Duncan’s Economic Blog

Savings Glut?

Posted in Uncategorized by duncanseconomicblog on July 13, 2009

On Saturday, in the company of Paul (who doesn’t really carry his big Bickerstaffe sign around with him) I attended the Progressive London conference on the economy.

 In the afternoon there was a very interesting session on ‘The Rise of the East’ and in particular China.

 The two speakers where John Ross (former economic advisor to Ken Livingston, who blogs here) and Danny Quah (head of Economics at the LSA, who blogs here). I asked a tedious question on Asian trade numbers and the issue of the whether or not the Asian model is necessarily based on exports…

 John is very bullish on China and, although I broadly agree with him, I do question some of his arguments. I’ll blog on this, again, more fully in the near future. But I do suspect that trade is more important to Chinese development than John believes.

Danny Quah raised a very interesting point disputing the concept of Excessive Asian Savings. He called the concept ‘Western Centric’. To an extent I agree. 

Professor Quah is certainly correct to note that in previous debt crisis (Asia in 1997, various LatAm incidents in the 1980s and 1990s, etc) the blame has been firmly placed on those who have borrowed more than they could afford. It is the reckless borrower who suffers the consequences of their actiosn thourough structural adjustment.

However in this crisis, a crisis of the developed West, borrowing too much we hear less talk from macroeconomists of ‘Excessive Western Consumption’ and more talk of ‘Excessive Asian(and Petro-State) Savings’. Of course there are two sides to a ‘Global Imbalance’ but is telling that phrases like ‘Savings Glut’ are heard more than ‘Consumption Glut’.

 But I do worry that Danny Quah overstates his case. He has also blogged on this issue.

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. With global savings and consumption, however, looking at a third indicator, namely world interest rates, is suggestive. The Figure shows world money market interest rates falling sharply through the 1990s, as would be suggested by a global savings glut driving the large global imbalance.

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 recessiondrove nominal interest rates there to zero.

It seems useful to obtain additional evidence on whether the global imbalance was indeed driven by a global savings glut or, in some interpretations, Asian thrift.

 …

The reality, however, is almost surely that some combination of factors—central bank policy, Asian thrift, US consumer profligacy, US government actions, cheap East Asian goods resulting from a low-wage yet productive workforce (which must be a good thing surely)—was responsible for the large global imbalance of the early 2000s. To put the blame monocausally on Asian Thrift seems both irresponsible and inconsistent with the facts. And it is important to get to the root of this: the resulting global imbalance and its associated massive flows of financial assets likely led to the extreme financial engineering that now everyone claims no one responsible ever really understood in the first place.

Here we find common ground between Wuah and the recent work by Brender & Pisani:

Like Martin Wolf, Brender and Pisani recognize that globalization took an unusual turn over the past several years: the globalization of finance resulted in a world where the poor financed the rich, not one where the rich financed the poor. And what’s more, this “uphill” flow was essentially a government flow. Despite the talk of the triumph of private markets over the state a few years back, the capital flow that defined the world’s true financial architecture over the past several years was the result of the enormous accumulation of foreign exchange reserves in the hands of the central banks of key Asian and oil-exporting economies.

 …

They recognize that the current crisis could not have happened in the absence of an accumulation of credit risk by private financial intermediaries (big banks, broker-dealers and the “vehicles” that operated in the shadows) in the US and Europe. But they also recognize that the accumulation of credit risk by private financial intermediaries would not have been possible if emerging market governments hadn’t been so willing to accumulate exchange rate risk.

 …

Brender and Pisani highlight all the steps in a “global chain of risk taking” that allowed the savings of a Chinese household to be used to finance a US subprime mortgage. But the chain was such that the Chinese household actually never took on all that much risk. (My emphasis)

To me this is key.

Whilst Professor Quah is certainly correct to that any ‘Savings Glut’ argument neglects the role played by the over-consuming West, he perhaps understates the extent to which the ‘Glut’ was a deliberate act of policy.

As FX marker participant Macro-Man has long noted the Chinese State Administration for Foreign Exchange (SAFE, or Voldemort to Macro-Man) has long intervened in the FX market.

China has run a deliberate policy of holding down the value of the renmimbi in order to make its exports competitive, it is because of this that they have acquired so many US dollar holdings.

The side effect of this deliberate policy action has been to flood Western financial system with cheap capital, keeping interest rates low and allowing excessive borrowing.

So whilst the Western financial system must take some blame for what it did with this capital much of the problem can be laid at China’s (and others’) door.

 The problem was not Chinese workers saving too much, but action by the Chinese state aimed at supporting their export industries. So maybe ‘Savings Glut’ is an unfair term, but seeking to lay some blame for the global imbalance at Asia’s door is perhaps not too Western Centric.

6 Responses

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  1. Paul said, on July 13, 2009 at 10:53 pm

    What steps has China taken to hold down the renmimbi?

    There’s a wider debate here about how the ‘Western-centric model’ is likely to be challenged more robustly as China becomes THE main player in/driver of the world economy. Maybe our schools really should be gearing up to teach Cantonese. I feel a post coming on……….

    • duncanseconomicblog said, on July 14, 2009 at 7:51 am

      Deliberate intervention in the FX market – buying (mainly) US bonds (Federal and mortgage agency). Hence they ended up with oiver a trillion’s worth.

  2. charliemarks said, on July 14, 2009 at 1:35 am

    Here in the UK the govt has held up the value of the pound – witness the late Eddie George’s candour that the continued decline in some regions of england was the price worth paying for a strong city of london.

    Now the chinese are trying to increase domestic consumption, perhaps the govt should take advantage of a lower pound.

    I was disappointed the govt made no attempt to get a joint-venture going w/ the chinese around the time of the rover take-over so that production could continue for export to the chinese market…

  3. […] He covered, amongst other things, the debate about whether China’s recently reduced surplus balance is likely to maintain its downward trajectory, reflecting the John Ross argument that the huge surplus established has been accidental, or whether it is simply a temporary blip as China invests heavily in copper (the Duncan position). […]

  4. Danny Quah said, on July 25, 2009 at 1:21 pm

    Duncan –

    Thanks for your thoughtful post.

    I don’t disagree entirely with your blog entry. And, like you say, you don’t disagree with me either, although you worry about whether I overstate my case.

    Here’s why I believe my case is not in fact overstated.

    First, certainly SAFE buys considerable quantities of US dollars – but is that intervention? Or is it just the result of an after-the-fact imprudent faith in the continued strength of the US dollar? And remember it is not just China whose official coffers and portfolios fill to overflowing with US dollars. Japan comes a close second. And the UK, a surprising third, is estimated to hold nearly two-thirds of the amount China does in US Treasury bonds.

    Second, perhaps more critical, as you saw from my blog post

    http://dq6bn.blogspot.com/2008/11/where-in-world-is-asian-thrift-and.html

    it is not just China that has been running large bilateral surpluses against the US (and thus resulting from whatever rate the RMB has gotten to, through SAFE’s actions). The EU and the oil-exporting countries have seen bilateral surpluses against the US of about the same magnitude and dynamics as China’s – it has got to be a strain to say that those trade surpluses against the US derive from SAFE’s interventions to keep down the RMB.

    The Federal Reserve, on the other hand, doesn’t explicitly need to intervene – most of the world jumps into the US dollar short-term every time anything spooks markets. Similarly, a few choice words from the US Treasury Secretary or the Fed Chairman moves US currency. I find it difficult to believe that fundamentals (or true, deeply-held, well-reasoned views of fundamentals) can change so dramatically so quickly, so I have to conclude that those US dollar movements are, similarly, the result of de facto intervention, whether or not we think of such actions conventionally as intervention.

    I find particularly troubling this tension in US dollar dynamics between short-run pressures (up, mostly) and long-run tendencies (down). Beyond this, we still need to reconcile longer-term decisions such as consumption and savings with the shorter-run volatile movements in exchange rates more generally.


    Danny

    • duncanseconomicblog said, on July 27, 2009 at 10:54 am

      Danny,

      Thanks for the comment.

      You’re certainly right that the long term issue is the dollar. And I’d fully agree that FX markets are not always rational. The reaction to any decrease in risk tolerance is simply ‘buy dollar and yen’.

      Although I do buy the argument that last year the world economy was structurally short of dollars. Lots of debt (around the world) that suddenly had to be repaid – might explain some of the upwards move from September onwards.


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