Sunday, August 26, 2007

Global Economic Imbalances: a 'Saving Glut', a 'Liquidty Glut', or Both?

Although there have been many takes on the current imbalances in the world economy, I believe they can all be broadly put into two camps. The first view is that there is excess saving (over domestic investment) in Asia and oil-exporting countries that has to go somewhere, so it ends up coming to consumption-addicted United States. The story goes that many of these excess-saving countries experienced severe financial crises in the 1990s that led to a sudden and devastating outflow of capital. As a consequence, these countries are building up "war chests" of foreign reserves to protect themselves (i.e. saving up for the next big financial crisis). Another story is the surge in oil prices for the oil-exporting countries is creating an excess of income over spending. There also might be institutional reasons for the saving glut such as the lack of a good social safety net prompting household to save excessively.

This 'saving glut' view was first put forth by Ben Bernanke in his now famous 2005 speech, "The Global Saving Glut and the U.S. Current Account Deficit." Here the United States is a hero, coming to the rescue of world economy in need of spending. According to this view, if it were not for the courageous saving-rate reduction and consumption spending increase of the United States there would be all of this excess saving sitting around idly doing nothing--we would have a global recession, or at least weaker global growth due to restrained spending. As I noted in my last posting, this is what Martin Wolf is appealing to when he calls on the Federal Reserve to keep the party going.

I believe there is some truth to this argument. Parts of the world are saving an inordinate amount of their income, and this may be due to the past financial crises, institutional factors, and high oil prices. But is this the whole story? I think not. Rather, like Mark Thoma I believe the 'liquidity glut' view has merit too and provides a complementary perspective. One big proponent of the 'liquidity glut' view is Stephen Roach of Morgan Stanley as seen in his classic "Original Sin" and his more recent "The Great Unraveling" . Daniel Gross and friends at the Centre for European Policy Studies also have some goods things to say about the 'liquidity glut view'. So what is the 'liquidity glut' view? I already touched on it in my previous posting, but here is Martin Wolf's description of this view (taken from his column titled "Villains and Victims of Global Capital Flows"):

"In the [liquidity-glut view]. . . the world’s savers are passive victims, profligate Americans are villains and the Federal Reserve is an anti-hero. In this world the US central bank is a serial bubble-blower, has distorted asset markets and visited excess monetary emission on trading partners around the world, above all, on those who seek monetary stability through pegged exchange rates... The argument is that US monetary excess causes low nominal and, given subdued inflationary expectations, real interest rates. This causes rapid credit growth to consumers and a collapse in household savings. The excess spending floods across the frontiers, generating a huge trade deficit and a corresponding outflow of dollars. The outflow weakens the dollar. Floating currencies are forced up to uncompetitive levels. But pegged currencies are kept down by open-ended foreign currency intervention. This leads to a massive accumulation of foreign currency reserves (up $3,445bn between January 2000 and March of this year). It also creates difficulties with sterilising the impact on money supply and inflation.

In this view of the world economy, savings are not a driving force, as in the savings-glut hypothesis, but a passive result of excess money creation by the system’s hegemonic power. Profits (and so measured corporate savings) rise simply because of increased exports and output under economies of scale. Governments of countries that possess the huge trade surpluses then follow the fiscal and monetary policies that sustain the excess savings needed to curb excessive demand and inflation."

Unfortunately, most of the world seems to be subscribing solely to the 'saving glut' view, at least that is my impression. If anyone out there knows of studies have estimated what portion of the global economic imbalances can be attributed to the past monetary profligacy please let me know.

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