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Bernanke’s global savings glut

by Brad Setser
May 21, 2005

Bernanke’s global savings glut argument is quite subtle, more subtle than I perhaps have recognized in the past. Bernanke’s argument goes beyond the “US current account deficits don’t matter since there is a global savings glut” headline that I occasionally push.

Bernanke takes his argument that there is a global savings glut to its logical conclusion. He argues that without a federal budget deficit, the global savings surplus that was invested in US government debt over the past few years would instead have been invested in other US assets. Real interest rates would be even lower, housing prices would be higher, investment in housing would be higher, and consumption in the US would be even stronger. As a result, the US current account deficit would not be much different.

The weakening of new capital investment after the drop in equity prices did not much change the net effect of the global saving glut on the U.S. current account. The transmission mechanism changed, however, as low real interest rates rather than high stock prices became a principal cause of lower U.S. saving. In particular, during the past few years, the key asset-price effects of the global saving glut appear to have occurred in the market for residential investment, as low mortgage rates have supported record levels of home construction and strong gains in housing prices. Indeed, increases in home values, together with a stock-market recovery that began in 2003, have recently returned the wealth-to-income ratio of U.S. households to 5.4, not far from its peak value of 6.2 in 1999 and above its long-run (1960-2003) average of 4.8. The expansion of U.S. housing wealth, much of it easily accessible to households through cash-out refinancing and home equity lines of credit, has kept the U.S. national saving rate low–and indeed, together with the significant worsening of the federal budget outlook, helped to drive it lower. As U.S. business investment has recently begun a cyclical recovery while residential investment has remained strong, the domestic saving shortfall has continued to widen, implying a rise in the current account deficit and increasing dependence of the United States on capital inflows.

According to the story I have sketched thus far, events outside U.S. borders–such as the financial crises that induced emerging-market countries to switch from being international borrowers to international lenders–have played an important role in the evolution of the U.S. current account deficit, with transmission occurring primarily through endogenous changes in equity values, house prices, real interest rates, and the exchange value of the dollar.

Emphasis added.

Note that the US budget deficit did not play a role in Bernanke’s presentation. To put it a bit crudely, Bernanke’s argument implies that the drain on global savings created by the budget deficit is all that has stood between the United States and an even bigger housing boom.

Implicitly, Bernanke assumes that any fall in the US budget deficit would have a big impact on world interest rates and, in turn falls in the world interest rate would have a big impact on US investment and on US consumption — helped along by things like interest-only mortgages. In formal terms, the elasticities need to be large.

Obviously, there is a bit more to the story. At some point, the global savings glut flowing into the US would have pushed down US interest rates to the point where investments outside the US started to look attractive — or reduced the incentive for foreigners to save. The overall impact would not have just been higher home prices, more investment in new homes, stronger consumption, lower US savings and an unchanged US current account deficit. Investment outside the US would have picked up too, global savings might be a bit lower, and the US current account deficit might have shrunk just a bit.

Plausible or not, Bernanke tells a full story — he identifies the channels through which the global savings glut would have, in his view, generated large US current account deficits over the past few years even in the absence of large US fiscal deficits. The US is simply finding various ways to mop up the world’s spare savings – and thus is doing the world a service. Compare that with say Krugman, who accuses other countries of enabling bad policies here in the US: “Over the last few years China, for its own reasons, has acted as an enabler both of U.S. fiscal irresponsibility and of a return to Nasdaq-style speculative mania, this time in the housing market. Now the U.S. government is finally admitting that there’s a problem – but it’s asserting that the problem is China’s, not ours.”


Bernanke — correctly — identifies the origins of the world’s excess savings in the world’s emerging economies. Europe may be stagnant, but European savings more or less match European investment, particularly if you take Eastern Europe into account. Parts of East Asia may be booming, but the booming bits of East Asia (China) still save more that they invest. In the rest of East Asia, there is not so much of a savings glut as an investment dearth; investment fell after the 97-98 crisis, and savings has yet to fall commensurately. The real beneficiaries of China’s boom — the world’s commodity exporters — have generally tended to save rather than spend their windfall.

I still don’t find Bernanke’s analysis completely persuasive, for the following reasons:

1) Attributing current “excess” savings in Asia to the legacy of the 97-98 crisis seems strange. First, the timing is off. Asian reserve accumulation surged in 2002, then surged some more in 2003, then some more in 2004 and (leaving Japan aside) looks to surge even more in 2005. I understand that emerging Asia needed to rebuild reserves/ pay down debt in the period immediately after its crisis. That explains Asia’s 2000 reserve buildup. But is the lagged impact of the crisis still driving the 2005 reserve buildup? After all, the IMF thinks Asia already has reserves to protect against everything short of the apocalypse, and Korea, which experienced the crisis first hand, clearly thinks it now has more than enough reserves even though its reserves (relative to its GDP) lag China’s. Second, China had relatively little external debt relative to its reserves even BEFORE 97-98; it had the smallest vulnernabilities and the least need to add to its reserves after the crisis. But right now China is adding to its reserves faster than anyone else …

Neither the timing of the surge in reserve buildup nor the countries currently adding to their reserves most rapidly fit that well with the “its was the crisis” hypothesis.

2) In the Asian NICs, savings surpluses have come from a fall in investment, not a rise in savings (see the data in this IMF speech). But in Emerging Asia as a whole, investment must have surged over the past few years. China is the biggest economy in the region, and investment in China has grown at an amazing pace. Fixed investment has gone from roughly 37% of Chinese GDP in 2000 to over 45% of GDP in 2004. And, by all accounts, investment in China continues to grow faster than China’s GDP, so investment to GDP keeps on rising. In dollar terms, investment in China has surged. It has gone from maybe $400 billion in 2000 to $740-750 billion in 2004. Had China’s savings rate stayed at 39% of GDP, its 2000 level, China would have needed to borrow about $100 billion from the rest of the world to finance this kind of investment.

As it stands, China’s savings rate rose, so China was able to finance its 2004 investment entirely out of domestic savings. All inflows from abroad were just added to its own domestic savings surplus and stored away in reserves. Compare what happened in 2004 — $200 billion plus in reserve accumulation — v. what might have happened if Chinese savings had stayed around 40% of GDP — a $100 billion current account deficit financed by a combination of FDI and other inflows. After 2000 their “surplus” savings in Asian NICs could quite easily have been used to finance China’s investment surge — had China been prepared to let its exchange rate move and to run a current account deficit.

Rather than talk of a global savings glut, we really should talk about a Chinese savings glut (consumption dearth). China’s 2005 savings rate looks to be well above 50% of its GDP.

3) I don’t think China’s high levels of savings are entirely independent of a wide range of Chinese government policies, including China’s extraordinary defense of its current exchange rate peg. Indeed, I don’t see why the same market mechanisms that turned capital inflows into the US into a trade deficit would not have worked in China. China certainly seems to be an attractive destination for foreign investment: one investment bank recently estimated capital inflows to China are running at about $50b a quarter (FDI + hot money), or $200 billion a year. FDI alone is probably running at around $70b a year.

Bernanke argues that inflows into the US equity markets in the late 90s bid up US stock prices, making Americans feel richer and thus to consume more, and that inflows into the debt market over the past few years have the same effect through the housing market. Presumably similar, or perhaps different, channels would work in China as well.

Blocking this channel of adjustment is a big deal. With a projected current account surplus that might reach $150b and perhaps $200 b in capital inflows in 2005, China’s reserves — the source of much of the surplus savings surging through global markets — could swell by as much as $350 billion this year. $350 billion is about 3% of US GDP, and almost 20% of China’s GDP. In other words, real money.

p.s. — Thanks to Calculated Risk and Glory for useful housing links.


  • Posted by anne

    Republican Chairman Exerts Pressure on PBS, Alleging Biases

    WASHINGTON – The Republican chairman of the Corporation for Public Broadcasting is aggressively pressing public television to correct what he and other conservatives consider liberal bias, prompting some public broadcasting leaders – including the chief executive of PBS – to object that his actions pose a threat to editorial independence….

  • Posted by anne

    A Battle Over Programming at National Public Radio

    WASHINGTON – Executives at National Public Radio are increasingly at odds with the Bush appointees who lead the Corporation for Public Broadcasting.

  • Posted by anne

    Now, I would have not the slightest difficult learning how to make maple syrup from Emma Riesner. And, I am rather partial to Buster Rabbit.

  • Posted by anne

    So, for Paul Krugman, when the Chinese come to revalue the Yuan, the effect will likely be an increase in interest rates and a resultant end to what he terms the housing bubble. Of course, this is what Brad Setser and Nouriel Roubini have written for so long.

    Notice Krugman speaks of a housing bubble as does Setser, while I have wondered whether there is a real estate bubble.

  • Posted by Stormy

    Has any Republican of note ever spoken out about Anne Coulter, Rush Limbaugh, Pat Robertson, or Jerry Falwell? Notice that the right-wing pundits never say a word here: Brooks, Will? Never. Galloway’s defense in the Senate was a welcomed breath of fresh air.


    As of September, the NYT will charge for internet access, sigh. But even the NYT is cautious these days, aside from Krugman and Dowd.

  • Posted by Joseph Wang

    The vast majority of Chinese savings goes into the four big banks, with smaller amounts going into rural credit cooperatives or smaller banks. There isn’t very much of a securities market.

  • Posted by Joseph Wang

    One problem in talking about the Chinese financial system is it tends to work into extremes. People talk about China as if it is either going to be a hyperpower next month or if it is going to collapse, when the truth is probably between the extremes. (In particular, people often forget that China is for the most part still a developing country and will remain so for most of the 21st century.)

    One the one hand, the Chinese financial system is inefficient and in many cases corrupt. On the other hand, at the end of the day, it does manage to generate sustained economic growth, and I don’t see any barriers that would keep China from growing over the next several decades.

    One other thing to keep in mind is that the issues and troubles that the Chinese economy are looking at right now are trivial compared to the issues and troubles that had to get resolved to get to this point. For example, right now the China has a messy banking system, which looks bad until you realize that in 1978, China didn’t have any banks in the Western sense at all. Many of the issues that China has right now, an overvalued currency, too much savings, too much investment, an industrial base that triggers protectionist sentiments are problems that most developing countries would be ecstatic to have.

  • Posted by brad

    MTC — re: taking a “position in price gougers” — at least then you get a share of the profits …

    Joseph: “overvalued currency”??? — that generates the same reaction in me as jen’s argument that the dollar is massively undervalued (i.e. look at the China’s trade surplus and the trend line, and the US trade deficit and the trend line). While i agree with much of what you are saying, i tend to think China’s challenges now are quite profound. their existing model, to my mind, is running up against economic and political limits, and china’s leadership has been slow to adapt. Exporting $700 b v US exports of $810 b (goods) makes China something more than your averaged developing country, tho it no doubt has aspects of that.

    Glory — i wanted to work bilmon’s (slightly more recent) blogs in, but could not find a clever way …

  • Posted by MTC

    Mr. Setser, you write:
    “MTC — re: taking a ‘position in price gougers’ — at least then you get a share of the profits …”

    I can see it now…

    “Ladies and gentlemen, please keep your hands up while you step out of the coach. Thank you. Keep those hands up. Now ladies and gentlemen, we are going to relieve you of your valuables. But before we do, we would like to extend an invitation to all of you to take an equity positing in Butch & Sundance Enterprises. Shareholders would receive a percentage of the profits, if there are any…”

  • Posted by Movie Guy

    MG previous post:

    The Fed used mortgage policies, low rates, and buying trends to carry a larger than normal portion of the U.S. economy during the recent economic period. The Fed wanted citizens to pump their equity investments back into the economy. And citizens did just that.

    So, when the Fed complains or whines about low U.S. household savings, I question the Fed’s integrity on this matter.

    Greenspan Q & A after a speech to the New York Economic Club on 20 May 2005

    There’s a risk that consumer consumption may decline if the housing market slows, Greenspan said. “If it occurs, and eventually it will, it will reduce the fairly large and still accelerating degree of extraction of equity from existing homes,” he said. “This has been a major force in financing consumption expenditures.”


    And what happens when household consumers can not extract any more of that precious existing home equity? What will be the next economic Las Vegas play, Alan?

    More at Calculated Risk

  • Posted by cymack

    Another vote here for those who have found the recent NPR/PBS decline appalling.

    NPR itself has addressed the issue, on Friday’s Morning Edition (links are more than style, I guess, but here goes):
    CPB Moves Spark Tensions in Public Broadcasting

    Also, an interview with Tomlinson, the new CPB head, on the WNYC show On the Media:
    where free transcripts and mp3 downloads are available.

  • Posted by anne

    An important note: The New York Times will not be charging for internet access to news, rather to access the work of columnists. There will be a 50 dollar a year charge only for those who do not subscribe to the paper. The internet service will be free to subscribers of the paper.

  • Posted by anne

    Joseph Wang

    I deeply appreciate your comments on China.

    “Many of the issues that China has right now, an overvalued currency, too much savings, too much investment, an industrial base that triggers protectionist sentiments are problems that most developing countries would be ecstatic to have.”

    Every person I talk with who is from a developing country is looking to China as an economic model. This is not surprising for friends from Africa, but has been surprising in listening to Indians.

  • Posted by Steve

    “As for the probability of being eventually allowed to float — “eventually” is the key word… China may repeg at a slightly higher level and introduce a band, but with its current trade surplus, it will immediately (in my view) hit the upper limit of its band.”

    Brad, this sounds like a revision of your previous view. Or would you characterize it as consistent, in the sense that you and Roubini have long suggested that, despite strong incentives to revalue, there were middling paths (like a broader range) yet to be tried, and given China’s nervousness, these would be tried before a mor major change?

  • Posted by gillies

    this thread began with a question about a ‘global savings glut.’ in my lifetime the population of the world has doubled. over the period of industrial expansion its fossil fuel resources have declined – oil by perhaps half. like a complex chemical reaction, the economy of the world needs a certain proportion of essential ingredients to keep bubbling along . . .

    starting from the real world, rather than the world of esoteric financial theory – there is a glut of people, the labour component of the global economy. it is logical that the price of labour should be less, much less, than if the global population had remained static.

    within a democracy, trade unions and voting blocs are able to maintain wages and welfare benefits through political action. only across international boundaries are major inequalities possible. there have to be political and economic ‘lock gates’ to maintain different levels in different countries . . .

    now the developed nations think that they have found a way – by exporting jobs – to tap into the labour glut without being financially responsible for the welfare of the workers. that ‘savings glut’ is the chinese share of the labour exploitation. if it exists, it is just part of the profits of outsourcing that was never handed on to the workers. and if it exists there must be another part to it – a profits glut in the earnings of the companies that do the outsourcing.

    but there is a downside – it is hitting the companies ( e g ford and g m ) already deeply committed ( through pensions) to the levels of wages of the recent past. they will be at a disadvantage to newer auto companies.

    the savings glut is a glut of liquidity borrowed / lent into existence. (do they print dollars any more ?) this global glut is parting like the red sea to a tide of asset prices at our side and a tide of savings at the asian side. when it leaves the ordinary american (and british and irish and spanish) first time wage-earning home buyer stranded on dry land in between, the tides will have to turn.

    at the moment – even the reintroduction of slavery in america could not boost the profits of the outsourcers by any more. one american slave would cost more to feed than 5 per cent of the present average wage, the cost of a chinese worker in a less developed economic environment.

  • Posted by brad

    Steve — I continue to think some form of revaluation (a change in the peg, a move to a band which effectively becomes a change in the peg) is likely, indeed probable before the fall — so long as China doesn’t hold out just to prove that it won’t be pushed around. I also think the probability of a move that is closer to 10% than to 3% is higher than many other analysts, though the odds still favor the smaller move. There certainly is a group inside China that realizes the risks of doing too little — political risks to China’s access to US markets and also the more fundamental risks that it doesn’t slow China’s current rate of reserve accumulation.

    None of that implies I ever thought a float was in the cards. Floating implies letting the market pick the exchange rate, with minimal intervention. I agree with most on this point — China is a long way from being ready for that. So long as their cap. controls are effective, there won’t be two way flows, and right now, leaving aside “hot money,” China is bringing in about $200 b (projected FDI inflows/ trade surplus and earnings on its reserves) more dollars and euros than it spends abroad — so there would be lots of pressure in the market toward appreciation (in my view, again, assuming the controls remain effective — in both ways). So there would need to be a substantial jump to bring about equilibrium in the market absent PBoC intervention — I don’t see that jump happening. I see a move, followed by continued large-scale PBoC intervention. And then another move …

  • Posted by anne


    With No Time for Twilight, Matisse Filled Old Age With Vibrant Colors

    PARIS – Henri Matisse had good reason to feel morose in early 1941. France was under German occupation; his wife, Amélie, had left him; and he was suffering from cancer. Before undergoing a risky operation in Lyon, he wrote an anxious letter to his son, Pierre, insisting, “I love my family, truly, dearly and profoundly.” He left another letter, to be delivered in the event of his death, making peace with Amélie.

    But when the surgery was successful, Matisse quickly bounced back, declaring that he had won “a second life” and, at 71, led his art in remarkable new directions. He had a beautiful Russian-born assistant, Lydia Delectorskaya, to keep him company. And while ill health later returned to slow him down, he remained optimistic until his death in Nice on Nov. 3, 1954, just a few weeks short of his 85th birthday.

    “I haven’t much to complain about,” he wrote to his old friend André Rouveyre on Sept. 19 of that year. “When I find something is not going well, I look in some satisfying corner and I find I have no reason to complain.” And he added: “We have good friends – can one ask for more? I am still working a bit and I observe that its quality has not fallen, thanks to good discipline. But one must remain modest.” …

  • Posted by anne

    Starbucks Aims to Alter China’s Taste in Caffeine

    HONG KONG – The Starbucks Corporation plans to announce soon an accelerated push into the Chinese market, company executives said on Friday, the latest in a series of aggressive efforts by international food and beverage companies to expand in China.

    What is striking about these efforts, by McDonald’s and KFC as well as Starbucks, is that they have made few concessions to Chinese tastes, instead cultivating in China an appetite for Western favorites, like Big Macs and grande lattes….

  • Posted by Stormy


    Re the charge for those who do not have a subscription (boonies like me):

    Only the columnist will be out of reach? I understood that the NYT will have the same policy as Wall Street Journal…Not having a subscription, I cannot access any part of the WSJ. Yes, I can see headlines…but no articles.

    Please clarify.

  • Posted by anne

    All regular New York Times articles will be freely available, the charge will only be for the New York Times columnists and added access to archives. There will be no difficulty, no charge, with access to news to arts to books to styles.

  • Posted by anne

    Alan Greenspan in response to a question remarked that a change in the value of the Yuan would not appreciably change America’s trade deficit; which is just what I would say. The trade deficit is not being forced on us because there is all sorts of saving needing to be poured in on America to induce us to buy abroad. How can we not have a trade deficit when there is minimal household saving and a fierce government deficit?

  • Posted by anne

    Definitely, the Times will be completely free and open save for the columnists.

  • Posted by anne

    By the way, the Times has a mail subscription. For years, I have routinely filed away Times articles of importance to me. There is a link generator that allows Times articles of less than 3 years in print to be opened.

  • Posted by brad

    in bernanke’s view, the low household savings rate is a by byproduct of the global savings glut, which bids down us interest rates and drives up housing prices …

    I wish Alan Greenspan had qualified his statement by noting a change in China’s peg sufficient to cut into their “savings glut/ consumption death” would make it more costly for the US to run a savings deficit, and through the channels Bernanke describes operating in reverse, lower the trade deficit …

  • Posted by anne

    Brad Setser:

    ‘I wish Alan Greenspan had qualified his statement by noting a change in China’s peg sufficient to cut into their “savings glut/ consumption death” would make it more costly for the US to run a savings deficit, and through the channels Bernanke describes operating in reverse, lower the trade deficit … ‘

    Ah, I understand, surely.

  • Posted by Joseph Wang

    Brad: Overvalued currency – I think I flipped my signs a bit. I meant undervalued.

    Also, about “China’s economic model”, I think that you and I might have some disagreement over what that term means. The huge amount of money going into investment and the boom in exports are things that I don’t consider to be “fundamental” to the Chinese economy, since they have only existed in the last two or three years. China has only been running a net trade surplus for the last year or two. Huge investment and net trade surpluses are unusual over the last thirty years of Chinese development, and efforts are being made to deal with them.

    Also, I disagree with the idea that the Chinese leadership has been particularly slow to respond. The issue of RMB values has only been one in the last two years, and it’s really not clear what the optimal policy is. Taking a year or two to think through something this fundamental which could have bad outcomes is not unwise.

    As for the general issue of the overheating economy, the leadership has been working on this for a while, and didn’t let things slip as much as in 1992. They’ve been pretty active on this issue. Now one could argue as to whether or not what they are doing is useful, but they haven’t had their head in the sand.

    In fact, the notion of a “Chinese economic model” mind be misleading. Basically, China has been making things up as they go along, and they been doing “whatever works” without too much of a theoretical basis for what they are doing.

    giles: The trouble with your argument is that the decision to save a huge fraction of income is made voluntarily by individual consumers. If you boost incomes without providing some social safety nets, you’ll have even more of a savings glut.

  • Posted by Joseph Wang

    Actually, talking about this presents a possible criticism of Bernanke’s thesis. Or at least something to discuss. The question is “why now?”

  • Posted by Joseph Wang

    If the issue is maintaining political support for access to American markets, then there are policy alternatives other than revaluation. For example, export taxes. The nice thing about export taxes is that you can tailor them so that they have maximal political impact, for example export taxes for goods which compete with things from key US senators.

    This is an answer that drives economists crazy since it is a messy solution that doesn’t fit in a nice mathematical model.

  • Posted by Joseph Wang

    One other thing that is something of a cultural difference.

    Americans tend to like bold, decisive one shot solutions that solve everything in a single stroke and find half-measures distasteful since they don’t resolve the “real issue.” Chinese have had very bad experiences with “one shot” solutions (i.e. Great Leap Forward) and are much more comfortable with incremental piecemeal solutions.

    Also, Americans like short decision cycles (I think a guy named John Boyd had a lot to do with this). Something happens, and you want or need a bold, decisive decision made in 30 seconds. Chinese tend to focus on “setting up the battlefield” which is to create an environment so that you don’t need to make rapid decisions.

    Also, Americans find it distasteful to state that they are doing something for a “special interest group,” whereas Chinese find nothing wrong with stating that they are doing something for their “special interest group.” (This is where statements like Chinese tend to be more group-centered are superficially true but misleading.)

  • Posted by anne

    Joseph Wang:

    ‘In fact, the notion of a “Chinese economic model” mind be misleading. Basically, China has been making things up as they go along, and they been doing “whatever works” without too much of a theoretical basis for what they are doing.’

    This pragmatic approach makes perfect sense, but we can identify what they have done right in retrospect.

  • Posted by anne

    Thanks Joseph 🙂

  • Posted by mycousindean

    “…in Bernanke’s view, the low household savings rate is a byproduct of the global savings glut, which bids down interest rates and drives up housing prices…”

    …which from the macro viewpoint of most on this board contributes to dangerous economic problems ahead. And I agree, but then again I’m old, a serial saver and a consumption miser, and think Americans would be long term better off if they acted more like me.

    And yet–as the financial go-to guy in my extended family–I just okeyed the “business plan” of a 26 year old, newly married relative, who currently rents, and who wants to buy a house where they live in (expensive) California, 98% on debt.

    From the micro point of view, this household appears to go from a very small savings rate to a large debtor position. But this is not how I see this situation.

    They have two incomes both likely stable. They have identified current non-durable expeditures (eating out, nice clothing, vacations) they are willing to reroute into house payments/owner costs that (net) will consume 60% of their after tax income.

    In the minds of this young couple, they are savers–and I guess I can’t disagree–since they are substituting non-durable transitory expenditures for the prospect of owning a durable and possibily appreciating tangible asset. A fixed 15 year note matches their payments to their incomes, with a 50% balloon to refinance at their then higher income levels in 15 years.

    Compared to renting, I think it is the stronger case that this young couple is acting prudently and is risking only the loss of immediate gratification to (maybe) gain longer term rewards.

    The alternative prefered advice for this young couple (from those advocating for higher savings rates) would be to route the identified non-durable expenditures into savings–let it build up over time–and then buy your house.

    But with safe savings rates near the inflation rate, and not favorably taxed, I can’t see how we savings advocates–and presumed financial sophisticates–can advocate that this young couple should heed our advice to save, instead of buying this house now.

    When I imagine how this desireable micro situation is merged into aggregate macro numbers that flash warning signs, I wonder more and more if we are trying to measure economic things that cannot be measured with the accuracy to make reasonable analysis of future events or if we are basing our notion of “unsustainable” on past data sets that are not necessarily applicable today.

    If the (presumably prudent) behavior of my relatives were multiplied by 5 million households per year, can we continue to make the case that America’s growing debt to GDP ratio is absolutely imprudent.

    Maybe our low savings rate is not a problem. Maybe our measurements and assumptions based on the past are wrong. I really don’t know.

    Maybe we don’t really want…(Brad) these channels to be put into reverse to lower the trade deficit.

    Sorry for the length, it won’t happen again.

  • Posted by Guest

    A few questions/comments:

    1) Is there information available on the composition of Chinese savings? I imagine the vast majority of it is not at the individual level, but at the corporate/government-private joint venture level. I don’t think that Chinese citizens are sitting on a pile of cash, but I could be wrong?

    2) There must be a huge increase in Chinese agricultural productivity (or imports of food) given the reported migration of rural labor to the cities. If not, then China must be experiencing severe pressures feeding their population.

    3) Nixon started the thaw with China back in 71. I don’t think that China is making up economic policy on the fly. While true that surpluses have only exploded in the past few years, they don’t come out of nowhere – there has been steady investment and advice going into China for at least the past 15 years.

    4) Given that the RMB floats with respect to currencies other than the US – can we calculate the strength of the USD due to its tie to RMB? In other words, the recent strength of the USD is more of a market bet against signficant re-valuation. A true float would be a disaster for the USD.

  • Posted by pebird


    Why is it that your family friends decided to purchase consumptive housing rather than an income property (apartment building, etc)? One reason could be that it is certainly easier to qualify for a home purchase than a commerical property.

    As you say, their behavior appears rational given the current interest rates and property value increase expectations. However, given that 60% of after tax income is going to housing (assume that includes property tax and insurance) – when I qualified for a mortgage it had to be below 33% – it seems risky.

    You have to hope that over 15 years, if there is an asset deflation, there is time to recover. Also that in the event of a deflation, that incomes increase relative to consumption-related expenditures.

  • Posted by mycousindean


    Agreed on all your counts.

    But even assuming deflation, and their position is wiped out after 15 years, they will have only lost that which they were going to lose anyway, mainly, house rent and loss of gratification from eating out, nicer clothes and vacations.

    When the dire consequences of various bubbles pop–as outlined very clearly by Brad et al–I don’t think it is at all clear if deflation or inflation results. Deflation is the natural tendency, but most would be reluctant to bet against the inflationary tools available to the Fed. In which case, my relative wins.

    Since the only choice available was to buy or not buy, what would you have advised my relative to do, given only the data I’ve presented??

  • Posted by Movie Guy


    I believe it appropriate that there be a considerable and meaningful distinction made between those factors which influence a potential closure of the U.S. trade deficit and the current account deficit.

    Greenspan has helped make that distinction. Others should follow suit.

    Greenspan’s trade deficit remarks (and here) (and here)

    A rise in the value of China’s currency won’t cut the overall U.S. trade deficit, but would likely boost domestic prices, Greenspan said.

    A move by China to revalue its currency “does not follow that that will lower our overall trade balance,” Greenspan said. “Indeed, it’s probably quite unlikely.”

    If the prices of Chinese exports to the U.S. increase, American consumers will likely purchase goods from other foreign countries, not from domestic manufacturers, Greenspan said.

    “So essentially what we will find is we are importing from a different area but we’ll be importing the same goods,” Greenspan said.

    “The effect will be a rise in domestic prices in the United States and as a consequence of that, we will have other impacts which I could trace through but I’ve fortunately run out of time in this question.”

    Anne said:

    The trade deficit is not being forced on us because there is all sorts of saving needing to be poured in on America to induce us to buy abroad.

    How can we not have a trade deficit when there is minimal household saving and a fierce government deficit?

    Brad said:

    I wish Alan Greenspan had qualified his statement by noting a change in China’s peg sufficient to cut into their “savings glut/ consumption death” would make it more costly for the US to run a savings deficit, and through the channels Bernanke describes operating in reverse, lower the trade deficit …

    It’s my judgment that Greenspan got it right. His views echo in clear language what I have addressed regarding the U.S. trade deficit on other threads.

    Import prices increases will likely occur, but the overall production of such finished goods (as presently manufactured and assembled in China and elsewhere overseas) will remain offshore. The production cost differentials, barring considerable cost increases abroad, will not result in a shift to manufacturing and/or assembly of such goods in the USA.

    As such, there is little likelihood that the U.S. trade deficit will decline in dollar terms due to production price increases in China if we’re relying on a supposed reduction in imports for such trade deficit reduction. Yes, Americans may buy fewer finished goods products from Asia due to price increases, but the dollar value of the such overall imports may not decline at all. Or will not decline until such time as the USA suffers another recession or significant economic slowing due to interest rate increases. In point of fact, the import dollar value of the trade balance may increase.

    U.S. household savings will not necessarily increase because the currency of China is revalued. As the finished goods prices increase, Americans will hard pressed to add to such household savings without wage and other income increases. As long as the majority of household finished goods in this category of purchase are manufactured overseas, Americans will continue to buy them without regard for “Made in USA” substitutes because such substitutes do not, in general, exist. Americans will simply be paying higher prices for such goods.

    As imports prices rise, the Fed may very well step in and mount a quick fight to stem inflation if enough other prices rise on the heels of import price increases or occur concurrently. So, American consumers may be stuck with higher interest rates as well. That effort may be followed by federal taxes/fees increases in 2008 which will further dampen U.S. household savings. In the meantime, municipal, county, and state taxes/fees may increase to offset budget shortfalls. And lurking in the background will be the probable decline of available equity extraction used for consumer consumption expenditures of goods and services.

    The likelihood that poor and lower middle income U.S. household savings will increase is minimal in my judgment.

    I suggest that alternate solutions to resolving the U.S. household savings dilemna be addressed, as imported household finished goods from Asia and other cheap global production sources will not decline substantially.

    As Greenspan stated, “it’s probably quite unlikely” that an increase in the value of China’s currency will reduce the overall U.S. trade deficit.

    Worthy separate follow up discussions of the U.S. household savings rate, national savings rate, trade policy and current account deficit reduction should be undertaken.

    We’re barking at the wrong car.

  • Posted by pebird


    Good question – and lets take this as a hypothetical argument, as they have made their decision and this is not investment advice.

    I’ll tell you want I wish I had done back when I purchased my house – bought a small apartment building. You have something that produces income – you can always live in one of the units if needed. If asset prices continue to increase – you do well, if not, then there will be renters out on the streets. You need to work hard to get cash-positive, but after that you own a truly leveragable asset.

    As it turns out, when we were looking for a home way back when, there was a duplex available – another rental agent snapped it up before it could go on the market.

  • Posted by Movie Guy

    gilles: Excellent points.

    Dr. Joseph Chen-Yu Wang of Austin, Texas: John Boyd’s OODA Loop theory involves much more than quick decisions. In fact, it’s a intentionally delayed performance model based on adjusting the perceived or known reality of one’s opponent.

  • Posted by Joseph Wang

    1) For the most part Chinese citizens *are* sitting on piles of cash. Individually, they aren’t huge piles of cash, but we are talking about a billion people. This is not only because there are lack of social safety nets, but also because a lot of expenses (such as rent) are state-subsidized.

    2) Chinese agricultural productivity is fairly low, and even with these numbers there are just too many people in rural areas to have a viable economy based on agricultural. Food production are easily resolvable with mechanization and with food imports. One important decision that the Chinese government made in the 1990’s is not to go down the Japanese/European/American route and subsidize agriculture.

    3) Yes they are making it up as they go along, because there were in 1978 no good models for how to convert a centrally planned economy into a market based one. In 2005, we can look back post hoc and see what people did and what they got right and wrong, but all of this is stuff that people made up through trial and error when they did it.

    Also, you have to be careful with outside experts. They often have no idea what they are talking about. Unfortunately, they also tend to be unwilling to say “I don’t know.”

  • Posted by anne

    Joseph Wang

    Make sure to keep a record of each of your comments, for they will be valuable even to you in developing your thoughts, as they are valuable to us.

  • Posted by anne

    ‘Yes they are making it up as they go along, because there were in 1978 no good models for how to convert a centrally planned economy into a market based one. In 2005, we can look back post hoc and see what people did and what they got right and wrong, but all of this is stuff that people made up through trial and error when they did it.

    ‘Also, you have to be careful with outside experts. They often have no idea what they are talking about. Unfortunately, they also tend to be unwilling to say “I don’t know.”‘

    Through the century there were always and forever developing economies that never would develop. Development economics was quite lacking in success through 1978. Brad DeLong has several times written about this. China is the model in many senses.

  • Posted by Scott Peterson

    I think that the surplus savings are being invested in the US because savers worldwide see the US and its citizens as more trustworthy and productive debtors. Which would you rather invest in; a country with a history of productivity growth, relatively transparent financial reporting, and smooth political transitions, or a country governed by an opaque and corrupt oligarchy with no history of smooth political transition or productivity growth?

    The answer is obvious

  • Posted by Joseph Wang

    Scott Peterson: Actually no. The decision to save is one that invididual Chinese are making, but the decision that those savings ultimately end up in the United States is a decision by the People’s Bank of China. China maintains capital controls, and so individual savers and private banks are for the most part are not allowed to invest in foreign securities.

    Playing devil’s advocate, this is part of the argument that the RMB *isn’t* undervalued, and that the current exchange rate is the *correct* one. The argument is that if China *were* to lift capital controls that there would be a flood of money exiting China toward the United States, thereby decreasing the value of the RMB.

    Essentially the argument goes that the two deviations from “market pricing” (the currency peg, and capital controls) cancel themselves out.

  • Posted by anne

    Joseph Wang

    “Playing devil’s advocate, this is part of the argument that the RMB *isn’t* undervalued, and that the current exchange rate is the *correct* one. The argument is that if China *were* to lift capital controls that there would be a flood of money exiting China toward the United States, thereby decreasing the value of the RMB.”

    Were this the case the RMB would actually be overvalued. Nice argument.

  • Posted by David

    Brad & Joseph:

    My impression has been that the ‘global saving glut’ has been the result of policy, a forced saving of sorts. However, Joseph is arguing saving in China is voluntary and only where it ends up is policy driven.

    What is driving the global saving glut, both in China and more broadly, in the world? Is policy more important or is individual choice?

    An idea I have been mulling over is that the Fed is effectively contributing to the saving rate in China, given the pegged exchange rate. Since China’s monetary policy is locked into the U.S. monetary policy via the peg, loose monetary policy in the U.S.means China has to create more Yuan to buy up dollars which is then invested in dollar assets…forced savings.

  • Posted by Anantha Nageswaran

    A visit (or Visits) to Brad’s BLOG is a daily ritual for me. For the most part, I tend to agree with his lucid analysis and conclusions. With such a rigorous analysis behind his statements, it is but natural that his conclusions are robust.

    Nonetheless, let me be bold (Or, foolish) enough to venture to differ. There is a tendency to run down the Americans or hold the country and its macro-economic policies largely responsible for the global imbalances. Part of it must be because most of the regular commentators on the BLOG are not necessarily sympathisers of President Bush and his policies.

    I am an Indian living in Singapore for the last six years and I had lived in Zurich for five years before that. So, I presume I could claim some neutrality in this debate.

    Until very recently, I was a bear on the US dollar citing the twin deficits and their likely continuation. However, I have had a re-think. Of course, it is not that I enrolled in the Republican Party in the US. I have no interest in that.

    It must be said that exchange rate determination models are hard to pin down. It is not often the case that current account deficits explain exchange rate movements. Also, sometimes interest rate differentials do a good job and on other occasions they break down. Hence, it is not necessarily automatic that a rising current account deficit should necessarily result in a weaker dollar.

    In hindsight, there are some explanations for the USD rebound and that it need not be a disaster for the US current deficit. First, the near universality of dollar bearishness at the turn of the year – and I was part of it – is part of the explanation for dollar’s recent strength.

    Further, the dollar’s recovery against the Euro need not necessarily result in a higher current account deficit, for its weakness over the last two years has not necessarily resulted in a surge in US exports to the region. Aggregate demand in the Eurozone has become so weak that exchange rate competitiveness in the exporting countries might not help at all.

    For every piece of evidence on America’s structural imperfections, Europe has matched it with more than one piece of evidence of its own economic malaise. With the return on holding American dollar exceeding that on the Euro by a full percentage point and rising, the saga of the Euro is well and truly over. More importantly, I do not believe that it is bad news for the US current account deficit.

    The keys to the US current account deficit are therefore two: Asian exchange rates and the housing bubble induced consumption. On the former, there are stop-and-go signs that Asians are beginning to get the message. Korea is a recent example although it is far from clear that there is a consensus in the country on not intervening in the foreign exchange market.

    But, the point is that more than what happens to the Euro-USD, what happens to Asian currencies against the USD is going to be far more important. If that happens, unlike Brad, I would not worry even if the USD were to strengthen against the Euro.

    He has been focusing on the Asian Reserve accumulation since 2002 and has therefore tended to question Bernanke’s statement that the ‘savings glut’ was an outcome of the Asian crisis.

    Honestly, he is right. Whether it is a savings glut or inadequate domestic investment opportunities relative to domestic savings is hair-splitting. The link below shows that it excess of savings over investments was there from 2000 onwards and it had become worse of course, lately.

    Prior to the crisis, East Asian economic formula was about investment spending (Mostly real estate) and export growth through competitiveness achieved through fixed exchange rates and low wages in the export sector. Now, it is all about exports only.

    This can also be seen in the Investment/GDP ratio in most Asian economies in the web site of the Asia Regional Information Centre of the Asian Development Bank:

    One cannot minimise the role of Asian mercantilism in the global imbalance. Faced with an asset price deflation and a geo-political shock (911), America did what text books suggest. It is a different matter that IMF conditionalities did not allow Emerging economies to follow the same prescription. It is also a different matter that the Bush administration used the opportunity to push ideologically driven fiscal measures rather than cyclically driven measures. But, the need for monetary and fiscal stimulus was unquestionable.

    Hence, it was very unavoidable that American current account deficit would rise. Europe was and is dead and Asia had lost confidence in itself. So, the only global economic growth engine was the American consumer. Yes, it was not the US and China. China was growing because of the US. Even the most ardent China admirer, Stephen Roach, concedes the absence of domestic demand drivers in that country. Further, look at the mess that Thailand and Korea have created for themselves with experiments in domestic consumption. They still are cleaning up the credit card mess. There goes through the window, claims of natural Asian thrift. It is, perhaps, more policy induced.

    So, why blame the American consumer instead of being grateful to him? Who knows what the world would have endured had America decided to belt up from 2003? So, is it also fair that Mr. Martin Wolf wants the American Treasury Secretary to crawl on his knees before his Chinese counterparts? At the minimum, Communist Party of China Central Committee members should be down there below the table, first.

    If Asian economies begin to face up to the costs of their exchange rate management, then it is half the battle won, for America, on the current account deficit and global rebalancing. The other half is in dealing with the housing market that has supported American consumption.
    One needs as much luck as skills in handling that. America might be close to getting that stroke of luck. China might be beginning to count the cost of its ‘growth at all costs’. The weekly ‘Greed and Fear’ news letter of Credit Lyonnais Securities Asia Equity Strategist (CLSA) Mr. Christopher Wood dated May 19th and titled, ‘Kamikaze capitalism’ is a very good read on China’s darkening economic clouds and its economic strategy that is beginning to outlive its usefulness.

    Therefore, the pressure exerted by China on the global price of crude oil has a good chance of abating. If the price of crude oil stays below USD 50, then there is a good chance that corporate spending in the US would revive. That might also give a more solid underpinning to household income and Networth than home price gains through a pick-up in hiring. The unambiguous all-round solidity and strength in the April employment report could be the harbinger of things to come.

    Then, with a gentle rise in the long-term interest rates, the housing market could correct so ‘smoothly’ as is happening in the UK without triggering any major economic slowdown. Let us face it: even if there is a recession, the American democracy and its USD 12 trillion economy could handle its consequences far better than the Central Committee of the Chinese Communist Party and its USD1.6 trillion economy.

    So, the battle against its imbalances is not over for America. But, the signs are more encouraging than they have ever been in the last few years. Further, our distaste for the ‘absolutes’ of the neo-cons should not blind us to the reality that America has been playing its geopolitical cards quite adroitly, regardless of whether we agree with the tactics used. After China did not rule out the use of force against Taiwan, both America and Japan declared Taiwan as their strategic concern in the region. Then, China’s orchestrated anger against Japanese ‘non-acceptance’ of its wartime atrocities backfired. Now, China has been forced to impose 400% export duty on its Textile exports. The European Union has not only been impotent but its hypocrisy in dealing with Iran and China too has been exposed.

    Hence, America might be beginning to get it right. I know that this has been a provocative exercise – if only in an intellectual sense (I hope) more than an analytically tight exercise. But that is the purpose. We all are vulnerable to the feeling of comfort that comes from sticking to familiar and entrenched positions. If this piece just forces us to re-examine our comfort zones, then it would have been a useful exercise, even if the conclusions are not changed.

  • Posted by pgl

    Read DeLong’s comments before I read this. My comment was that the savings glut thesis implicitly assumed a high savings elasticity with respect to changes in interest rates. Had I bothered to read this first, I would have noticed you already noted this implicit assumption.

  • Posted by Movie Guy

    Anantha Nageswaran

    An excellent post.

  • Posted by ChasHeath

    There are certainly interesting things to think about when you’ve got one nation that has a savings rate of 40%, another with a savings rate of 1%; one nation with a very large population and an economy that was about 50 years behind the other in development. We’re not talking about equilbrium here. We’re talking about opening the flood gates and seeing what happens.

    However … PULEEZE!

    First, it is everywhere and always the FED’s responsibility to qualify that stimulus should be the province of the FED rather than of congress. Greenspan even said that, well, sort of, when he said it wouldn’t be such a bad idea to stop running surplusses. In retrospect, now, why would the FED have been supposed to say that, and having said that, back in the 2001..2003 timeframe, if now, “it doesn’t matter”?

    And Bernanke … the one who said we could consider unconventional monetary warfare just a couple years ago … admittedly with very little dissent … now says if we hadn’t been running a huge fiscal deficit, we’d have just pumped that much more juice into negative real interest rate home loans … well, whose idea was that, anyhow?

    OK. So it’s a complex problem, and most everyone agreed it wasn’t such a bad idea to reflate things a few years ago. But isn’t it still the FED’s job to remind everyone that where we are now is a bit unbalanced, and we’d like to start leaning in the right direction, and the fiscal stimulus that might not have been the worst thing in the world three point five years ago is now “leaning in the wrong direction” ?

  • Posted by Erick

    I think the definition of “savings glut” needs to be clarified. It must be realized that the money China used to finance American economy are DOLLARS, which are collected from the exporters and the foreign investors. However, the money Chinese people save in the banks are RMB. Therefore, if we define “savings” as the money the PEOPLE save in the chinese banks, then the entire “savings glut” thesis is false, as Chinese people’s savings had nothing to do with the money China has been using to buy those bonds. Moreover, the savings rate statisitics can not justify the thesis because that rate is probably telling us how much money the people save, which are in RMB, not how much DOLLARS China accumulated.