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By HaleStewart October 30, 2016 8:03 am
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US Bond Market Week in Review: The Global Savings Glut is Alive and Well

     Over the last few weeks, 2 central bankers have argued the “global savings glut” is a primary reason for low interest rates.  In a speech on October 17th, Fed President Fisher commented:

Let me move now to the second major development on my list. In addition to its effects on labor force growth, the aging of the population is likely to boost aggregate household saving. This increase is because the ranks of those approaching retirement in the United States (and in other advanced economies) are growing, and that group typically has above-average saving rates.9 One recent study by Federal Reserve economists suggests that population aging--through its effects on saving--could be pushing down the longer-run equilibrium federal funds rate relative to its level in the 1980s by as much as 75 basis points.

ECB head Mario Draghi made a similar observation this week:

The second factor is a global imbalance of saving and investment, which has led real yields to fall even relative to growth prospects. On the saving side, a “global saving glut”, produced among other things by ageing populations, has bid up the price of safe assets at a time when the supply of those assets has been shrinking, thereby compressing real yields. Factors such as a decline in the relative price of capital goods have also led to a fall in desired investment.

Ben Bernake first advanced this idea in a speech on March 10, 2005.  And although controversial at the time, it has now become a cornerstone of monetary policy discussion.

     In the 2005 speech, Bernanke offered a then controversial explanation for the U.S. trade deficit.  Rather than accept the conventional explanation that the deficit was a sign of a faltering U.S. manufacturing sector, he argued it was caused by an excess of global savings pouring into the U.S. seeking out higher returns.  Here’s the key section from that speech:

In the United States, as in all countries, economic growth requires investment in new capital goods and the upgrading and replacement of older capital. Examples of capital investment include the construction of factories and office buildings and firms' acquisition of new equipment, ranging from drill presses to computers to airplanes. Residential construction--the building of new homes and apartment buildings--is also counted as part of capital investment.4

All investment in new capital goods must be financed in some manner. In a closed economy without trade or international capital flows, the funding for investment would be provided entirely by the country's national saving. By definition, national saving is the sum of saving done by households (for example, through contributions to employer-sponsored 401k accounts) and saving done by businesses (in the form of retained earnings) less any budget deficit run by the government (which is a use rather than a source of saving).

As I say, in a closed economy investment would equal national saving in each period; but, in fact, virtually all economies today are open economies, and well-developed international capital markets allow savers to lend to those who wish to make capital investments in any country, not just their own. Because saving can cross international borders, a country's domestic investment in new capital and its domestic saving need not be equal in each period. If a country's saving exceeds its investment during a particular year, the difference represents excess saving that can be lent on international capital markets. By the same token, if a country's saving is less than the amount required to finance domestic investment, the country can close the gap by borrowing from abroad. In the United States, national saving is currently quite low and falls considerably short of U.S. capital investment. Of necessity, this shortfall is made up by net foreign borrowing--essentially, by making use of foreigners' saving to finance part of domestic investment. We saw earlier that the current account deficit equals the net amount that the United States borrows abroad in each period, and I have just shown that U.S. net foreign borrowing equals the excess of U.S. capital investment over U.S. national saving. It follows that the country's current account deficit equals the excess of its investment over its saving.

In retrospect, his argument is hardly controversial.  Aging populations (which are occurring in the U.S., the EU and Japan) naturally save more.  Open borders allow savers in one country to send excess savings to another – a process encouraged by the increased size and sophistication of financial intermediaries.  Bernanke supported his argument by noting that while the US had a very large trade deficit, emerging economies had a growing trade surplus.  The latter figures represented excess savings flowing from emerging economies to developed economies.

    This week, the Counsel of Foreign Relations published an article by Brad Setser, which shows that the Asian savings glut has returned to high levels:

The combined savings of China, Japan, Korea, Taiwan, and the two city-states of Hong Kong and Singapore is about 40 percent of their collective GDP, a thirty-five-year high. No other region of the world currently contributes more to the global glut in savings that has brought interest rates around the world down to record lows. Asia’s current account surplus—its excess of savings over investment—has increased significantly in the past two years and is now about as large, relative to the GDP of its trading partners, as it was prior to the global financial crisis. Without a policy push to bring down savings, East Asia’s excess savings will continue to give rise to new economic and financial risks, both inside the region and globally.

The article contains numerous graphs, but this is the most salient:

The combined trade deficits of the oil countries and developed economies equals Asian and European surpluses.

     The evidence is very clear: the global savings glut is alive and well.  More importantly, it will exert downward pressure on interest rates for the foreseeable future.

For those of you who follow me on Twitter, I'm moving from @captivelawyer to @originalbonddad.  

I'm a Financial Adviser with Thompson Creek Wealth Advisers and an attorney with the Law Office of Hale Stewart

 

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