Brad Setser

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Yet more on Bernanke and the savings glut

by Brad Setser
October 28, 2005

Brad DeLong seems to have dug up what Dr. Bernanke thought about fiscal deficits before he discovered the global savings glut …  namely, structural fiscal deficits tend to raise real interest rates. 

Suppose the government increases spending without raising taxes, thereby increasing its budget deficit…. An increase in the government budget deficit… reduces public saving… [and] will reduce national saving as well…. At the new equilibrium F', the real interest rate is higher at r', and both national saving and investment are lower… the government has dipped further into the pool of private savings to borrow the funds to finance its budget deficit… investors [must] compete for a smaller quantity of available saving, driving up the real interest rate… mak[ing] investment less attractive, assuring that investment will decrease along with national saving.

In his savings glut speech, Bernanke makes a slightly different argument.  The US fiscal deficit is all that stands between the US and even lower real interest rates and even more investment in housing.  Actually, the US fiscal deficit and the US consumer's willingness to spend is all that stands between an even larger savings glut (equivalently, a global shortage of consumption and investment) and even lower real interest rates around the world.

The key quote (emphasis added): 

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.

Note the variable that Bernanke left out – namely the increase in the US fiscal deficit.

Bernanke's thesis (taken to its extreme) suggests that the US is doing the world a favor by spending so much and being so willing to borrow their funds; that implication – and the implication that US policies bear no responsibility for the rising US current account deficit – certainly bothers me.   I don't think today's US current account deficit is the simple response to a shortage of spending abroad, and would be the same irregardless of US fiscal policy choices.  Nor does borrowing abroad to finance fiscal deficits, high levels of consumption and investment in residential real estate obviously create the future export revenues needed to pay the interest on the United States' rising external debt.

But Bernanke was responding to a real puzzle. As Dr. Altig notes: a shift from a structural fiscal surplus of maybe 0.5%  of GDP to a structural deficit of close to 3% of GDP, according to standard models, should have pushed up real interest rate and crowded out investment, particularly in residential housing.   It didn't. 

The absence of higher real interest rates is what led Bernanke to postulate a global savings glut – a thesis that has now been refined into a "fall in investment relative to savings" outside the US, and particularly in emerging economies.

And in some ways, it is not that different from the answer to the low interest rate puzzle that Nouriel, I and many others have put forward – a surge in reserve accumulation by emerging economies (with reserve accumulation defined broadly enough to include the investment funds of the big oil exporters).   As I never stop pointing out, private capital is pouring into emerging economies, but by using this capital inflow to grow their reserves, emerging economies have chosen to use that capital to support the US government bond market (and in China's case, the mortgage backed securities market) – not to finance higher levels of investment or higher levels of consumption.

I tend to emphasize that this reflects a policy choice, and in some cases, I think a policy error.  Bernanke – along with economists like Jonathan Anderson of UBS — tends to deemphasize the role of policy, or to suggest that this policy shift is a rational response, in various ways, to the 97-98 Asian crisis.   Mike Dooley and his merry band go one step further, and suggest that financing the US is a rational development strategy.

Do check out the debate in the comments section of Macroblog – it almost looks like a Wall Street Journal Econoblog on Bernanke's global savings glut.

As you can see from my overly long comments, I am frustratingly in the middle.  I don't buy Bernanke's explanation for why reserve accumulation in emerging economies surged, and think his thesis needs better explanation for why the surge in (net) private capital flows into China have not led to a fall in Chinese savings.   But I also give Bernanke real credit for focusing attention on the fact that the glut in "savings" relative to investment is primarily found in the world's emerging economies.

I cannot tell you how often I still hear pundits argue that access to US financial markets is the key to growth in emerging markets – even growth in China.   Right now, the opposite statement is more true – the US needs continued access to financing from emerging markets to sustain its own growth.  That's right, financial stability in the US hinges on continued inflows from emerging markets far more than financial development in emerging markets hinges on inflows from the US.  Bernanke, unlike many, recognizes this simple truth – and he also seems concerned about borrowing from abroad to finance home construction:

Because investment by businesses in equipment and structures has been relatively low in recent years (for cyclical and other reasons) and because the tax and financial systems in the United States and many other countries are designed to promote homeownership, much of the recent capital inflow into the developed world has shown up in higher rates of home construction and in higher home prices. Higher home prices in turn have encouraged households to increase their consumption. Of course, increased rates of homeownership and household consumption are both good things. However, in the long run, productivity gains are more likely to be driven by nonresidential investment, such as business purchases of new machines. The greater the extent to which capital inflows act to augment residential construction and especially current consumption spending, the greater the future economic burden of repaying the foreign debt is likely to be.

I am glad Bernanke shares this concern — even if he is not inclined to think it warrants a policy response.



  • Posted by Gcs

    nice post

    lots of meat

    quick comment
    emergers need access to high tech IP
    even if they need not a drop of first world capital

    and with the IP usually comes the trans nat that owns it
    and wants to protect it

    the upshot

    fdi value into emergers
    may well be way out weighed
    bythe value of capital flows back
    toward north country
    just to keep a trade surplused emerger’s exchange rate
    commdity export friendly

  • Posted by Skoobz

    Wondering if Bernanke’s ambition to become Fed chairman colored his analysis and led him to the global savings glut theory. It is plausible that he knew it would be more palatable to the current administration than alternative perspectives. Sometimes political correctness trumps the correct application of theory, especially when one has his eyes on a political prize.

    In other news, you might find it interesting to check the commitment of traders report at the CFTC. It looks like spec traders are lined up on the long side of the dollar trade, while commercial traders are short. This discrepency between traders is at its most extreme ever. In sum, this is a very bearish development for the dollar, usually indicative of a forthcoming protracted decline.

  • Posted by bsetser

    Skoobz – maybe. I am inclined to give him the benefit of the doubt tho. I suspect he thinks he just solved Greenspan’s conundrum.

    interesting point on the positioning of various accounts on the dollar. Finally, sorry about the italics. not sure how it happened. probably b/c i initially ended the post with an italicized quote.

  • Posted by Guest

    You didn’t really say ‘irregardless,’ did you?

  • Posted by Guest


  • Posted by Movie Guy

    Good post.

    Bernanke is not demonstrating a full understanding of investment convergence as relates to international production and trade flows. Once he makes that connection, perhaps in discussions with Richard Fisher, Dallas Fed governor, he will likely change his speech presentation.

    Investment savings are being accomplished presently, as related directly to trade policy initiatives supported by international corporate investment decisions.

  • Posted by DF

    “The US fiscal deficit is all that stands between the US and even lower real interest rates and even more investment in housing. Actually, the US fiscal deficit and the US consumer’s willingness to spend is all that stands between an even larger savings glut (equivalently, a global shortage of consumption and investment) and even lower real interest rates around the world.”

    If this is really what bernanke things then I am very surprised.
    I can understand that the US deficit is the last thing that protects the US from even lower rates.
    Asians are saving lots, if the US did not borrow lots, then there would be very low rates.

    But I don’t buy the idea that there would be more investment in housing and higher housing prices.
    IN fact,once asians have stopped to borrow, if the USA would stop there would be something like an international credit crunch. Nominal rates would fall and so would prices especially asset prices.

    I think that by running huge deficits, the US government is subsidizing the american consumer, and the asian producer. With a lower deficit, there would be less consumption in the USA, less investment in asia, more savings worldwide, much less endogeneous credit based money creation, falling prices, the first casualty being the housing bubble.

    What the US and asians have simultaneously decided is to postpone the burst of the world debt bubble (household debt in the US, company debt in asia).

  • Posted by Steven M

    “Bernanke’s thesis (taken to its extreme) suggests that the US is doing the world a favor by spending so much and being so willing to borrow their funds; that implication – and the implication that US policies bear no responsibility for the rising US current account deficit – certainly bothers me. I don’t think today’s US current account deficit is the simple respond to a shortage of spending abroad, and would be the same irregardless of US fiscal policy choices. Nor does borrowing abroad to finance fiscal deficits, high levels of consumption and investment in residential real estate obviously create the future export revenues needed to pay the interest on the United States’ rising external debt.”

    Brad–thank you for saying that, It’s a big relief to those of us who think there’s something wrong with current policy, but occasionally wonder whether we’re missing something. It’s good to hear you lay out the facts with such clarity. The simple fact is that we have to look at many fundamental parts of our economic policy, and place them on firmer ground. Good work. See you.

  • Posted by Joe Rotger

    Interesting thoughts, great thread.

    In general, I tend to agree with Bernanke, events outside of the US are driving the current CA deficit, even potentially inducing the government to overspend to subsidize an ailing US economy.

    There is no doubt in my mind that the conundrum is wage driven; foreign CB’s buy US bonds to prop the US dollar, in order to sustain their growth in exports by maintaining lower domestic wages.

    The 4 billion Chinese, Asian, Indian, East Europeans and Russians seeking employment in the new economy with better paying jobs –and their political influence over their leaders, who fear the consequences of the unrest this wage gap engenders, mandate that they promote a strong growth in their economies to absorb this discontent marginal labor.

    Since incorporating this huge labor force into the world economy is going to take awhile, foreign CB’s will be forced to keep on buying US bonds to prop the US dollar. Hence, IMHO, the future scenario is real interest rates will stay low worldwide and the US dollar will sustain its value (with its tendency to deteriorate) for a very long period of time…in excess of 5 years.

    BTW, I don’t see why the surprise (conundrum) in the fact that the trade partner whom is exporting the goods is very willing to lend to the importing partner…Hasn’t it always happened this way before? You give credit, you sell more?

    The real issue is what is going to happen to the American worker? It would seem that through lack of investment in the US, fleeing investments to Asia, outsourcing and bankrupting US cos., the US wage level will steadily deteriorate till some sort of equilibrium is reached.

  • Posted by bsetser

    Joe — you just described real exchange rate adjustment via US deflation. the dollar stays strong, but us wages (and domestic prices) fall in nominal terms, making the us more competitive. that is one scenario, but not one i like!

    as for “more credit, more purchases” — sure it is not a new thing. what is new is that the credit is coming from the poor to the rich on this scale, and that it is coming from central banks, not other institutions.

    compare today with the marshall plan era — back then, the us provided credit to europe (And europe bought more us goods as a result), but that was a flow from the richer usa to the then poorer war ravaged europe, and it was done on budget, not via the central bank.

    so some things are different. by any standard — $ billion, share of world GDP, $600 b of reserve accumulation by emerging economies is rather unprecedented.

  • Posted by DF

    Brad, I think that if you erase the qualificatives “rich” and “poor” from what you just wrote and replace them by producer consumer you would discover that other similarities and discrepancies with the marshall plan.

    Just like during the marshall plan, a producer and exporting country is lending to a consumer and importing country.

    That’s a huge similarity between the marshall plan and the present situation. It happens to be that the producer and exporting country was richer than the consumer importing country back in the post war marshall plan era. That’s true. And now it is the opposite. China is poorer than USA and EUrope. But this does not affect this very strong common point.

    Now there’s a major difference that you do not point.
    Back in postwar era, US money pouring into europe fueled a lot of investment, and that investment boosted Europe’s production even more thant it boosted its demand.
    So back then, the marshall plan was a tool towards rebalancing the world economy. With a stronger industrial base, europe would be able to export too.

    Nowadays, chinese lending practices boost consumption but encourage disinvestment in Europe and USA (through an artificially low RMB). Those lending practices are then aggravating the imbalances.

    Of course the Chinese are not the only to be blamed, back then the borrowing practices of europeans were sound, nowadays the borrowing practices of the USA and to a lesser extent of europe are unsound.

    So I think the main difference are not those you point out : in the rich/poor criteria or private/public flows, hard budget money lent / debt based created out of thin air money lent …

    Of course these differences matter.

    I think it is much more important to assess where the money flows, and hitherto if the flows can rebalance the world economy or not. (And I’m sure you agree on that you pointed it out on other post).

  • Posted by Joe Rotger

    Brad, Yeap…sounds terrible. You know I’ve been hammering for a US dollar devaluation as the easy solution. But, if foreign lending CB’s steadfastly commit themselves to a dual policy of domestic employment growth and market share expansion, their rate of exchange to the US dollar should change very little…they can do it…they have the reserves, who is going to decline their lending?

    Why do I get a chilling feeling that the Chinese are saying -Check- to the US.

    …I still have some hope that worldwide inflation (oil and others) may still wreak havoc in their prices.

  • Posted by ReformerRay

    The Bernanke article can be critiqued from many different perspectives.

    I see his major problem as a problem you share, Brad. The U. S. trade deficit does not require that money come into the U. S. to subtitue for lack of savings in this country. You are ignoring our stored assets, which amounted to 49 Trillion at the end of 2004. The U. S. is not in the position of other countries. We pay for our trade deficit by drawing down on our supply of stored assets.

    The fact that we have a fiscal deficit, and that countries like China choose to use the dollars we send them to purchase Treasury bonds is irrelevant to how our trade deficit is financed.

    Bernanke is completely, 100% wrong when he says developing countries are sending money to the U. S. as a result of our trade deficit. All they are doing is converting cash we sent them into bonds or other assets that pay a return. The total value of finicial assets in both the U. S. and the developing countries is the same before and after the conversion.

    The U. S. does not need to get funds from overseas to participate in international trade – so long as the dollar is accepted by exporters to the U. S.

    The important consequence of my point is that the U. S. created its trade deficit by accepting in this country more imports than we could sell exports. Regardless of whatever is done on the financial side, we will continue to have a trade deficit as long as imports are not controlled or limited by us and our exporters are not able to sell enough to cover the imports.

    We created the trade deficit and we should take unilateral action to reduce it.

    Our refusal to limit imports is a unilateral action, is it not? What other country has our combination of high purchasing power and open borders?

    The continued growth of our trade deficit is not a mystery if we focus on trade rather than financing.

  • Posted by bsetser

    Europe has quite open borders and relatively high purchasing power. Chinese exports to Europe have actually grown faster than Chinese exports to the US since 02.

  • Posted by ReformerRay

    Europe has quite open borders and relatively high purchasing power”

    Whatever Germany is doing – including high unemployment and slow growth in GDP – if that is what it takes – we should emulate.

    Their share of world merchandise export in2004 is 10%,growing at a rate of 21%. Their share of world merchandise imports 2004 is
    7.6%, growing at a rate of 19%.

    Now that is the kind of participataion in world trade that the U. S. should try to achieve.

    How do they do it? I don’t know.

    U. S. share of world exports Mer only is 8.9%, growth rate of 13%. Imports we accept 16.1% of world, growth rate of 17%.

    I would gladly exchange ourhigh rate of economic growth for the German’s sustainable participation in international trade.

  • Posted by DF

    bet the thread will die, but I can’t let this pass.
    German have a 100 year specialisation in machine tools, robots, and other investment goods. WHen an industrial country like CHina is booming, they get to export lots.
    In a global investment boom, germany fares very well.

    Now is their position sustainable ? I doubt it.
    China is overinvesting, which means the german export growth to china is unsustainable.

    Once the investment boom stops, Germany will have nothing left to export, and if there is no finished good industry any more in europe because all of it went to china… Then europe and germany will suffer.

  • Posted by ReformerRay

    Germany will suffer when investment boom stops.

    We all will suffer when current growth pattern stops.

    Better to have an economy that can benefit from a growth period than one that cannot. GDP is not the only important indicator.

    Overinvesting in China? Not if they can undercut competitors in selling on the international market. Not if the U. S. continues to accept so much imports. The international markets must be closed to China before they have overinvested. Think that will happen?

    (I agree that this thread is on its last legs, but I thank you for keeping it open one more time)