This is Rachel Ziemba of RGE Monitor where this post also appears.
In a recent post, Jeffrey Frankel asks will the U.S. Keep Saving? noting that despite the recent increase in the U.S. savings rate, the demographics of the U.S. (as well as those of Japan and Europe) will contribute to a reduction in savings. He argues that despite the fact that wealth losses will boost savings rates, the dis-saving of the retired population will keep the savings rate relatively low, if higher than the pitiful rates of recent years.
The companion question, whether the Chinese will keep saving is equally of importance. Whether the Chinese stimulus is able to boost private consumption ahead will be critical to global and Chinese demand. So far Chinese consumption has held up and even grown slightly from a weak base –as illustrated by retail and auto sales. Yet one reason that the Chinese economic reacceleration is fragile is because it is uncertain where the new production in China’s factories will be consumed. Chinese domestic demand still seems weak and overpowered by some structural incentives to save.
In the near term U.S. savings rates, which reached 6.9% in May, seem destined to keep climbing as U.S. consumers retrench. This could contribute to slower growth in the so-called export-led economies which had grown reliant on exporting demand.
One outcome of the financial crisis has been a narrowing of global economic imbalances, as illustrated by the reduction in the Chinese trade surplus and a reduction in the corresponding deficits of countries like the U.S.. The combination of a sharp fall in consumption across the globe and withdrawal of credit, partly accounted for swift reductions in some countries. I wrote last week about the narrowing of the surplus of oil-exporters. All in all, surpluses and deficits might be smaller given the reduction in credit available even as the increase in government borrowing leads to higher long-term interest rates. This narrowing is likely despite the fact that reserve accumulation seems to have restarted in Q2. Setting aside China which will report reserves data at some point over the next day or so and adjusting for valuation, reserve growth was about $40 billion in the quarter of 2009. While this is much smaller than in the heyday of 2007, it is the first quarter of positive reserve growth since Q3 2008. Yet, there are some signs that we will not return to the earlier pace.
The U.S. current account deficit has been narrowing for some time and has fallen from 6.6% of GDP at the end of 2005 to 3.7% at the end of 2008 and the IMF estimates that it will fall further to 2.8% of GDP over the course of 2009. With U.S. consumers buying less (the savings rate rose to 6.9% in May 2009), Chinese producers need to find new markets.
The Chinese current account surplus was $420 billion in 2008 and is likely to be smaller this year. The Chinese trade surplus (the largest component of the current account) was about $100 billion in H1, but one month (January) accounted for almost half. The absolute level of China’s trade surplus has shrunk, to about $13 billion in April and May and just over $8 billion in June. While the greater cost of China’s commodity imports (watch for more on this tomorrow) accounts for part of this narrowing surplus, it may reflect a sign of things to come should Chinese exports stabilize at a weak level in the absence of external demand.
Should export-oriented “surplus” countries like China keep saving and keep trying to export demand, the reduction in imbalances could actually exacerbate the global economic contraction or contribute to a more sluggish recovery. The high savings rate or rather artificially low cost of capital in China has contributed to misallocations of capital that will be difficult to reverse and will take some time.
However expansionary fiscal policies in these countries and a reallocation of capital within these countries, could in the long-term contribute to reducing internal and global imbalances. Chinese officials seem cognizant of the need to rebalance the domestic economy even as some of their policies seem to operate at cross-purposes.
While government incentives are contributing to an increase in some purchases, Chinese consumption (and that of other emerging economies) may find it very difficult to pick up the slack from a U.S. consumer that is spending less. However, Chinese fiscal stimulus does seem to be doing more to potentially boost domestic demand. Yet the effect of some of these incentives could diminish over time and there is of course a risk that Chinese production could add to global overcapacities in the absence of an increase in domestic demand.
In the Wilson Quarterly, Michael Pettis argues that whether or not the Chinese start consuming more, their savings rate will drop from the 50% marked in 2007. Either Chinese policies will contribute to more private consumption or the reduction in global demand will lead to reduced growth, limiting savings.
So what would be the package of consumption-led growth?
Eswar Prasad details how China and other Asian savers might rebalance their domestic economy through removal of the policies that suppressed domestic demand. These are largely long-term in nature including the development of China’s capital market to increase the return on domestic assets and patching holes in the social safety net.
The massive credit extension in China, which rebounded in June 2009 after slowing slightly in April and May suggests that the cost of capital in China remains well below global costs. This distortion raises the risk that non-economic projects are being financed to meet bank quotas. Thus there is a risk that even as Chinese officials try to take some steps to support domestic demand, other policies might add to the misallocation of capital, contribute to asset bubbles (especially property). Meanwhile, some Chinese investors are worried about future inflation. The blunt policy tools continue to be hard to manage.
The raft of Chinese data to be released over the next few days may give us some more clues as to the trajectory and possible risks ahead