Sunday, November 16, 2008

Where in the world is Asian Thrift and the Global Savings Glut?

Sometime in the early 1990s the US began to move its international trade account from approximate balance into burgeoning deficit. From then on the US trade deficit grew year on year so that by 2006 the US consumed nearly US$900 billion more than it produced.

Such excess amounted to 7% of US GDP—up from an average of 2% over 1990–1994. For perspective, the US trade deficit in 2006 was nearly as much as the entire annual production of goods and services in the 1.1 billion-peopled economy of India (this was an improvement, though: in 2005, the US deficit was strictly greater than India’s GDP). And a 7% ratio is the same as that Thailand had in June 1997 on the eve of the run on the Thai baht precipitating the Asian currency crisis.

Except for the possibility of trade with outer space, the US deficit has to be matched dollar-for-dollar by trade surpluses in the rest of the world. Correspondingly, therefore, the rest of the world has been saving—consuming less than it has been producing—and accumulating dollar claims against the US as a result.

In this description, however large the global imbalance, a savings glut—wherever or however it might arise on Earth—has no independent existence. It makes as much sense to say the world’s excess savings caused enthusiastic US consumers to flood into Walmart to buy $12 DVD players, as to say US consumer profligacy made hungry Chinese peasants abstain even more and instead plow their incomes into holdings of US Treasury bills.

When two variables have always-identical magnitudes, obviously neither can usefully be said to cause the other. With global savings and consumption, however, looking at a third indicator, namely world interest rates, is suggestive. The Figure shows world money market interest rates falling sharply through the 1990s, as would be suggested by a global savings glut driving the large global imbalance.

(The Figure is for short-term nominal interest rates. Charting this for real long-term rates accentuates the fall. Subtracting actual inflation to construct real short rates makes the decline less obvious although not vanish. But I’m going to dispute this reasoning next anyway, so let’s keep the Figure.)

Many other factors could, of course, have driven down short rates: US monetary policy responded to national economic downturns in 1991 and 2001. Through the 1990s inflation rates worldwide converged and fell, together with short-term interest rates set by central banks everywhere. The burst of the dot-com bubble in March 2000 saw the NASDAQ index decline 77% in the following 18 months, prompting action by the US Federal Reserve. Japan’s monetary policy during its decade-long recession drove nominal interest rates there to zero.

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

The Figure shows that, indeed, Developing Asia in general and China in particular, were running large and growing bilateral trade surpluses against the US.

The next Figure, however, shows that running trade surpluses against the US was pretty much the pattern nearly everywhere in the rest of the world. Both the EU and the bloc of oil-exporting countries, had rising bilateral trade surpluses against the US too, although of course the notion of “EU Thrift” has hardly ever been bandied about in international relations. Summed, the EU and oil-exporters trade surplus against the US moved almost exactly in step with that of China’s.

Dwindling investment opportunities and an aging population in Europe might, indeed, over the longer run, smoothly and gently, end up pushing greater savings in the direction of the US. But why would those same persistent movements cause higher-frequency gyrations in the EU’s trade surplus against the US that match almost exactly that of China’s in particular and Asia’s more generally? It seems to me the most direct and straightforward explanation is that the causal impulse to these trade surplus dynamics is instead the US economy, and everyone else is simply passively responding.

Indeed the ratios to the overall US trade deficit of individual country bilateral trade surpluses—run by each of China, Developing Asia, the EU, and the oil exporters—have time-series profiles that, after the mid-1990s, were essentially flat. Sure, China's and Asia's trade surpluses against the US were large and growing. But they were growing only because they remained roughly constant in proportion to bilateral trade surpluses elsewhere and, more to the point, to the US overall trade deficit.

So, yes, of course, there was a global savings glut. It necessarily mirrored exactly US profligacy, both private and public. Looking at these last few Figures, however, one might be tempted to think that excesses in the US economy drove trade surpluses everywhere else in the world, rather than that causality ran from Asian thrift to US trade deficit.

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

In producing the Figures above I found useful the data and discussions in Ben Bernanke (2007) “Global Imbalances: Recent Developments and Prospects”; Thierry Bracke and Michael Fidora (2008) “Global liquidity glut or global savings glut”; Menzie Chinn and Jeffrey Frankel (2003) “The Euro Area and World Interest Rates”; Niall Ferguson (2008) “Wall Street Lays Another Egg”; Paul Krugman (2005) “The Chinese Connection”; Kenneth Rogoff (2003) “Globalization and Global Disinflation”; and Brad Setser (2005) “Bernanke's global savings glut.

Daniel Gross (2005) Savings Glut” traces the history of the idea that a global savings glut is to blame for many current US economic ills. The subtitle (The self-serving explanation for America's bad habits) reveals the conclusion that Gross reaches. Fareed Zakaria (2008) “There is a silver lining” describes the profligacy of the US consumer and government since the 1980s, and how the current global economic crisis might turn that around. He remarks that the US “cannot noisily denounce Chinese and Arab foreign investments in America one day and then hope that they will keep buying $4 billion worth of T-bills another day.”

The data I used are from the World Bank's World Development Indicators (WDI) Online, April 2008; and International Monetary Fund (IMF), Direction of Trade Statistics (DOTS) and International Financial Statistics (IFS), November 2008, ESDS International, (MIMAS) University of Manchester. Developing Asia, in IMF terminology, comprises Bangladesh, Bhutan, Cambodia, China, Fiji, India, Indonesia, Kiribati, Lao People's Democratic Republic, Malaysia, Maldives, Myanmar, Nepal, Pakistan, Papua New Guinea, Philippines, Samoa, Solomon Islands, Sri Lanka, Thailand, Tonga, Vanuatu, and Vietnam. In the Figures, China refers to China Mainland.

(This post also appears 21 November 2008 on RGE's EconoMonitor on Global Macro and Asia.  See also December 2008 discussion on the FT Economists' Forum on global imbalances.)


Anonymous said...

refers to this blog entry as counter against the "Global Savings Glut - Asia is to blame for all the world's economic ills" view.

Anonymous said...

Really interesting perspective, especially for non-economists! There is still so much confusion about correlation and causality 'out there'.

Are there any normative consequences of this analysis that can be drawn? In terms of policy, state behaviour and that of other actors of course...? Perhaps this is the wrong question for economists but who else can one ask about what is to be done?

Louise said...

sometimes very obvious points still need to be made.

Anonymous said...

I'm not sure what Louise means by "very obvious points". Martin Wolf's Financial Times column (03 December 2008) and the subsequent discussion seem to disagree considerably with the points made in this post.

Anonymous said...

I see that the Niall Ferguson - Harvard Professor after all - that Cherrybites's post rails against now even has an entire TV show devoted to his idea. Is Louise saying that what "DQ - Unplugged" talks about here is obviously wrong? Seems to me heavyweight opinion out there is massed against the "obvious points" here.

DQ said...

Normative consequences? An anonymous poster has already mentioned the debate going on (from 2008 December 3rd) at the Financial Times's Economists' Forum. Lots to think about there.

mannfm11 said...

What I see missing is the fact that being the reserve currency places the US dollar in a position to be hoarded in the form of immediate loans back to Wall Street, a feature that was a complaint of Jacques Rueff as far back as the late 1950's in his writings titled "The Monetary Sins of the West". This would have mattered only a little had Wall Street not created a pile of derivative products and CDO's to pawn excessive consumer credit onto the rest of the world. Had the typical Chinese had access to credit to buy what they wanted, pay emergency bills and other factors along with a massive asset bubble to give them the feeling of being rich, it is highly doubtful we would be talking about a savings glut or a huge trade surplus. The combination of reserve currency and widely available credit is the culprit and there would be no surplus without the capacity of the US consumer to spend beyond his means through credit. This is why there won't be much of a recovery going forward and Asia is looking at a rough go of it going forward.