Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Print Print Cite Cite
Style: MLA APA Chicago Close

loading...

The global savings glut and the current crisis

by Brad Setser
January 9, 2009

I have always believed that the debtor and the creditor tend to share responsibility for most financial crises. One borrows too much, the other lends too much. Wynne Godley (ideologically, no Hank Paulson), Dimitry Papadimitrriou and Genaaro Zezza seem to agree. They write:

“The process by which U.S. output was sustained through the long-period of growing imbalances could not have occurred if China and other Asian countries had not run huge current account surpluses , with an accompanying “savings glut” and a growing accumulation of foreign exchange reserves …. flooding the US market with dollars and thereby helping to finance the lending boom. Some economists have gone so far as to suggest that the growing imbalance problem was entirely the the consequence of the savings glut in Asian and other surplus countries. In our view, there was an interdependent process in which all parties played an active role. The United States could not have maintained growth unless it had been happy to sponsor, or at least permit, private sector (particularly personal sector) borrowing on such an unprecedented scale.”

Thanks to Martin Wolf for highlighting the Godley et al paper.

Their argument seems right to me. Absent a large savings surplus in Asia and the oil exporters, rising US rates would have choked off the housing bubble much earlier. High long-term rates aren’t conductive to rising home prices — and without rising home values it is hard to turn a home into an ATM. Felix Salmon writes:

it was the global liquidity glut, and the concomitant demand for a bit of extra yield on fixed-income assets, which encouraged the lax subprime underwriting which etc etc. If the world hadn’t been perfectly happy to throw trillions of dollars a year into America bottomless appetite for capital, the bubble would never have happened, and neither would the subsequent bust.

At the same time, US policy makers didn’t exactly try to reign in US borrowing or leverage in the financial sector. They were far more likely to cheer this process on than to try to get in the way.

Five additional observations:

There is little point denying that there was something of a “savings glut” in much of the emerging world. Just look at Table A16 of the statistical appendix of the IMF’s WEO. In 2006, 2007 and 2008 the developing world’s savings was around 33% of its GDP, well above its 24% average in the late 80s and 90s. That allowed emerging economies to both increase investment above their historic levels (think of all the construction in the Gulf and China) and at the same time lend unprecedented sums to the US and increasingly Europe. (Graph here)

There is actually much more evidence of a savings glut from 2006 to 2008 than there was back in 2003 and 2004. In 2003 and 2004, it was plausible to argue that the emerging world — counting the Asian NIEs — was suffering from investment draught. Savings rates in the developing economies were only a bit above long-term averages. That argument though didn’t work in 2007 and 2008. Average investment rates in the developing economies by then were well above their historical averages – around 29% in 06-08 v 25% in the 80s and 90s — even as the developing economies were running record current account surpluses.

Global savings also rose above its long-term average in the 2005 to 2008 period, though not by as much — as the offsetting deficit in the US reflected a fall in US savings far more than a rise in investment. US national savings was 14% of US GDP in 2007 — and 12.5% in 2008; it was more like 16% of GDP in the late 80s and 1990s. As Godley, Papadimitriou and Zezza illustrate, high levels of household borrowing to support high levels of current consumption kept the US household savings rate down. US Investment by contrast wasn’t above its level in the late 80s or 90s, especially after residential investment started to fall.

Central banks reserve growth in the savings surplus countries carried this surplus to the US. Most emerging economies with large savings surpluses were, until recently, also attracting private capital inflows. Private investors globally, in other words, wanted to finance deficits in the high growth emerging world not in the US. In most of the big surplus countries, reserve growth (counting a sovereign fund if there was one) exceeded the current account surplus (See the WEO Statistical Appendix Table A13). That is telling.

Central banks didn’t buy many subprime mortgages or CDOs of CDOs, and thus were not directly financing the riskiest borrowers in the US economy. They needed some accomplices to finance high levels of US consumption when the US fiscal deficit came down after 2004. Central banks didn’t lend to borrowers trying to home that they really couldn’t afford, or to Americans borrowing against their homes to finance a vacation that they couldn’t really afford. The entire process could only be sustained as long as private intermediaries were willing to take the credit risk central banks generally speaking didn’t want to take.

The process that led to the boom in risky assets was indirect: Central bank demand for safe assets drove down the return on safe assets and encouraged private sector risk taking. Private banks, famously, didn’t want to sit out the dance. James Kwak of The Baseline Scenario writes:

All of the U.S. dollar reserves held by all of these countries were effectively loans to the U.S. Treasury bonds were loans to our government; agency bonds were loans to our housing sector. This large appetite for U.S. bonds pushed up prices and pushed down yields, lowering interest rates and thereby fueling the U.S. bubble. Even though the money didn’t go directly into subprime lending, it lowered the costs for all the investors who were investing in subprime. so at the same time that irrational beliefs about asset prices were driving those prices up, the increased availability of money looking for things to buy also drove prices up. Looking at it counterfactually, if there had not been so much global demand for U.S. assets, it’s unlikely that even the once-divine Alan Greenspan could have kept 30-year mortgage rates as low as they were, since the only lever he had control over, the Fed funds target rate, is an overnight rate. And if mortgage rates hadn’t been so low, the bubble couldn’t have been as big.

Of course, the US regulators didn’t exactly try to stop this process. Nor did the Fed try to counter surprisingly low long-term rates by raising short-term rates more. It was far easier to argue that low long-term rates (and a run-up in home prices) was a natural consequence of the Great Moderation.

The impact of US policies to restrain domestic demand on global adjustment is complicated by the the fact that the large savings surplus countries peg to the dollar. Suppose the US takes steps that restrain domestic demand growth (tighter regulation of risky lending, tighter fiscal policy, higher policy interest rates). The result would tend to be slower US growth — and less US import demand. Less import demand translates into a smaller current account surplus in the exporting countries. Their income falls a bit, and unless spending or investment falls, their savings would fall too. That is the first effect. But a US slowdown — at least one not induced by a strong rise in US rates — tends to put downward pressure on the dollar. The US imports a lot, but a US slump still has a bigger impact on activity in the US than activity in the world. And a slowdown in the US — especially one that leads to lower rates — tends to put downward pressure on the dollar. If say China (or any other major emerging economy) pegs to the dollar, their currencies go down too — and that tends to push up exports to places like Europe that let their currencies float. That keeps Chinese income and savings up.

And if a weaker dollar leads to higher commodity prices even as the US– still a big commodity importer — slows, that helps support savings in the commodity exporters.

That dynamic, remember, is more or less what happened from 2006 to 2008. The US slowed — and US domestic demand growth no longer was the engine of global demand growth. The trade deficit was still big, but it wasn’t growing — and the non-oil deficit shrank. US domestic demand growth lagged European demand growth in 2007 and 2008 (IMF WEO Table A3). But the savings surplus of the emerging world remained large — driven by an expansion of China’s savings and current account surplus and by high commodity prices. The dollar’s depreciation — in a context where China depreciated against the dollar and restricted demand growth to avoid over-heating — helped to shift the deficit that offset China’s surplus to Europe. If China didn’t depreciate along with a slowing US, the dynamics could have been different. Rather than relying on exports to Europe and the commodity exports to keep export growth up even as exports to the US slowed, China might have been pushed to take steps to support its own domestic demand earlier. At a minimum, it wouldn’t have needed to restrain lending and run a tight fiscal policy to limit inflation.

The emerging world’s savings surplus should fall in 2009; among other things, that implies that most the rise in the fiscal deficit of the advanced economies will need to be financed domestically. The oil exporters won’t be saving much at all at current oil prices. Big fiscal surplus will in some cases turn into big fiscal deficits. And I doubt that China’s savings rate will rise enough to offset the fall in the commodity exporters’ savings. In other words, the windfall to commodity importers won’t all be saved. Aggregate emerging economy savings — relative to emerging economies’ GDP — should fall. That would, absent a commensurate fall in investment, bring down the emerging world’s current account surplus. And that, in turn, implies a fall in the offsetting deficit of the advanced economies. The only real risk here is that a huge fall in investment in places like China and Russia keeps the aggregate surplus up … in other words, the investment drought might reemerge.

What then should the world do now that the process where rising consumption and falling savings in the US and Europe supported export-led growth in the emerging world has come to an end? The US has taken the lead in adopting macroeconomic policies to try to offset what most expect to be a sharp slowdown in US — and global — activity. That could, if big enough, eventually trigger a recovery in the emerging world’s exports and thus bring up their income and savings. After a harsh down cycle, the old relationship could be restored — with large US fiscal deficits playing the same role that the large increase in borrowing by US households formerly played. But, as Martin Wolf ably illustrates, it would be a mistake to rely too heavily on a US stimulus to support world demand. Far better if surplus countries do their part. Dr. Wolf writes:

The US and a number of other chronic deficit countries have, at present, structurally deficient capacity to produce tradable goods and services. The rest of the world or, more precisely, a limited number of big surplus countries – particularly China – have the opposite. So demand consistently leaks from the deficit countries to surplus ones. In times of buoyant demand, this is no problem. In times of collapsing private spending, as now, it is a huge one. It means that US rescue efforts need to be big enough not only to raise demand for US output but also to raise demand for the surplus output of much of the rest of the world. ….

Now think what will happen if, after two or more years of monstrous fiscal deficits, the US is still mired in unemployment and slow growth. People will ask why the country is exporting so much of its demand to sustain jobs abroad. They will want their demand back. The last time this sort of thing happened – in the 1930s – the outcome was a devastating round of beggar-my-neighbour devaluations, plus protectionism. Can we be confident we can avoid such dangers? On the contrary, the danger is extreme. Once the integration of the world economy starts to reverse and unemployment soars, the demons of our past – above all, nationalism – will return. Achievements of decades may collapse almost overnight.

Yet we have a golden opportunity to turn away from such a course. We know better now. The US has, in Barack Obama, a president with vast political capital. His administration is determined to do whatever it can. But the US is not strong enough to rescue the world economy on its own. It needs helpers, particularly in the surplus countries. The US and a few other advanced countries can no longer absorb the world’s surpluses of savings and goods. This crisis is the proof. The world has changed and so must policy. It must do so now.

The alternative to global adjustment is a world that relies on huge and sustained fiscal deficits in the US to sustain an acceptable level of global demand. That isn’t very appealing. It works for a year or two. But not for ten.

Godley, Papadimitrriou and Zezza argue — quite correctly — that the more a fall in the US (non-oil) deficit contributes to the United States’ recovery, the less the burden on fiscal policy. But the US external deficit won’t fall unless the world steps up to pull itself out of trouble. It won’t happen without policies to support global demand growth.

136 Comments

  • Posted by Twofish

    Don’t be fixated by houses. Houses were just an excuse to find ways of looting bank vaults.

  • Posted by Kien

    China can be faulted to some extent for maintaining a trade surplus and not letting the RMB appreciate. On the other hand, the Asian financial crisis also taught Asian governments that the IMF could not be trusted, and they had to build large foreign currency reserves. Perhaps in addition to blaming the Chinese (for building trade surpluses) and the United States (for not regulating their financial markets), blame also lies with the IMF and the champions of the “Washington consensus” for putting the interests of international finance ahead of financial stability. Perhaps one good thing about the financial crisis is that the IMF is no beholden to the princes of international finance. If the IMF can help establish a new consensus around financial stability and appropriate controls over capital flows, governments of developing countries may be more confident of running trade deficits.

  • Posted by Twofish

    Here are some more graphs:

    http://mortgage-x.com/trends.htm

    http://mysite.verizon.net/vodkajim/housingbubble/united_states_1890-2007.png

    Long term, there is no correlation I can see between inflation adjusted housing prices and interest rates, and there really shouldn’t be one. Why should the value of a house change if interest rates change? Unless….

    It’s not really a house, but an “investment.” The real point at which things started falling apart was in the late 1990’s, when people starting thinking of houses as an investment rather than as a place to live in.

    Suppose China didn’t exist and you didn’t have people pumping money into the system. I’d argue that you still would have had a housing bubble and bust. The argument is that if you have less money coming in, then interest rates would have increased. I argue that they wouldn’t have.

    I can take a rock and if I can convince people that it is a magic rock, then I can get people to sell that rock to each other for a $1 million and we are all convinced that we all are millionaires. People were using houses to print funny money, and you don’t need China to help you with that.

  • Posted by Albion

    Brad
    The interest rates yield curve is not driven by supply and demand, it is too academic for an explanation.

    See the outstanding position in the IRS and interest rates futures (quarterly report controller of currency)
    The latest ten years Bund auction has seen a 87 Pct cover that means 13 Pct of the auctioned amount had no bid. This lack of attraction from genuine bonds holders had no effect on the existing 10 years yield.
    The whole spectrum of financial prices have been perverted since long through cartels and it is no wonder that at some point of time prices are and will be moving from a convex reflexivity towards a concave reflexivity .

    « German bond sale’s fate signals trouble ahead
    By David Oakley in London
    Published: January 7 2009 13:30 | Last updated: January 7 2009 20:45
    A German sovereign bond auction failed on Wednesday as investors shunned one of the most liquid and safe assets in the world in a warning for governments seeking to raise record amounts of debt to stimulate slowing economies.
    The fate of the first eurozone bond auction of 2009 signals trouble ahead as governments around the world hope to issue an estimated $3,000bn in debt this year, three times more than in 2008. »

  • Posted by glory

    global savings glut?

    whatever 😛

    a revised WTO?

    the gloves are off!

  • Posted by geert

    I will try a different approach, a more legal one, in an “attempt” to be original. The idea originated when 2Fish wrote that the reserves are “a cushion for this crisis” (2:01)

    The two main sources for international reserve building are: the trade surplus and the FDI / hot money flow. Let us suppose for a moment that both contributed equally to the Chinese international reserves.

    The part coming from the trade surplus is the property of the Chinese people. They earned it and can spend it the way they want (and please do respect ownership on an international level as you do on a national/individual level = the pilar of US civilization). And why not include the $ 9 trillion cash on the sidelines in the saving glut?
    http://www.sfgate.com/cgi-bin/article.cgi?f=/n/a/2008/12/23/financial/f135629S16.DTL

    The second part, they don’t own in the real sense. It is the subject of an exchange/swap/barter whereby the Chinese government accepts dollars and gives Yuan. This swap is a temporary agreement (long for FDI and maybe very short for hot money), with a foreigner who will at some point in time exit and demand the reverse exchange. The Chinese government MUST be able to meet that demand at any moment.
    If I reason as a good family man then I know I shouldn’t spend the dollars but invest it wisely. As I neither want a currency risk nor a debtor risk, the only available instrument is US treasuries.

  • Posted by Indian Investor

    Brad:
    But the US external deficit won’t fall unless the world steps up to pull itself out of trouble. It won’t happen without policies to support global demand growth.

    I fully agree with this statement and I’m not clear why there’s a lot disagreement on it. There has to be a lot of Government fiscal stimulus spending in countries like India so that local demand and US exports to that country can increase and allow the Reserve Bank of India “a painful adjustment is now inevitable” conclusions to actually pan out. Somebody has to convince the Reserve Bank of India that “inevitable” things don’t happen all by themselves. Somebody or other has to actually work on the inevitable things of life and make them happen.

  • Posted by ReformerRay

    Indian Investor says: “But the US external deficit won’t fall unless the world steps up to pull itself out of trouble. It won’t happen without policies to support global demand growth”.

    Assuming the U.S. will not change its policy. The U.S. government has not made any seriou attempt to reduce the size of the U.S. trade deficit. It is my firm conviction that this passivity is detremental to the long term interests of the U.S. I cannot understand why it continues.

    Global demand growth will not necessarily reduce the U.S. external deficit. Whoever is supplying goods to the world today will continue to do so tomorrow.

    The only path to reduction in the U.S. external deficit is action by the U.
    S. to change the situation.

  • Posted by ReformerRay

    Any U.S. citizen that provides advice to the Chinese government on what its trade policy should be is wasting their time.

    The Chinese leadership will decide what is in the best interests of China.

    The rest of the world, including the U.S., should concentrate on what their own country should do, in response to what China and all the other trading partners do.

  • Posted by tip

    The formula is pretty simple. Immediately withdraw all troops from Iraq, cut out missions in Afganistan and reduce military capacity around the world by 50%.

    If the U.S. does not do this then it’s going to default on it’s debt. Sooner before later.

    When empires decline, it takes time, but one key component is the decline in the empires military. Of course the majority of Washington is brainwashed and does not see the severity of the crisis, or the severity of the u.s. trade defecit. I think a few of the G20 leaders are becoming aware.

    The transition will not be easy, and i do wonder how Americans will feel when the Dow Jones sits at 3-5K level the next 10 years and suddenly emerging markets start moving higher.

    The Dow Jones will be the Nikkei…but we could be Iceland with a massive default in the not too distant future.

  • Posted by ReformerRay

    I vote for tip.

    Yes, a bloated military is part of our problem. Reduction in military spending is part of the solution.

    Do we have time for Obama to see the wisdom of tip’s advice? And for him to persuade those Republican’s he wants to work with?

    Maybe so; maybe no.

  • Posted by Observer

    2fish:

    You don’t think social security guarantees and medicare had anything to do with a third of the babyboomers ending up with zero savings?

  • Posted by Observer

    2fish:

    Without demand from households, what is the incentive for private enterprises to invest?

  • Posted by seatrus

    # Observer responds:

    2fish:

    You don’t think social security guarantees and medicare had anything to do with a third of the babyboomers ending up with zero savings?
    ———————————————

    It also has a lot to do with the Fed’s policy of keeping interest rate low. A lot of near-retirees jumped the investment bandwagon because the interest on savings could barely keep up with inflation. This is “forced investment” by the Fed. The Fed may have thought that they had discovered the magic bullet to deal with the economical fluctuations: keeping interest low and money supply high, which caused over investment. But where was the demand? The U.S. government under the pressure of investment lobbyists sought to increase demand by relaxing rules about financial regulation, thus paved the way for reckless credit expansion.

    Credit expansion can boost consumption if used prudently, i.e. proportional to income. But in the past years, credit expansion far outpaced the rise in real income. It was a vicious cycle: on one hand increased money supply by the Fed caused over investment and speculative bubbles. On the other hand, to solve the lagging income/demand problem, the U.S. government, instead of sought ways to increase real income for the middle class, allowed financial institutions to create “credit” based on bubbles, which artificially boosted demand to match the fake prosperity.

    The U.S.’ trade deficit with China was mainly caused by over investment by American companies in China, which was part of the overall over investment problem created by the Fed. Protectionism only hurts the poor who have benefited from the cheap Chinese goods, while ignoring the fact that the root cause of the current crisis was a combination of wrong monetary policies, irresponsible deregulations/credit expansion, and most importantly, the ignorance to the stagnant in real income. Bring back progressive taxation, like in the 50s and 60s, is the only way to long term prosperity.

  • Posted by Twofish

    One thing that worries me is that everyone is so much in panic mode that no one seems to be talking about the long term impact of what is happening. It’s easy to start economic stimulus. The hard part is turning it off after it becomes non-useful. If you put lots of money in construction, then you will end up with a construction lobby that will try to keep that money flowing indefinitely.

    Observer: You don’t think social security guarantees and medicare had anything to do with a third of the babyboomers ending up with zero savings?

    Curiously I don’t think so. You aren’t going to have a decent retirement if you rely only on social security.

    Also in the case of China, I can see a situation in which a good health care system and retirement system will result in lower savings in twenty years, but even if you have a magic wand and put in a system right now, it is very unlikely to have any immediate effect on savings.

    One thing that would be interesting would be to compare the savings habits of people who are covered by various health insurance and those that aren’t, and I don’t think that there is much of a difference. Also Chinese saved a huge amount under the pre-1978 socialist system even with health and education (largely because there was nothing to buy).

    You also want to be careful. If your only goal is to stimulate demand, then you want to end up with a bloated inefficient system, because the more inefficient the system, the more ways you can pump money into the system.

    In any case, Chinese household savings have been roughly constant over the last thirty years. What increased tremendously was Chinese corporate savings, and that was because Chinese corporates in the 2000’s were making money.

    Observer: Without demand from households, what is the incentive for private enterprises to invest?

    Expectations of future demand. If you run into a situation where private enterprises can’t find anything that they want to invest in, then at that point you generate demand buy having the government generate public goods.

    Observer: The Fed may have thought that they had discovered the magic bullet to deal with the economical fluctuations: keeping interest low and money supply high, which caused over investment.

    I don’t think it is “overinvestment” rather than “misinvestment.” The prevailing ideology at the time was that all the government had to do was to set interest rates, and the market would react in the most productive manner. This ideology turned out to be wrong.

    This matters for current policy. You can argue that Obama’s policy of cheap money and fiscal stimulus is the same, and you might be right if you just look at interest rates. However, Obama is likely to advocate a far more interventionist role for the government to determine how the stimulus is allocated.

    Personally, I think that with the fall of the Soviet Union, there was this notion that any sort of government intervention in the economy other than setting interest rates and enforcing contracts was a bad thing, and the pendulum swung a bit too far.

    2fish: On the other hand, to solve the lagging income/demand problem, the U.S. government, instead of sought ways to increase real income for the middle class, allowed financial institutions to create “credit” based on bubbles, which artificially boosted demand to match the fake prosperity.

    One thing. I don’t think that there was fake prosperity. Between 2000-2008, you had vast increases in productivity which resulted in vast increases in incomes for the wealthy.

    Observer: Bring back progressive taxation, like in the 50s and 60s, is the only way to long term prosperity.

    Except that the 1970’s weren’t that great.

    There is a problem with political timing.

    I think that Obama is very shrewd for talking about tax cuts now. If the stimulus package works, then he is going to have enough political support to do whatever he wants to in two years, if he really believes that high taxes on the wealthy is a good thing (and we’ll find out then whether he really believes this or not).

    If the stimulus package blows up, then he has bought himself insurance by including tax cuts. If you increase taxes now, and everything falls apart, the Republicans are going to blame the tax increases for everything that went wrong.

  • Posted by Twofish

    ReformerRay: Any U.S. citizen that provides advice to the Chinese government on what its trade policy should be is wasting their time. The Chinese leadership will decide what is in the best interests of China.

    No they aren’t wasting their time. The Chinese leadership is extremely open to listening to outsiders points of view and tends to be very good about listening to constructive criticism. One thing that is fascinating about the Chinese leadership is the amount of intellectual diversity there is.

    You have everyone between hard-line Marxists and people that worship Milton Friedman in policy making positions within the Communist Party. The interesting thing about the Chinese Communist Party is that as long as you don’t oppose keeping the Party in power, there really aren’t that many restrictions on what you can believe.

    The views of foreign economists on the Chinese economy are extremely influential in internal Chinese political discussions. You just have to remember what their point of view is.

    If you come up with clear and convincing arguments that free trade will benefit China and destroy the United States, well, they really don’t care that much what it does to the United States. It will certainly influence the Chinese leadership, although maybe not in the way that you want.

  • Posted by Observer

    2fish: Also Chinese saved a huge amount under the pre-1978 socialist system even with health and education (largely because there was nothing to buy).

    And health care costs were low back then, unlike now. The situation now is that you have a clash of social norms based on filial piety and you also have exploding medical costs as more and more of the most advanced medicine and medical treatment are becoming available. That’s an entirely new dynamic.

    2fish: Expectations of future demand. If you run into a situation where private enterprises can’t find anything that they want to invest in, then at that point you generate demand buy having the government generate public goods.

    Government spending can only be a short term fix. To the people who are unemployed right now and are able to work, do they really care if the government pays them $20 an hour to build highways or to dig holes in the middle of a desert? It surely won’t matter to them, but the effect is that you end up with the government printing money by keeping people on its payroll and not really producing any goods that the private sector demands. If the situation lasts perpetually, then you’d have a boatload of money chasing very few real goods and services, and thus you’d have inflation.

    In the long run, you need people to produce real goods and services, and to do that you need people to consume them. Transactions have to be viewed as delayed barters, so this way, it’s easier to see that for one to produce, one must also consume.

    Lastly, figuring out how all of this is going to impact China is great, but US policy makers are only accountable to their own constituents, and that doesn’t include the Chinese. The Chinese really ought to just stop feeding the bureaucrats and really start to allow individuals and businesses preserve their capital by stripping officials of the power to corrupt their savings. You wonder why the Chinese corporations have saved so much? Perhaps you ought to look at all the layers of government bureaucracy and legal ambiguity that make it nearly impossible to undergo long term investment projects without the fear of having some initial projection going completely awry.

  • Posted by ReformerRay

    After all the above discussion, we have missed the elephant in the room, trillions of dollars of private contracts, constructed on the basis of the false assumption that the people that promised to pay regularly would do so. Until these are “disposed” in some way, stimulus packages, no matter what their nature, will go to increase the balance sheet of all firms that feel threatened by current reality.

    We should reject the notion that private contracts are sacred and must be enforced by U.S. courts. Instead, we should pass a law saying these contracts should never have been written and that they will not be enforced as written in U.S. courts.

    That will open the door to additional laws which specificy ways these various contracts should be valued. Serious discussion will be needed to come up with the least unfair way of resolving the situation.

    I am assuming here a massive change in the Congress. My only hope is that they continue to be responsive to public opinion and that the problem will be recognized before it is too late to deal with it.

  • Posted by ReformerRay

    I still think it is presumptous and inappropriate for citizens of the U.S. to try to tell the Chinese government what policy it should take.

    Each nation should defend its own sovereignty. That includes intervening in the world trade system in a way that preseves the power of each nation.

    Twofish initially disagrees, then he says that the Chinese leadership will be influenced by what is said in the U.S., but not in ways that you might want. Seems to agree with me.

  • Posted by ReformerRay

    If you use the componenets of GDP to estimate the size of national savings, as in Savings = Investment + Trade Balance, this formula requires that Investment and the Trade Balance control or determine the level of Savings.

    And variable that can only be estimated by calcuations from the level of other variables in the equation cannot be a causal variable.

    The size of national savings in China reflects the combination of investment and a large trade surplus. If the investment level were equal to the level of the trade balance, national savings in China would be zero.

    Personal savings have very little to do with the level of national savings. Governmental savings and business savings outweigh personal savings.

    Think anwew, guys. Most economists view savings as a causal variable but that is a mistake which should be corrected.

  • Posted by ReformerRay

    Instead of “And” the first word in the second paragraph should be “Any”. And that sentence should conclude with the phrase “in that equation”.

    Addendum. Savings is defined as that part of national output that is not consumed. Thus Savings = GDP – Consumption (public and private). Two sides of the orginal equation remain equal after Consummption is moved from the right to the left side of the equation. Thus S = I + TB.

  • Posted by ReformerRay

    I mispoke above. Only when the trade balance is negative, will the savings level be zero, when the positive investment is large enough to balance the negative trade balance.

    A positive trade surplus plus a positive investment will produce a very large national Savings. As in China, currently.

  • Posted by Twofish

    Observer: You also have exploding medical costs as more and more of the most advanced medicine and medical treatment are becoming available. That’s an entirely new dynamic.

    The exploding cost of health and education in China and the United States has nothing to do with technology. The issue is that in the 1960’s in China, it was really cheap to hire people to be doctors and teachers, because there were no other job opportunities. Today, there are, and if you pay people low wages to be doctors and teachers, they won’t be.

    If you look go to a nursing home and see what they spend their money on, high technology is not where the big costs are. Technology tends to be a capital cost that can be spread over large numbers of patients. The really big costs are people. You can share one X-ray machine with 100’s of people, but you can’t do this with nurses.

    Observer: Government spending can only be a short term fix. To the people who are unemployed right now and are able to work, do they really care if the government pays them $20 an hour to build highways or to dig holes in the middle of a desert?

    No. But if the government borrows money, it makes a big difference since highways create wealth that generate tax revenue that pays back loans.

    Observer: It surely won’t matter to them, but the effect is that you end up with the government printing money by keeping people on its payroll and not really producing any goods that the private sector demands.

    If they are public goods that increases the efficiency of the economy, then you don’t have a problem. You print money, but the total wealth of the society increases, and so things balance themselves out.

    Observer: If the situation lasts perpetually, then you’d have a boatload of money chasing very few real goods and services, and thus you’d have inflation.

    But you can have public goods and then taxes can pay for those goods. Public goods can improve private wealth.

    Observer: The Chinese really ought to just stop feeding the bureaucrats and really start to allow individuals and businesses preserve their capital by stripping officials of the power to corrupt their savings

    No. You need to pay bureaucrats *MORE* money. If you pay bureaucrats less money, then you end up with lousy inefficient bureaucrats that figure out how to make money in bad ways anyhow. If you pay bureaucrats *MORE* money, you end up with a more honest, cleaner, more efficient bureaucracy that that ends up generating more private wealth.

    If you want quality, you have to pay for it. If you start nickle and diming everything, you end up paying the same or more, but getting less. An honest banker or bureaucrat will tell you upfront how much he is going to take from you. If you try to go for the lowest bidder, chance are that you will end up with someone that won’t tell you what they are doing to take from you.

    This is the problem that you end up with teachers, doctors, and bureaucrats. People in private parts of the economy make a lot more money (compare the salaries of policemen with stock brokers). The trouble with that is that you end up with a system out of balance.

    Observer: You wonder why the Chinese corporations have saved so much? Perhaps you ought to look at all the layers of government bureaucracy and legal ambiguity that make it nearly impossible to undergo long term investment projects without the fear of having some initial projection going completely awry.

    But then you ask is it a bad thing that Chinese corporations save so much, and it isn’t. Chinese corporations have saved a lot because you have a government bureaucracy that intentionally put in measures to encourage corporate savings. This is a good thing.

    If it were not for government regulation, China would be in the same situation as the United States with busted banks and bankrupt corporations.

    Ronald Reagan may have been right in 1980, but his ideas have outlive their usefulness, and the pendulum needs to swing back.

    Government is not the problem. It is the solution.

  • Posted by Twofish

    ReformerRay: If you use the componenets of GDP to estimate the size of national savings, as in Savings = Investment + Trade Balance, this formula requires that Investment and the Trade Balance control or determine the level of Savings.

    The problem here is that you can’t just change one number and keep all the other numbers fixed. If you change trade balance then all of the other numbers change.

  • Posted by Twofish

    ReformerRay: I still think it is presumptous and inappropriate for citizens of the U.S. to try to tell the Chinese government what policy it should take.

    I think it is quite appropriate. I think that the Chinese government should do X because I stand to make a lot of money if they do X and stand to lose a lot of money if they don’t do X.

    Now if they do X just because I think that they should do X, then they are idiots, but the good thing about the Chinese government is that they have the will and ability to make up their own minds. This isn’t true with the government of Upper Volta. Because China is as powerful as it is, this means that “hard ball” is appropriate in a way that it isn’t for a lot of other countries.

    ReformerRay: Each nation should defend its own sovereignty. That includes intervening in the world trade system in a way that preserves the power of each nation.

    I don’t see anyone in Beijing or Washington DC that much disagrees. The trouble is that when you get into the details of *how* to do that. People in Beijing and Washington that support free trade do so largely because they think that it is in their national interest to do so.

    The fact that there is very little support for trade protectionism suggest to me that there is a very strong possibility that open trade is in fact in the national interest of the United States. If everyone is making more money doing X than doing not-X, that suggests that X may be a good thing.

    China is largely open to foreign investment, foreign trade, and foreign ideas because it tried for 30 years to close itself off, and it was a total economic and political disaster that no one in China ever wants to repeat.

  • Posted by Observer

    2fish: The exploding cost of health and education in China and the United States has nothing to do with technology.

    I’m not familiar with education costs, but the notion that exploding healthcare costs have nothing to do with technology is flat out wrong. Google some congressional studies on the subject. This point is really not up to debate.

    2fish: If they are public goods that increases the efficiency of the economy, then you don’t have a problem. You print money, but the total wealth of the society increases, and so things balance themselves out.

    The question is not whether new roads will improve efficiency; if one passenger gets to save 10 minutes from his morning traffic, you’d also have an improvement in efficiency. The question is by how much. There’s a reason why the Japanese couldn’t spend their way on public projects to get out of the recession. New roads sound nice, but over the long term, when you neglect the goods and services provided by the private sector, it doesn’t matter how much money your government has printed or borrowed to fund your paycheck, you’d still be in queue at a bread line.

    2fish: No. You need to pay bureaucrats *MORE* money.

    Maybe if we just give them all the national treasuries, that would perhaps solve all of our problems. No political reforms necessary. Just legitimize grey income.

    2fish: This is a good thing.

    The lack of investment by Chinese corporations in China to create jobs and expand business activity is a good thing? I’m not following.

    Again, a large part of China’s social norms is built around filial piety. Even though the middle class has been getting richer, the healthcare costs that they are responsible for have also climbed up. Imagine if you are a engineer in a Chinese firm. Are you going to decline the latest cancer treatments available for your mom?

  • Posted by Twofish

    Observer: I’m not familiar with education costs, but the notion that exploding healthcare costs have nothing to do with technology is flat out wrong. Google some congressional studies on the subject. This point is really not up to debate.

    This may be the case in the United States. It’s certainly not the case in China. The basic health care system has broken down, not because of access to high technology, but because when Communist central planning fell, some of the good things of Communism (like decent basic health care) also fell apart.

    Observer: There’s a reason why the Japanese couldn’t spend their way on public projects to get out of the recession.

    China isn’t Japan. If China were at Japanese levels of development building new railroads wouldn’t be productive, but it isn’t there yet.

    Observer: New roads sound nice, but over the long term, when you neglect the goods and services provided by the private sector, it doesn’t matter how much money your government has printed or borrowed to fund your paycheck, you’d still be in queue at a bread line.

    Governments can provide goods and services also. The state owned enterprise sector of the Chinese economy does everything that the private sector companies do in the US.

    Observer: Maybe if we just give them all the national treasuries, that would perhaps solve all of our problems. No political reforms necessary. Just legitimize grey income.

    The problem with most developing countries is that they don’t have a tax system and so they aren’t subject to central control. The problem with legalizing grey income is that they are then not subject to either market or administrative control and bad things happen.

    Observer: The lack of investment by Chinese corporations in China to create jobs and expand business activity is a good thing? I’m not following.

    What lack of investment? Chinese companies make money, lots of money. They either build factories or put their money in the bank which then loans it out for someone else to use.

    Observer: Again, a large part of China’s social norms is built around filial piety.

    Chinese social norms are changing rapidly enough so that it’s very hard to make generalizations.

    Observer: Even though the middle class has been getting richer, the healthcare costs that they are responsible for have also climbed up.

    The middle class is not the problem. If you have a job at a large Chinese company, the odds are that you have decent health care insurance for you and your family. The problem is that this isn’t true if you are a migrant worker, you don’t have any insurance at all.

    Observer: Imagine if you are a engineer in a Chinese firm. Are you going to decline the latest cancer treatments available for your mom?

    It’s not the latest cancer treatments that are the problem. It’s what happens if you break your arm or get in a car accident. Right now, if you don’t have money to bribe the doctors, there is a good chance that you just end up dying.

  • Posted by Observer

    2fish: This may be the case in the United States. It’s certainly not the case in China.

    That is in fact the case and this is from the experience of a family member. As more advanced medical treats are made available, the cost of hospital visits go up. I don’t know why it’s so hard to comprehend this reality.

    The paradox is that those with greater income automatically share a greater burden as well, because of their ability to pay for more advanced treatment that the lower income people can’t afford.

    2fish: China isn’t Japan.

    I was referring to American fiscal spending, my bad for the confusion.

    2fish: Governments can provide goods and services also.

    As could the USSR and Chinese SOEs of the bygone era. That didn’t work out too well did it.

    2fish: The middle class is not the problem. If you have a job at a large Chinese company, the odds are that you have decent health care insurance for you and your family.

    Like I said in my original post, the problem is not medical care costs for yourself but for your aging parents who do not enjoy adequate state support.

  • Posted by Twofish

    Observer: That is in fact the case and this is from the experience of a family member. As more advanced medical treats are made available, the cost of hospital visits go up. I don’t know why it’s so hard to comprehend this reality.

    Look at where the money actually goes to, and you find that most of the costs end up going to the people that run the machines rather than the machines themselves.

    And in any case, what is true for Kansas may not be true for rural China. The problem in China is basic health care (i.e. getting a doctor to look at broken arm).

    Observer: As could the USSR and Chinese SOEs of the bygone era. That didn’t work out too well did it.

    Well Chinese SOE’s figured out what the problem was and started fixing it. The problem with Chinese SOE’s in the 1990’s was *exactly* the problem that General Motors has, which is that it is getting burying in health care and pension costs. The problem is that if you are buried in health care and pension, you can’t put money into technology and process improvement, and you get into a bad cycle.

    Observer: Like I said in my original post, the problem is not medical care costs for yourself but for your aging parents who do not enjoy adequate state support.

    You are taking your own experiences and assuming that the situation in China is similar when it isn’t.

    For one thing, US hospitals have legal requirement to treat emergency patients, Chinese hospitals do not. If you get hit by a truck in front of a US hospital, they will treat you. If you get hit by one in front of a Chinese hospital, and you have no cash, there is a good chance that you will bleed to death.

  • Posted by ReformerRay

    Twofish says: “ReformerRay: If you use the componenets of GDP to estimate the size of national savings, as in Savings = Investment + Trade Balance, this formula requires that Investment and the Trade Balance control or determine the level of Savings.

    The problem here is that you can’t just change one number and keep all the other numbers fixed. If you change trade balance then all of the other numbers change.
    January 12th, 2009 at 12:53 pm

    Of course, Twofish. My point is that the trade deficit is the controlling variable (along with Investment). When the trade deficit increases (negative trade balance), National Savings MUST decrease, unless Investment intervenes. The question of which is the controlling variable is very important. Larry Summers and others have said, in the past, that the U.S. must increase national savings in order to reduce the trade deficit. WRONG. The U.S. must reduce the trade deficit to increase savings.

  • Posted by ReformerRay

    Twofish says: “ReformerRay: Each nation should defend its own sovereignty. That includes intervening in the world trade system in a way that preserves the power of each nation.

    I don’t see anyone in Beijing or Washington DC that much disagrees”.

    Paying outsiders to produce goods for sale in your nation does not preserve the power of a nation. GDP is reduced by imports. GDP is increased by exports. The U.S. is commiting suicide for the priviledge of consuming more goods than we can produce. We are the suckers because we are childlike in our desire to have it now.

    No, U.S. policy is not protecting the power and wealth of the U.S.

    The fact that people want something does not show that it is good for them.

    Protectionism has a bad name in the U.S. because economists have insisted that there is only one kind of protectionism – the kind that creates retailation. There are lots of ways to reduce the U.S. trade deficit without creatintg retailation. When that message gets across, we will see more support for less imports into the U.S.

  • Posted by ReformerRay

    I find much to admire in the behavior of the Chinese leadership. They recognize that a powerful central government is necessary to keep all the outside preditors at bay. And they are right. Control over the inflow of money into China allowed China to escape from the Asian financial crisis of 1999.

    And I admire the same kind of realism in much of what Twofish says.

    However, I get the feeling that the two of us disagree so much because he is looking out for the interests of China and I am looking out for the interests of the U.S. In my view, China does not need any help in the matter of international trade. They are doing the right things for China in terms of international trade. It is the U.S. that doesn’t understand how to defend its national interest.

  • Posted by don

    The policy of exporting the nation to prosperity has a long tradition and many examples to recommend it. I have long argued that the policy would not voluntarly be foresaken. The habit will be very hard to break, but it is leading ot unsustainable imbalances. What is needed now is cooperation and agreement. Assigning blame for the current collapse probably will not do much to further this effort.

  • Posted by MFMartin

    The “savings glut” theory looks like a repackaged version of Say’s Law — that supply creates its own demand. Focusing the analysis of the global economic crisis only on the financial side can create misleading images of the economic dynamics. While I can see an argument that China and other nations holding excess foreign reserves facilitated the economic crisis, the main force driving the crisis came from the United States and to a lesser extent, Western Europe. The real danger of the “savings glut” theory is that some people will use it to deny the need for the United States and Europe to raise their savings rates and curtail their fiscal, trade and current account deficits.

  • Posted by Massimo GIANNINI - M.G. in Progress

    The “savings glut” theory it’s a kind of “conspiracy theory”. Alan Greenspan elaborated on that in his testimony in 2005 and I discussed it HERE. One could wonder why nothing was done about it…

  • Posted by ReformerRay

    Don – Can’t you see the inconsistency in your first proposition, that nations have exported themsevles to propserity and that the habit will be very hard to break and then your next sentence call for cooperation?

    don responds:
    The policy of exporting the nation to prosperity has a long tradition and many examples to recommend it. I have long argued that the policy would not voluntarly be foresaken. The habit will be very hard to break, but it is leading ot unsustainable imbalances. What is needed now is cooperation and agreement.

    Cooperation and agreement has been sought consistently by the U.S. for 3 decades. Your position should be that any nation that is unhappy with a “unsustainable imbalace” because the imbalance is reducing the wealth and power of that nation, should take unilateral steps to correct the situation.
    Why should a trade surplus nation cooperate?
    The have worked very hard to create a trade surplus – and it is working for them.

    Any change must be caused by the U.S. – unilateraly. Your first statements leads to that conclusion.

  • Posted by df

    well all in all it all sums up to : well nothing new under the sun. We ve seen the scheme already and it was obvious that all this was bound to happen 10 years ago.

    Savings glut has been caused by huge growth with spending habits following with a delay. That also had already been seen.

    Protectionism will rise since it has too. It is a good thing that it does.

    Free trade has led to massive global pollution and social disorder. Free trade has been part and parcl of the present situation.

    Yes

  • Posted by thomas

    Hi, I think your website is interesting very colorful. Good job! I feel helping job seekers finding their ream home jobs are a fulfilling quest. Good luck in your quest too.

Pingbacks