which China is just one more of those entities within that flat business model which handle a part of the multi-national production process. Investment in tradable goods sectors must be made there. How that gets integrated financially without creating imbalanced capital flows, and the stresses which follow, is beyond me. That’s why it amuses me to read these blogs. But it’s also why I think rebalancing must come from Chinese demand.
Houhui: “Well this debate has certainly got legs. Most impressive all around! The FT has swept into action on China’s economy the last two days, including mention of the new 4 character phrase “guojinmintui” – the state enters and the private citizen (Sector) retreats. I would recommend the IRON ROOSTER article from the FT to anyone who hasn’t seen it yet.”
Here is a quote from the FT article on IRON ROOSTER: “Yet over the next three years, the railways ministry plans to add 20,000km of track to the existing 80,000km, with a total investment of more than Rmb2,000bn. At this rate, China’s rail network will this year overtake that of India to become the second-longest in the world, behind the US.”
Overtake that of India this year? What an astonishing achievement for China! Don’t you find a little irony in this statement? Doesn’t it tell you something about the status of China’s railway (and the necessity of the investment)?
The author of the article has formed an opinion and went out to collect information to “prove” his point; in the process he either collected wrong information or simply misinformed.
For example, the author quotes that China’s passenger vehicles stand at 38 million (vs 230 million in the US). With China’s automobile sales projecting to exceed 11 million this year and have been close to 10 million sales in the last few years, don’t you think the number of 38 million is a bit suspicious or fair (why include only passenger vehicle only)? I’m sure everyone understand you don’t build infrastructure for this year or next year, particularly with the growth that China has had.
The quoted number that “China’s high-speed road network would expand to 180,000km in the next few years” is misleading. The number 180,000km is combined total of PROPOSED by the provincial governments, not something planned or budgeted for the next few years. One thing is for sure: it’s NOT going to happen. And, if you remember, last year when central government announced the 4 trillion stimulus package, the combined total PROPOSED projects submitted by the provincial and local governments is 18 trillion!
The provincial and local governments’ zeal in investments is nothing new. But there are check-and-balance built into the system. Large infrastructure investment projects have to go through a set of processes to get approved, with China Development and Planning Commission serving as the gate-keeper (large airport projects will even need to be approved at the Premier’s regular meeting). Take another example, twice in the last 15 years, the State Council has put a freeze on all city metro projects when local governments were getting out of control, once in 1995 and once in 2002.
There have been a lot of wasted infrastructure investments in China in the past (the most notorious being the Zhuhai Airport); there are wasteful spending in the current wave of infrastructure investments and I suspect there will be stupid infrastructure projects in the future. The important thing is to keep some perspective, put it in the right context, and look at the big picture (even though the execution is equally important).
This discussion has been going on for a while, so I shall just add a couple of points that have not already been made.
The fact that, before the crisis, credit and liquidity spreads were historically narrow suggests that the driver of the imbalance between China and America was a greater investor demand for lower-quality US debt, probably fostered by financial innovation. Although demand for this debt displaced US treasuries, these loans financed increased housing investment and consumption, drawing in more goods imports from China, which given the renminbi peg (at, incidentally, a level set well before the Asia crisis), prompted China to buy dollars and thence treasuries. China’s reserve accumulation was an automatic reaction to a US domestically-led boom. The alternative explanation, that US investors responded to Chinese buying with a “search for yield” would require, since the yield on spread product fell by proportionately more than on treasuries, that US investors had an irresponsibly strong preference for yield over safety (from credit risk or illiquidity).
While musing about a “saving glut” driving down long term yields, the Federal Reserve itself was in fact the biggest central bank holder of treasuries (to supply and collateralise their own currency) until about 2006. At the time the Fed would have argued that treasury yields were set by monetary policy expectations so that their open market operations did not shape the yield curve, but the Fed’s present quantitative easing strategy of buying long term debt to lower long term yields suggests that the Fed would now accept that they could have done something to resist falling long term yields before the crisis if they had wanted.
As usual, thanks for your comments, RE. I see this is one of the issues that will take years to resolve. Two points: First, it seems to me that during most periods of very rapid monetary expansion, whatever the cause, risk appetites rise sharply and cause spreads to decline even as the risk-free rates decline (and as a emerging-markets bond trader for fifteen years I can say that I have seen that happen many times). That is why we would have seen the search for yield in the midst of the savings glut. As an aside I have argued before that the reason why “stages” of the industrial revolution seem always to occur during asset bubbles and globalization periods is that they are all driven by the same thing — increasing risk appetite that drives investment into developing countries, high techs, Florida swamp land and lots of other risky assets.
Second point: the fact that the Fed could have stopped the process by raising interest rates and didn’t, was probably a mistake, but there was anyway a cost to doing so. If the increase in liquidity was indeed caused by the savings glut mechanism, one consequence would have been a rise in US unemployment as the tradable goods sector in the US shrank to accommodate the expansion in the Asian trade surplus (this is Martin Wolf’s argument, by the way) and the Fed had to choose between higher unemployment and too-loose money. They may have made the wrong choice, but it is not obvious that they were fully responsible.
From the Baseline Scenario blog http://baselinescenario.com/ – another logical, sensible and insightful perspective that “excess Chinese savings” DID NOT cause the US financial crisis.
Posted: 28 Aug 2009 03:00 AM PDT
Menzie Chinn, one of my favorite bloggers, and Jeffry Frieden have a short and highly readable article up on the causes of the financial crisis.
Chinn is not given to ideological ranting and is a great believer in actually looking at data, so I place significant weight in what he says.
Chinn and Frieden place the emphasis on excessive American borrowing, by both the public and private sectors.
This disaster is, in our view, merely the most recent example of a “capital flow cycle,” in which foreign capital floods a country, stimulates an economic boom, encourages financial leveraging and risk taking, and eventually culminates in a crash.
They have little patience for the idea that the financial crisis was the fault of Chinese over-saving:
“It is necessary to dispense with the view that all this excess saving from the rest of the world was “forced” upon us. The rest of the world’s capital flowed to us, in part, because we wanted to borrow, and we wanted to borrow because of the Bush administration’s emphasis from 2001 to 2008 on cutting taxes while still spending.”
They do endorse as exacerbating factors the low interest rates set by the Federal Reserve earlier this decade, and the growth of a large and unregulated financial sector:
“Essentially, the development of an unregulated financial sector has circumvented the entire panoply of banking regulation created in the wake of the Great Depression. This made the financial system vulnerable to traditional “bank panics,” or “runs” on the financial system. The abdication of regulatory oversight (particularly in allowing high leverage) in the presence of too many institutions “too large to fail” meant the buildup of implicit financial liability on the part of the government”
Hmmmmm.
Nice done. Your article gives another layer of abstraction.
Using a bit less of abstraction, the drivers were:
1.) Global wage arbitrage: the US (global!) consumer buying cheap products, undermining his own economy, buying from cheap Asian workers thereby getting relatively high(er) wages. Exacerbated primarily in the US by:
2.) Cheap US credit.
3.) Lax credit and financial regulation in the US.
4.) “everyone should own a house” mentality by political officials in the US (and, I think, even in Spain)
5.) As I have heard — Chinese officials trying to prevent direct connections between domestic production and consumption. Why? Maybe because of the Asian crisis as you mentioned. Maybe because of unsustainable live style that would have developed thereby (pollution, high oil consumption etc.).
6.) Chinese demand for high-quality production enterprises in order to accelerate their technical evolution.
7.) Missing wage arbitrage regulation in front of the background of neoliberal thinking distributed by officials at the IMF, Worldbank etc. etc. etc.
According the Galbraith, one of the most devastating drivers of imbalances are social moods boosted by officials (US housing, for example) and accompanied by ccoresponding liquidity generating actions.
My actual point is: beware of the politicians. Their regulations form the world much more than anything else.