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.