"savings glut" explanations

Losing Interest by Barry Eichengreen

safe assets

After Clinton, Greenspan and the tech stock boom/bubble balanced the budget there was a shortage of safe assets, to the private market in collusion with the ratings agencies created the shadow banking system with mortgage-backed securities and sold them as safe.

Bernanke has said he might have been wrong to call this a "global savings glut." There's something else going on on the flip side, a dearth of investment and asset prices move higher. Interest rates move lower. But Beckworth says interest rates remain the same, it's just the risk premium goes up.

asset prices and monetary policy

Yglesias tweets

Seems like Richard Fisher has been reading @Neil_Irwin without understanding him:
http://www.dallasfed.org/news/speeches/fisher/2014/fs140716.cfm

To get a sense of some of the effects of excess liquidity, you need look no further than Neil Irwin’s front-page, above-the-fold article in the July 8 issue of the New York Times, titled “From Stocks to Farmland, All’s Booming, or Bubbling.” “Welcome to … the Everything Bubble,” it reads. “Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals.” Irwin’s comments bear heeding, although it may be difficult to disentangle how much these lofty valuations are distorted by the historically low “risk-free” interest rate that underpins all financial asset valuations that we at the Fed have engineered. 

I spoke of this early in January, referencing various indicia of the effects on financial markets of “the intoxicating brew we (at the Fed) have been pouring.” In another speech, in March, I said that “market distortions and acting on bad incentives are becoming more pervasive” and noted that “we must monitor these indicators very carefully so as to ensure that the ghost of ‘irrational exuberance’ does not haunt us again.” Then again in April, in a speech in Hong Kong, I listed the following as possible signs of exuberance getting wilder still: 

The price-to-earnings, or P/E, ratio for stocks was among the highest decile of reported values since 1881;
The market capitalization of U.S. stocks as a fraction of our economic output was at its highest since the record set in 2000;
Margin debt was setting historic highs;
Junk-bond yields were nearing record lows, and the spread between them and investment-grade yields, which were also near record low nominal levels, were ultra-narrow;
Covenant-lite lending was enjoying a dramatic renaissance;
The price of collectibles, always a sign of too much money chasing too few good investments, was arching skyward. 

I concluded then that “the former funds manager in me sees these as yellow lights. The central banker in me is reminded of the mandate to safeguard financial stability.”[1] 

Since then, the valuation of a broad swath of financial assets has become even richer, or perhaps more accurately stated, more careless. It is worrisome, for example, that covenant-lite lending has continued its meteoric revival and has even surpassed its 2007 highs.

Irwin:

But while central banks can set the short-term interest rate, over the long run rates reflect a price that matches savers who want to earn a return on their cash and businesses and governments that wish to invest that savings — whether in new factories or office buildings or infrastructure.

In this sense, high global asset prices could be the result of a world in which there is simply too much savings floating around relative to the desire or ability of businesses and others to invest that savings productively. It is a reassertion of a phenomenon that the former Federal Reserve chairman Ben Bernanke (among others) described a decade ago as a “global savings glut.” 

But to call it that may not get things quite right either. What if the problem is not too much savings, but a shortage of good investment opportunities to deploy that savings? For example, businesses may feel that capital expenditures are unwise because they won’t pay off. 

Mr. Bernanke himself has been wrestling with the possibility that the original framing of a global savings glut got the problem in reverse. “I may have made a mistake in trying to assign a name,” Mr. Bernanke, now at the Brookings Institution, said in an interview. “A glut means more than is wanted. But it doesn’t necessarily arise because people want to save more. It can be because they invest less. 

“It’s entirely possible that if you look at the world, you have slow-growing advanced economies, China cutting back on capital investments, that the rate of return is just going to be low.” 

If this analysis of the world is correct, investors have an unpleasant choice: consign themselves to returns lower than the historical norm, or chase ever more obscure investments that might offer an extra percentage point or two of return.

Robert Shiller

Until the recent crisis, economists were talking up the “great moderation”: economic fluctuations were supposedly becoming milder, and many concluded that economic stabilization policy had reached new heights of effectiveness. As of 2005, just before the onset of the financial crisis, the Harvard econometricians James Stock (now a member of President Barack Obama’s Council of Economic Advisers) and Mark Watson concluded that the advanced economies had become both less volatile and less correlated with each other over the course of the preceding 40 years. 

That conclusion would have to be significantly modified in light of the data recorded since the financial crisis. The economic slowdown in 2009, the worst year of the crisis, was nothing short of catastrophic. 

In fact, we have had only three salient global crises in the last century: 1929-33, 1980-82, and 2007-9. These events appear to be more than just larger versions of the more frequent small fluctuations that we often see, and that Stock and Watson analyzed. But, with only three observations, it is hard to understand these events. 

All seemed to have something to do with speculative price movements that surprised most observers and were never really explained, even years after the fact. They also had something to do with government policymakers’ mistakes. For example, the 1980-82 crisis was triggered by an oil price spike caused by the Iran-Iraq war. But all of them were related to asset-price bubbles that burst, leading to financial collapse. 

Those who warn of grave dangers if speculative price increases are allowed to continue unimpeded are right to do so, even if they cannot prove that there is any cause for concern. The warnings might help prevent the booms that we are now seeing from continuing much longer and becoming more dangerous.

Triffin's Dilemma And the Global Safety Shortage by Yglesias

Why the Global Shortage of Safe Assets Matters by David Beckworth

In the early-to-mid 2000s, the Fed exacerbated the asset-shortage problem as its loose monetary policy got exported via fixed exchange rates to much of the emerging market world which in turn recycled it back to the U.S. economy via the "global saving glut" demand for safe assets. (For more on this point see this post and my paper with Chris Crowe.) Since late 2008, both the Fed and the ECB have worsened the asset-shortage problem by failing to first prevent and then restore nominal income in each region to its expected path. In other words, since 2008 both the Fed and the ECB have passively tightened monetary policy and this has caused some of the AAA-rated securities to disappear. (Yes, some of the AAA-rated MBS and sovereign debt would have defaulted on their own, but some of them like French sovereigns would have maintained their safe asset status were it not for insufficient aggregate demand caused by passively tight monetary policy.)

I would look into the "loose monetary policy" and the context of it.

Via Krugman,  Andrew Haldane, the executive director for financial stability at the Bank of England, says

In fact, high pre-crisis returns to banking had a much more mundane explanation. They reflected simply increased risk-taking across the sector. This was not an outward shift in the portfolio possibility set of finance. Instead, it was a traverse up the high-wire of risk and return. This hire-wire act involved, on the asset side, rapid credit expansion, often through the development of poorly understood financial instruments. On the liability side, this ballooning balance sheet was financed using risky leverage, often at short maturities.

In what sense is increased risk-taking by banks a value-added service for the economy at large? In short, it is not.

Many people say that the problem of the 2000s was an easing of credit. How much of that was the increase of risk and leverage, that is, credit created by the private market? It also created a boom and housing bubble.

Better regulation could have forestalled this "easing." How about Greenspan raising rates? But he had lowered rates to prevent a double-dip.

Did the "easing" help create the savings or banking glut?

Explaining Global Financial Imbalances: A Critique of the Saving Glut and Reserve Currency Hypotheses by Thomas Palley

I don't know what to make of his critique. Wages haven't kept up with productivity gains.

With regard to policymakers, pre-1980 economic policy was framed by Keynesian logic and policymakers viewed trade deficits with concern as they represented a leakage of aggregate demand (AD). After 1980, policymakers increasingly turned a blind eye to trade deficits and even started viewing them as semi-virtuous because trade helped constrain inflation.

Interesting analogy here:

Second, it is theoretically incoherent. That is because the saving glut hypothesis is simply an updated global statement of 1930s classical loanable funds interest rate theory that Keynes discredited in his General Theory. Loanable funds theory claims interest rates are determined by demand and supply of real saving; trade surpluses are accounted for as real saving, and ergo they affect interest rates in an integrated global economy: hence, the claim that China’s trade surplus significantly determines US interest rates and China injured the US by distorting US interest rates.

I don't know. The global savings glut theory still makes sense to me and it seems like Bernanke's savings glut theory doesn't contradict what Palle is arguing in his countertheory of neoliberal globalization.

For instance, the trade deficit holds down inflation, but wouldn't inflation be held down in any event by the Federal Reserve even if there wasn't a trade deficit? Is it just that it gives the Fed more room to maneuver?

(via Thoma)

Global Banking Glut and Loan Risk Premium by Hyun Song Shin

Get Ready for A Bigger "Global Savings Glut" by Yglesias

Get Ready For A Bigger ‘Global Savings Glut’ by Yglesias

Remember the “global savings glut” of the mid-aughts? This was Ben Bernanke’s explanation for the large U.S. current account deficit as of 2005. It’s also an important part of the backdrop for the housing boom and the financial crisis. What happened is that in the late-1990s, many East Asian countries suffered from a classic financial panic. The international investment community, once bullish on places like Thailand and South Korea, suddenly turned pessimistic. Currencies collapsed, and borrowers were left awash in debt. The IMF stepped in to prevent the global financial system from falling apart, but in exchange for liquidity assistance, it imposed tough austerity conditions on the states in need of rescue.

The imposition of austerity is in part supposed to avoid moral hazard problems. And in the case of Asia, it worked. Arguably it worked a bit too well. The entire region became obsessed with amassing foreign exchange reserves to ensure that it would never again need to go hat in hand to the IMF. That created an unusually large level of global demand for AAA-rated dollar-denominated financial assets which helped kick off all manner of events in the American economy.

The IMF qua IMF seems to have decided that this was a mistake, and under Dominique Strauss-Kahn and now Christine Lagarde has largely been pushing a non-austere agenda. But Angela Merkel, European Commissioner Olli Rehn, and the European Central Bank seem to be re-inventing the late-’90s IMF prescription for economic recovery. They’re afraid of creating a situation in which poor economic management isn’t adequately punished, so they’re determined to make sure that troubled European states enact unpopular austerity packages in order to get help even if they need to remove democratically elected governments from office to get the job done. Whatever else this does, it should certainly succeed in persuading European governments that stockpiling foreign exchange isn’t just for Asians anymore. If the world succeeds in coming out through the other side of this crisis, you should expect to see even more countries joining the perpetual surplus brigades leading to even more demand for safe dollar denominated financial assets. That, in turn, means either big U.S. budget deficits or else some bold new innovations in financial engineering to meet the demand.

Yglesias links to Steve Randy Waldman's post on negative interest rates. A commenter at interfluidity writes:

“Land owners at full gluttony can eat no more than a small fraction of potential output, and they cannot store the surplus. Technology and population are stable, but land owners face negative real interest rate. There are laborers who would be glad to borrow the surplus bread, but they have no capacity to repay. The real interest rate on the bread lending market would be -100%.’

SRW, this observation seems too close to Marx’s prediction that capitalists capturing more of the surplus value will eventually experience falling profit, while workers become more exploited. It seems the world has been in this place before, and we need to save capitalism from destroying itself.

"The sense of entitlement carried by savers in our society would put any welfare queen to shame."
(or a Balance of Payments Problem / Global Savings Glut)


Krugman blogs about a Randy Waldman post and they are both getting at what I've been trying to describe by way of a Grand Unified Theory (GUT) of "late capitalism." Krugman writes:

He then argues that the”natural” real rate of interest — the interest rate that would match savings and investment at full employment — has been negative for quite a while, and that we’re only seeing this now because various bubbles and deregulatory schemes have masked the reality.

What he doesn’t say, but immediately strikes anyone who knows some of the history here, is that this amounts to a return of the “secular stagnation” hypothesis that was popular in the early postwar years; the hypothesis was that there was a fundamental excess of desired savings over desired investment, and that this would require government intervention on a sustained basis to achieve full employment.

That hypothesis proved wrong at the time, but that doesn’t mean it couldn’t be true now. And I’m somewhat sympathetic to the view that it might indeed be true.

Waldman goes on to suggest that high income inequality is what’s driving this — he has a little parable involving bakers and bread that ultimately comes down to the rich being satiated while the poor cannot afford to buy.

OK, I like little parables. But I have a problem with this one, for one simple reason: any such story, basically an underconsumptionist story, would seem to depend on the notion that rising inequality has led to rising savings. And you just don’t see that. Here’s private saving as a share of GDP:

Obviously it jumped up after the housing bust, but until then it was actually declining, and even now it’s below historic highs. I just don’t see how to make the underconsumption story work.

But then the question is, why do we find it so hard to achieve full employment even with saving somewhat low by historical standards. And the answer seems clear: it’s the trade deficit. America in the 70s and 80s could have high savings, not hugely strong investment, but still have full employment because trade deficits weren’t as large compared with the economy as they are now.

And this in turn means that the savings glut possibly making the natural real rate negative is actually originating abroad, not at home.

Do you sort of see why I’m a hawk on China policy?

1997 Asian Financial Crisis

Another major factor was that these countries became excessively dependent upon exports for their economy. Indonesia, Philippines and Thailand had seen their exports to GDP ratio grow from average 35% in 1996 to over 55% in 1998. Such huge dependence upon trade made these countries susceptible to currency movements. At the time of the mid-1990s, Thailand, Indonesia and South Korea had large private current account deficits and the maintenance of fixed exchange rates encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors. In the mid-1990s, two factors began to change their economic environment. As the U.S. economy recovered from a recession in the early 1990s, the U.S. Federal Reserve Bank under Alan Greenspan began to raise U.S. interest rates to head off inflation. This made the U.S. a more attractive investment destination relative to Southeast Asia, which had been attracting hot money flows through high short-term interest rates, and raised the value of the U.S. dollar. For the Southeast Asian nations which had currencies pegged to the U.S. dollar, the higher U.S. dollar caused their own exports to become more expensive and less competitive in the global markets. At the same time, Southeast Asia's export growth slowed dramatically in the spring of 1996, deteriorating their current account position.

A Note on the U.S. Comparative Advantage in the Sale of "Political Risk Insurance" by DeLong

The Global Saving Glut and the U.S. Current Account Deficit by Bernanke

A Note on the U.S. Comparative Advantage in the Sale of "Political Risk Insurance" by DeLong

China Reigns in Liberalization of Culture 

Whether spooked by popular uprisings worldwide, a coming leadership transition at home or their own citizens’ increasingly provocative tastes, Communist leaders are proposing new limits on media and Internet freedoms that include some of the most restrictive measures in years.

The most striking instance occurred Tuesday, when the State Administration of Radio, Film and Television ordered 34 major satellite television stations to limit themselves to no more than two 90-minute entertainment shows each per week, and collectively 10 nationwide. They are also being ordered to broadcast two hours of state-approved news every evening and to disregard audience ratings in their programming decisions. The ministry said the measures, to go into effect on Jan. 1, were aimed at rooting out “excessive entertainment and vulgar tendencies.”

Maybe they're trying to head off the coming "reality show" onslaught and prevent a Chinese Jersey Shore craze.

The End of Cheap Chinese Goods by Floyd Norris

Yglesias reflects on the Internet bubble and 1998

People recall that the stock market went way down and then the economy never got as hot as it was in the late-1990s again, so the conventional thing is to say “bubble” and roll our eyes at all those old New Economy articles. But there was this deliberate decision to slow the economy down. And it’s not like having achieved whatever they were trying to achieve, the Fed then managed to flip the growth switch back on post-recession.

And links to a Justin Fox piece circa 1998:

If you look beyond postwar U.S. history, however, you can come up with very different patterns. Economist John Makin of the American Enterprise Institute sees the current expansion as an investment-led, inflation-free "golden age" similar to the U.S. scene in the 1920s and Japan's in the 1980s. Both those booms ended badly, of course--but they didn't end in bursts of inflation. James Paulsen, chief investment officer at Norwest Investment Management, looks back even further, to the U.S. in the second half of the 19th century. That was a period of no inflation, revolutionary technological advances, massive global capital flows, and rapid economic growth--and was also characterized by devastating spells of deflation.

What else happened in the 90s and early 00s? In 1997 there was the East Asian Financial crisis. And Long Term Capital Management hedge fund bust. China decided never to be put in the position to be forced to go to the IMF and so helped cause the Global Savings Glut. Could that be the x-factor? In 2000 Greenspan argued that the bubblicious Bush tax cuts were advisable because no government debt would be bad (Clinton had balanced the budget.) So is Yglesias saying the Fed didn't push down the accelerator in the Bush years? My guess is that he feels the Bush years were not boom years.

Revenge of the Global Savings Glut by Krugman

Dean Baker on Jacob Lew

Jacob Lew, the head of President Obama's Office of Management and Budget, had a column in the New York Times that should really scare the American people. While the purpose of the column was ostensibly to tell the American people that there are few easy budget cuts left, the scary part is that Mr. Lew seems to have little understanding of the economy.

Lew boasts about the huge budget surplus at the end of the Clinton administration. He shows no understanding of the fact that these surpluses were largely the result of a stock bubble, which was inevitably going to burst. The story of the economy's growth at that point was that the $10 trillion stock bubble fueled a consumption boom, which led to strong economic growth.

Of course the bubble was not sustainable, when it burst, the consumption it supported also disappeared. We only recovered from the recession when the housing bubble created enough demand to replace the demand lost from the collapse of the stock bubble.
The underlying problem was the over-valued dollar. This was a conscious policy of the Treasury Secretary Robert Rubin, who actively pushed a "strong dollar" policy. This policy effectively gave a large subsidy to imports and imposed a large tax on U.S. exports. The result was a huge U.S. trade deficit.

Given a large trade deficit, the economy needs either large government deficits or very low private savings to sustain high levels of employment. This is not a partisan issue; it is an accounting identity.

Mr. Lew shows no understanding of this basic point. Either this top Obama official is ignorant of basic economics or he is not being honest with the American people. Either way, it is an incredibly scary column.

Global Savings Glut

Dean Baker:

In the Clinton years, Robert Rubin had a policy of pushing up the value of the dollar. He put muscle behind this effort through the U.S. control of the IMF at the time of the East Asian financial crisis. The conditions that the IMF imposed were so onerous that developing countries decided that they needed to accumulate massive amounts of reserves in order to avoid being put in a similar situation. This meant accumulating large amounts of dollars. They did this by keeping down the value of their currencies against the dollar (i.e. raising the value of the dollar).

It is very misleading to assert that the value of the dollar is outside of the government's control. President Obama, like his predecessors, has allowed the dollar to remain over-valued. An over-valued dollar effectively subsidizes imports and imposes a tariff on exports. There is nothing that President Obama's new competitiveness panel can realistically hope to do that would come close to offsetting the competitive disadvantage created by an over-valued dollar.

Global savings glut Wikipedia entry

Decent column by Robert J. Samuelson (yes him) but it fails to mention the East Asian financial crisis.

"The Global Saving Glut and the U.S. Current Account Deficit" given March 10, 2005 by Bernanke

"Revenge of the Glut" by Krugman

Excellent New York Times journalist Sewell Chan on The U.S.-China Exchange Rate.

Would China benefit by letting the renminbi rise?
Yes, most experts agree that China would probably be better off if the renminbi’s value rose. Doing so would give Chinese consumers more purchasing power, lessen the risk of inflation and asset bubbles, and potentially reduce stark inequalities that have contributed to social unrest.

What’s stopping China, then?
Exporters, concentrated along the southern coast, wield enormous clout in Beijing and benefit from an undervalued currency, said Minxin Pei, a political scientist at Claremont McKenna College in Claremont, Calif. So do state-owned enterprises, which have excess capacity and need to be able to sell goods cheaply abroad. China’s importers are unhappy with the undervalued renminbi -- as are officials at the central bank -- but both groups are relatively weak.

In the United States, there must be someone against a stronger Chinese currency, right?
Large multinational corporations, and Wall Street, are comfortable with a weak renminbi. Many of the biggest American conglomerates make goods in China (or sell them in the United States) and benefit from the undervalued currency. Financial services companies find deal-making easier with a strong dollar and want to help invest the capital sloshing around China.

But aren’t the forces on the other side just as strong?
A high dollar places tremendous competitive pressure on American agricultural producers and domestic manufacturers, and thereby hampers job creation.

So, it’s not surprising that Midwest politicians and labor unions have been among China’s fiercest critics. High unemployment has also prompted the White House and most Congressional Democrats (and a substantial number of Republicans) to side with the critics.

Emphasis added in first answer. I would disagree with Chan and argue that if (when?) "Chinese consumers" get more purchasing power, this could contribute to unrest as one-party rule of the Chinese Communist Party could be challenged. Other nations have evolved from one-party states to multi-party democracies, but it could be messy in China given the size and poverty of the country. Having said that the Chinese have managed their economic growth and the economic crisis well. Chan may be right that reduced inequality would help mollify unrest, but I doubt it.

Yesterday I linked to "The Slump Goes On: Why?", the impressive tour d'horizon of the recent economic crisis by Robin Wells and Paul Krugman which ran in the New York Review of Books.

It might be the best comprehensive piece on the subject yet.* In their view, what happened:

1. a global savings glut
2. which led to a North Atlantic** housing bubble
3. which led to a "Minsky moment"***
4. which led to an old-fashioned bank run on the "shadow banking system"****
5. which led to a deleveraging of the American household*****

-------------------------------
* A second article on what needs to be done is coming.
** the U.S., England, Ireland, Spain
*** "Minsky’s theory, in brief, was that eras of financial stability set the stage for future crisis, because they encourage a wide variety of economic actors to take on ever-larger quantities of debt and engage in ever-more-risky speculation. As long as asset prices keep rising, driven by debt-fueled purchases, all looks well. But sooner or later the music stops: there is a "Minsky moment" when all the players realize (or are forced by creditors to realize) that asset prices won’t rise forever, and that borrowers have taken on too much debt."
**** A crisis of confidence in the banking system. In the United States, the banking system gave way to the more profitable "shadow banking system." As much as 60 percent of business now used "repo" (repurchase) agreements - very short-term loans to hedge funds and investment banks - to finance their business. In Europe, there was a crisis of confidence in governments' ability to backstop their overextended banks. So in addition to a run on the banks, there was a "sovereign debt crisis" in countries such as Iceland, Greece and Ireland.
***** American businesses are profitable and sitting on liquidity, however American households are collectively paying down debt so there is a lack of aggregate demand and government needs to step in and fill the gap.