Savings Glut or Money Glut?

Martin Wolf returns to the question of whether global imbalances and other features of the international economy are due to a “savings glut” or a “money glut”:

Villains and victims of global capital flows, by Martin Wolf, Commentary, Financial Times: Fast growth, huge current account “imbalances”, low real interest rates and risk spreads, subdued inflation and easy access to finance characterise the world economy. ...

The two interesting alternative explanations are the “savings glut” and the “money glut”. ... The “savings glut” hypothesis is associated with Ben Bernanke... A substantial excess of savings over investment  ... predominantly in China and Japan and the oil exporters ... has led to low global real interest rates and huge capital flows towards the world’s most creditworthy and willing borrowers, above all, US households. The short-term effect is an appreciation of real exchange rates and soaring current account deficits in destination countries. To sustain output in line with potential, domestic demand in those countries must also be substantially higher than gross domestic product. A country must choose fiscal and monetary policies that bring this result about.

Not only has the US absorbed 70 per cent of the rest of the world’s surplus capital, but consumption has accounted for 91 per cent of the increase in gross domestic product in this decade. Thus excess saving in one part of the world has driven excess consumption in another. ...

In the savings-glut world, governments are responsible for much of the capital outflow. This is either because domestic residents are not allowed to hold foreign assets (as in China) or because most of the export revenue accrues to governments (as in the oil exporters). Either way, governments end up with vast foreign currency assets as the counterpart of domestic excess savings.

In this world, the US is passive victim, excess savers are the villains and the Federal Reserve is the hero. In the money-glut world, however, the world’s savers are passive victims, profligate Americans are villains and the Federal Reserve is an anti-hero. In this world the US central bank is a serial bubble-blower...

The argument is that US monetary excess causes low nominal and, given subdued inflationary expectations, real interest rates. This causes rapid credit growth to consumers and a collapse in household savings. The excess spending floods across the frontiers, generating a huge trade deficit and a corresponding outflow of dollars.

The outflow weakens the dollar. Floating currencies are forced up to uncompetitive levels. But pegged currencies are kept down by open-ended foreign currency intervention. This leads to a massive accumulation of foreign currency reserves... It also creates difficulties with sterilising the impact on money supply and inflation.

In this view of the world economy, savings are not a driving force, as in the savings-glut hypothesis, but a passive result of excess money creation by the system’s hegemonic power. ... Governments of countries that possess the huge trade surpluses ... follow the fiscal and monetary policies that sustain the excess savings needed to curb excessive demand and inflation.

It is no surprise that the Federal Reserve is a believer in the savings-glut hypothesis. But many Asians blame their present predicament on “dollar hegemony”, which is the core of the “money-glut” hypothesis. The big questions, however, are which is true and whether it matters.

My answer ... is that the savings-glut hypothesis is truer, [and]... it does matter. If we live in the savings-glut world, the US current account deficit is protecting the world from deep recession. If we live in the money-glut world, that very same deficit is threatening the world with a dollar collapse and, ultimately, even a return of worldwide inflation.

The savings-glut view is far more comforting. Excess savers will learn to spend, in the end – sooner rather than later, if US spending were to weaken dramatically. But if we live in the money-glut world, the great gains in monetary stability of the past quarter century are at risk. Either way, the present world cannot continue indefinitely...

I will just add that it's possible to have both a high level of savings and a high level of liquidity growth at the same time.

Comments

[reason]

I will just add that it's possible to have both a high level of savings and a high level of liquidity growth at the same time.

And just maybe the two are related. (Borrowing always creates a lender - and the lender cannot spend the money he has lent).

How can this story be told without mentioning asset prices? It is asset price falls that are real dam that might burst. Does nobody remember Japan?

[Meh]

There's a bunch of worrying things here:

1) It seems Wolf says "savings glut must be true, otherwise we'd be teetering on the edge of collapse" which hardly seems like a good argument. Rather it seems like a dangerous one.

2) There might well be a savings glut, but all that really posits is that people are foregoing lifestyle improvement to invest. Where did the lifestyle improvement come from in the first place? Inflation? A money glut? Increased productivity?

What we have is lots of money swilling around the US. The contention on the one hand is that Asians (and others) are foregoing life improvements to swill that money around the US. (Savings glut)

But even if that is the case, if the Savings Glut was created out of inflationary policies, rather than increased productivity, then there are still "money glut" dangers around...

As "reason" notes above, the prices of certain other assets (like land/housing) suggest that there have been inflationary actions in the monetary supply...

[anne]

Mark Thoma:

"I will just add that it's possible to have both a high level of savings and a high level of liquidity growth at the same time."

Succinctly clever comment. Notice interest rates for the time being, for only rising long term interest rates bother me much from an economics or investing stance.

[Winslow R.]

"I will just add that it's possible to have both a high level of savings and a high level of liquidity growth at the same time."

The open question is will the unwinding of the money glut (forced by the high Fed rate and falling gov deficits) be matched by an equal, less than or greater than unwinding of the savings glut?

Only China etc. knows :)

How's it feel to have the gov capitulate control over our economy? With Bush in power, not so bad. If we had a decent leader with an acceptable world vision, I'd say spend and take back control.

[paine]

"I will just add that it's possible to have both a high level of savings and a high level of liquidity growth at the same time."
indeed

and further more
credit flows redirect net cash flows
toward "spenders"

and as to inflation

asset markets have seen plenty of that haven't they

this tweeble dee tweedle dum act

is just to cause tight money here so
the eurobank
can stop a credit policy
that's caused an over valued euro
and
a real squeeze in francogermany

larry summers among many others has pointed out

american householders and the bush crusade in oil eden
are the globe's spenders of last resort

[David Pearson]

The "savings glut" hypothesis implies that the Chinese economy cannot absorb its private savings, and that therefore they must be invested abroad. This assumption has the ring of truth to it: clearly the Chinese banking system is incapable of channeling savings to profitable investment projects.

What is less clear, however, is why the U.S. uses foreign savings to finance consumption rather than investment. This is where the "savings glut" hypothesis falls down. What is the justification for rapid consumer credit growth in the absence of capital investments that will create future income to service that debt? Doesn't this behavior imply, in and of itself, that real interest rates are too low? Which of course, leads us back to the "liquidity glut" argument, which has artificially low rates as its starting point.

says...

Doesn't this behavior imply, in and of itself, that real interest rates are too low?

Nope. Current consumption may simply be serviced by lowered consumption in the future, rather than increased income. In the absense of future consumption, most capital investments would be unsustainable.

[Martin]

Mark,

Could these things be the same thing? A kind of equilibrium between the 'cost' of money and the savings rate?

Or could cheap money make people feel no need to save?

[Winslow R.]

What is less clear, however, is why the U.S. uses foreign savings to finance consumption rather than investment. This is where the "savings glut" hypothesis falls down.

Disagree. There is little demand for U.S. product at level of exchange rates necessary to meet foreign saving desires

What is the justification for rapid consumer credit growth in the absence of capital investments that will create future income to service that debt?

Technology transfer and stability to China

Doesn't this behavior imply, in and of itself, that real interest rates are too low?

Not in China's eyes as they are the ones getting paid with real interest plus so much more

Which of course, leads us back to the "liquidity glut" argument, which has artificially low rates as its starting point.

The liquidity glut is ending because Bush is no longer manufacturing copious amounts of tsy secs for the Chinese to buy. To maintain currency stability, the Chinese are being forced to purchase other financial assets. The 'force' is from the Fed's decision to maintain the fed funds rate at 5.25% despite the imploding subprime market which was this first market to feel the effects of an inverted yield curve caused by China's desire to save.

If China had continued to purchase tsy secs despite Bush's lack of new ways to deficit spend, rates would have inverted even further than they already had taking more than just the subprime market down. The Fed may have blinked if the stock market had crashed, or some other catastrophe, but China blinked and started buying stocks instead of tsy secs.

I find the new arrangement highly unstable as well as inefficient like leaning against the wind. Unstable because as the wind stops (China stops buying equities) the whole economy falls down. Inefficient because the wind to support the economy is being blown through the stock market allowing Goldman Sachs types too large of a cut.

It would better for American workers if the Chinese start purchasing products that would make them more efficient. Perhaps they are too smart and rich and would rather just purchase the company.

If they start purchasing intellectual property like Microsoft or military hardware companies it could get too interesting. It would be quite a turnaround if the 'intellectual property' copiers started purchasing 'intellectual property' with all the money they've saved.

[ryyj]

There is a money glut caused by the Fed Reserve. The interesting thing is that the Chinese have had a pegged rate since 1994. There was no imbalance then. The US had small deficits but that changed after 2000. The large imbalances only started when interest rates were cut close to zero by the Fed. Then things started ballooning. Perhaps the entrance of China into WTO has also worsened the situation as US companies started offshoring in a big way. Is that the fault of the Chinese?

[Oupoot]

Its both a savings glut and a liquidity glut. Its a matter of causality, but given the extent to which it has grown, addressing it would require simultaneous and coordinated remedies on both sides. A ripple effect of a sudden change in any one of these could create an avalanche effect - starting small and only gain momentum as its impact continues to grow.

What would happen in financial markets if the Chinese govt were to allow citizens to invest their massive savings abroad? IMO investment in China by Chinese would probably decrease as local savings are send offshore, slowing the growth of the economy as investors would have to compete for local savings. Savings would change from govt owned reserves to private owned foreign reserves. Assuming Chinese residents would like to invest abroad if they were allowed to invest abroad without restriction, the "floodgates" may open, causing Chinese households savings to flood the international finanical markets, possibly even causing the yuan to depreciate - not what US congress may want. Keeping the yuan stable would require that foreigners be allowed to purchase yuan and/or the Chinese govt to purchase yuan with their foreign reserves. The impact on foreign markets and economies could be significant.

Addressing the liquidity problem is just as complex with potential disasterous consequences if not managed properly. Pushing up savings in the US through higher interest rates may cause more global savings, which will just push global interest rates down as savings>investments.

[ltlee]

Saving glut does not make sense. People are always making decisions on the trade off between current and future consumptions. They will spend the money now if the trade off is favorable.

The current problem reflects the gap between productivity and consumption. It is primarily an American problem. American productivity are below their onsumption level. America and Americans have to borrow to cover the gap.

Increase productivity can reduce the need to borrow and hence excessive liquidity.

[real person from the real world]

Money make it easier to get the things you need, as well as want. You save, so that when the time comes, and money is harder to get, you have some stored to byt the things you need, and want.
The real question is HOW DO YOU SAVE?

How do you save....

1) How do you save.... if your costs are the same or slightly more than what you take in? many examples: Credit Card Debt, Balloon Mortgages, getting sick and needing medical services, low wage competition from elsewhere.
2) How do you save....and is it worth trying to save, when you go to a bank that pays 2% to store those low wages. Aren't Lotto tickets, Stock Market, or other investments giving a better return? What about investing in the *global* economy? Not supposed to have all your eggs in one basket, are you?
3) How do you save, in "The Brave New World" of FEEs, Fees and more fees? ATM fees for "convenience", buy-to-rent-not-own software, medicines, patents, music, et al.... those rents keep pouring in to the owners, years and years and years into the future. Why even innovate when you can live on your laurels?

[Sean Zhu]

The prolonged underperformance by US companies in China, is a sign that the wealthy Chinese middle class is a myth. Chinese economy works infact like many medieval economies, where the money accrues with the government and does not filter through to the middle class. This creates a wealthy government (and officials ofcourse) but relatively poor citizens. This is what is happening in China (think medieval England), a very wealthy aristocracy (chronies of the Communist government) and a very poor mass (the sweatshop workers). The balance sheets of US companies in other parts of Asia such as Singapore, India and even Philippines is much more profitable because of the consumer participation. The US companies need to urgently rethink their Asia strategy and diversify into other more robust consumer markets such as Korea, Japan, India and the Philippines. China holds good long term prospect but it will take sometime for American businesses to be profitable in China