I was reading “Helicopter drops might not be far away” by Martin Wolf in the FT. By now those interested in macro economics/monetary policy/asset markets should be well aware of the long gradual easing in interest rates, especially since the 1990s. Lower interest rates did not just encourage people to borrow for consumption, but they also boosted the amount of borrowing for asset purchases with rising asset values also looping back into consumption for a while. During this period, global money supply growth also became ever more asset focussed.
For a while this helped stimulate consumption in key economies, also aiding in developing economy growth. Developed economy consumers became ever more indebted at a time when income growth was also slowing, but given that asset markets kept rising and interest costs kept falling, everything was able “to keep on going for a while”…many felt that this period of low interest rates and rising asset markets was a “great moderation” and few seemed to notice the enveloping divergence.
While the financial crisis was the bursting of this particular reality, it also marked the onset of a period of unprecedented financial engineering in response, itself a denial of that reality.
Everybody is asking and at times hoping to answer the question as to why world economic growth is slowing down, why is it so sub par, why has it not recovered post the turbulence of 2007 to 2009? There are many straws in the wind, but which ones are cause, which ones are consequence and which are accommodation linking both? In a world where diverging tiny margins can accumulate into significant distances it is hard to determine just what and which is the key.
If you stream through the data it is pretty clear that developed economy growth has been slowing for some time and that monetary policy has accommodated this adjustment with lower interest rates and a relaxed attitude towards money supply growth. At about the same time these trends were moving ever closer to their sweet spot on the horizon (because we are not yet at peak of this particular movement) certain developing markets really got going, with the help of a fair amount of their own monetary stimulus but also by a reconfiguration of global supply chains and offshoring in key economies. All factors combined to create a heady and dangerous global financial imbalance, a weak bridge cast across a widening economic divide. No wonder it all came crashing down..but who was to blame? The world’s central bankers who were blindsided into excessively lax monetary policy by a low inflationary world that had become obsessed with laying off and chopping and dicing of risk to those “who could best absorb and bear it”, or some of the finer strings in the mesh? Well, some have chosen to blame excess savings in the emerging/developing part of the world, principally China, but this is all too pat. The “savings glut” theory, if you can really call it “excess savings”, was merely a return of serve of part of the vast ocean of financial and monetary excess that barrelled through the early to mid 2000s.
For me the “Savings Glut” Hypothesis falls down on a number of key areas:
The first and most important is that it appears to ignore significant loan/monetary growth which breaks the point in time National Income Identity on which “Savings Glut” arguments apparently rest. I say apparently because much of the discourse supporting the SG hypothesis is either couched in nuanced semantic surfing and/or bereft of argument that you can trace directly back to the source of the flows from which they derive savings. Many supporters of the SG hypothesis either ignore these monetary dynamics totally or disavow them without cause.
The second is that it ignores the foreign exchange and central bank monetary dynamics involved in much of the FX/asset purchases. Key components of the trade balance/net investment position were orchestrated by Central banks creating new money to buy dollars and thence assets.
The third is that it ignores the fact that the major mega surplus economy, China, was and remains to a very large extent driven by loan financed (new money) gross fixed capital investment. Again the basic National Income Identity model misses a myriad of inter temporal dynamics. The SG argument was that it was excess savings and not monetary and financial system excess that caused the crisis and to fully understand the imbalances you have to look at where National Income/output is derived.
The fourth is that it ignores the very important development of emerging Asia as a global production hub and the off shoring dynamics that saw significant components of US and other international manufacturers move tranches of their manufacturing base to these countries. This issue is well covered and documented.
Finally, as discussed in numerous papers, focussing only on the net investment flows ignores vast sources of excess demand for assets that were also instrumental in pushing financial markets out of synchonisation with their economic fundamentals.
I will look to explore and illustrate these arguments in coming posts.