I sometimes feel like Michael Corleone when it comes to global economic imbalances. No matter what he did to move his enterprise from a life of crime, things kept dragging him back. And so it is that I have to once again been dragged into this territory. This time, though, I intend to make a definitive statement that I can refer back to in the future. All the while, I want to keep things simple in a language everyone can easily understand. For each instance, I will cite the work of someone with a seeming inability to stay away from"deficits don't matter"-style theories ;-)
(1) "Deficits don't matter because there's a global savings glut" - Michael Pettis has continually leaned on this idea first propounded by Ben Bernanke; he is not the only one. By accounting identity, all the world's current account balances must sum to zero. Bernanke's spin on the matter goes like this: East Asian exporters and to a lesser extent Middle East oilers have been running large external surpluses due to burgeoning goods exports in the former case and energy exports in the latter. Returning to the accounting identity, the concomitant savings of these regions have been accompanied by a lack of savings elsewhere. In effect, the large savings of LDCs are "forcing" the US to dissave. Aside from the chicken-and-egg quality--does LDC saving precede US dissaving or vice-versa--there is also the inconvenient truth that global savings rates are not particularly high by historical standards. This figure is from the September 2005 World Economic Outlook of the World Bank:
Also notice the caption. Recently, Brad Setser resurrected the discussion on Bernanke's global savings glut theory and was promptly shellacked by some of his readers. Ultimately, I am in agreement with what he says, despite a doubtful effort to salvage Bernanke's terminology. Everyone pretty much recognizes the need to spur domestic consumption in China--fellow IPE blogger Kindred, Martin Wolf, Brad Sester, even Michael Pettis. What separates me from this illustrious cast is that I regard the answer as something economics has precious little to say about. Yes, China needs to consume more--just as the Israelis and the Palestinians need to calm down. Tell me something new. But how do you do that? Well, that's where some knowledge of marketing comes in handy when the subject matter turns to Chinese consumption. On this economists are mostly silent as they aren't really trained to answer such questions. Hopefully, IPE as a multidisciplinary field is better suited to the task at hand. Again, watch this space.
Before moving on, the main problem with the global savings glut theory is that Bernanke refers to the distribution of savings when the term refers to the level of savings. A "global savings glut" implies that savings are high globally. Let me provide you with a number of basic illustrations:
For simplicity's sake, let's consider the case of savings for two hypothetical regions, North Amorica (NA) and Aisha (AI). Now, (1) depicts a situation in which the level of savings is a touch less than a quarter of the world's GDP as per the preceding World Bank chart. What if we were to change the distribution of savings levels for both regions but kept the global level the same? You get (2), similar to a situation described by Bernanke. Is this a global savings glut? Of course not. What you can instead say is that there is a regional savings glut in AI--see the encircled portion--and an accompanying savings shortage in NA. Bernanke's semantics are thus faulty as a real global savings glut would look something like (3) or a less-evenly distributed (4) in which events push savings levels dramatically higher on a global basis. In his most recent post, Setser points out that the global savings rates in 2007 stood at 24.1% of world GDP to lend some credence to Bernanke. While this may be above trend, it certainly isn't a "glut" and is well below oil crisis levels. Gently nudging Dr. Setser, a couple of inches more in yearly rainfall doesn't mean we should start copying the example of Noah. There is no great flood here--or a "global savings glut" for that matter.
Bernanke is not only incorrect; he is also disingenuous. Although I cannot comment on his motivations for obvious reasons, many including myself have suspected that he made this stuff up to suit his would-be political paymasters. Back then, he was just among the many angling to become Alan Greenspan's replacement as Fed chairman. Consider the counterfactual if Bernanke were more intellectually honest when asked to comment on these matters: "President Bush, the real reason for us running large deficits is a combination of policies encouraging a dramatic rise in unsustainable private and public spending as well as America's inability to create tradable goods and services." Would saying that put you in front of the line to become Bush's Fed chair nominee? I leave it up to you.
(2) "Deficits don't matter because they are a natural byproduct of demographic imbalances" - Michael Pettis is once again at the forefront of these arguments. China with its rapidly greying population (due to the infamous one-child policy among other things) is accumulating claims now against the US. Demographic imbalances should mean that, in a couple of decades, aging China will rely more on a steady stream of payments from the US to compensate for an unfavorable potential support ratio (PSR). I have two points of contention here, neither of which should be unfamiliar:
a. China's claims against the US are of distinctly low quality: You name it, China has been suckered into buying dollar-denominated assets that have already lost or will soon lose value--dollars (which owe a lot of their remaining value to China), low-to-no yield Treasuries, a reported $376B in Agency bonds, Blackstone, Morgan Stanley, etc. Why would China be better off by accumulating money-losing claims? From an investment POV, wouldn't it literally be better off hiding (non-dollar) cash under its mattress?
b. The fiscal cost of retirees to the US is much, much higher than to China. We get nothing from Pettis about the impending retirement of 78 million baby boomers who have lavished themselves with old age and medical benefits to enjoy their future days with. The folks at the Peterson Foundation who do more than just armchair theorizing have computed future obligations arising from Social Security and Medicare at $42.9 trillion in a more immediate time frame. Why don't we hear about this from Pettis who is fond of discussing demographics? In stark contrast, let's just say China isn't exactly obligated to splurge on its retirees.
(3) "Deficits don't matter because additional household savings will compensate for the fiscal deficit, resulting in no additional external borrowing requirement" - Owing to him, I have already gotten off my duff to do the math. As you can see, I at the time estimated the additional fiscal deficit of the US at $700B based on a very optimistic scenario. Let us reconsider these calculations in light of recent CBO estimates that the deficit will reach $1.2 trillion prior to consideration of additional Obamanite stimulus. The forecast of the CBO for 2009 before additional hell broke loose was $438 billion. With Obama contemplating a $775B package over two years, let's say the additional fiscal deficit conservatively amounts to [(775/2) + (1200)] - 438 = $1149.5B. Again using rather generous assumptions, the target savings rate comes to 1149.5/11,319.4 = 10.1%.
In response to a comment I made on his blog, Brad Setser replies that because of a combination of wealth effects (people feel less affluent in lean times) and credit constraints (banks are becoming more reluctant to lend money to many Americans, especially the bankrupt and/or foreclosed), US savings rates are headed upwards. This is of course true. However, personal disposable income is bound to dive in America contrary to the more optimistic assumptions I make to come up with the figure above. Among other things, these include dwindling interest income due to American ZIRP and falling dividends as corporations aim to conserve cash from reduced profits. There is considerable upward pressure on the target savings rate--considerations scarcely mentioned by those optimistic about America's deficits.
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On this matter I have not changed my line one iota, maintaining metronomic consistency. When your stuff is on the Internet, you can't cover up your tracks easily. I am thus at a loss as to why Pettis who's publicly said "I have never been terribly worried about the sustainability of the US trade deficit" is now cautioning about a financial "crisis." Why should we even bother dealing with these silly deficits if they're eminently sustainable for reasons he's given above? It sure beats me. Then again, I have deficit attention disorder.
As for Helicopter Ben Bernanke, I have some words of wisdom for him from, er, Nazareth that we're best advised to follow:
Some fools think of happiness
Of blissfulness, togetherness
Some fools fool themselves I guess
But they're not fooling me