Friday, February 18, 2011

The Savings Glut, Revisited

In a speech on "Global Imbalances" today in Paris, Ben Bernanke revisited the "savings glut" hypothesis he offered in 2005.  The current account balance (CA) is the difference between investment (I) and net national saving (NS):

 CA = NS-I

A current account deficit occurs when investment is greater than domestic saving - the gap is filled by selling assets to the rest of the world.

Although it is commonplace to criticize deficit countries for low savings - and the savings rate in the US did indeed become very low - Bernanke argued in 2005 that the US current account deficit was driven by foreign savings.  The financial inflows stemming from the foreign "savings glut" drove up the prices of US assets (including bonds, thereby driving down interest rates), and the decline in US savings followed from the resultant increase in wealth.

As a share of GDP, the US current account deficit peaked at just over 6% of GDP in early 2006.
I today's speech, Bernanke cites evidence that there was strong international demand for "safe" US assets, which supports his 2005 hypothesis.

He is careful not to blame the financial inflows for the crisis.  The failure was how the US dealt with them.  This has a parallel to the 1997 Asian financial crisis:
The preferences of foreign investors for highly rated U.S. assets, together with similar preferences by many domestic investors, had a number of implications, including for the relative yields on such assets. Importantly, though, the preference by so many investors for perceived safety created strong incentives for U.S. financial engineers to develop investment products that "transformed" risky loans into highly rated securities. Remarkably, even though a large share of new U.S. mortgages during the housing boom were of weak credit quality, financial engineering resulted in the overwhelming share of private-label mortgage-related securities being rated AAA. The underlying contradiction was, of course, ultimately exposed, at great cost to financial stability and the global economy.

To be clear, these findings are not to be read as assigning responsibility for the breakdown in U.S. financial intermediation to factors outside the United States. Instead, in analogy to the Asian crisis, the primary cause of the breakdown was the poor performance of the financial system and financial regulation in the country receiving the capital inflows, not the inflows themselves. In the case of the United States, sources of poor performance included misaligned incentives in mortgage origination, underwriting, and securitization; risk-management deficiencies among financial institutions; conflicts of interest at credit rating agencies; weaknesses in the capitalization and incentive structures of the government-sponsored enterprises; gaps and weaknesses in the financial regulatory structure; and supervisory failures.
Ouch.  That's harsh, though he could take the Asia analogy one step further - as Simon Johnson does - and acknowledge that the "breakdown" in the US was partly because we have our own form of "crony capitalism" where the financial industry has, to a degree, captured the regulatory and political system.

Bernanke also has an uncomfortable analogy for the surplus countries that are not allowing their currencies to appreciate:
These issues are hardly new. In the late 1920s and early 1930s, the U.S. dollar and French franc were undervalued, with the result that both countries experienced current account surpluses and strong capital inflows. Under the unwritten but long-standing rules of the gold standard, those two countries would have been expected to allow the inflows to feed through to domestic money supplies and prices, leading to real appreciations of their currencies and, with time, to a narrowing of their external surpluses. Instead, the two nations sterilized the effects of these capital inflows on their money supplies, so that their currencies remained persistently undervalued. Under the constraints imposed by the gold standard, these policies in turn increased deflationary pressures and banking-sector strains in deficit countries such as Germany, which were losing gold and foreign deposits. Ultimately, the unwillingness of the United States and France to conduct their domestic policies by the rules of the game, together with structural vulnerabilities in financial systems and in the gold standard itself, helped destabilize the global economic and financial system and bring on the Great Depression. 
In his central banker-ly caution, he refuses to name names, but he's obviously alluding to China's policy of keeping renminbi undervalued. 

Although he has a knack for giving very comprehensive speeches sometimes, there are some important closely-related issues that Bernanke did not touch on this time.  In particular, the demand for US assets was partly due to the fact that the dollar is the most widely-used "reserve currency" (i.e., held in official portfolios).  This periodically generates complaints from the rest of the world (and for the US, its a mixed blessing), but Bernanke did not point to any alternative.  Nor did he suggest that it gives the US any special responsibility (and, personally, I don't believe that it does).  Also, one significant motive for reserve accumulation is self-insurance - countries burned by reliance on inflows of foreign savings decided to build up their own.  An better international insurance mechanism would reduce that need.  In theory, that is part of what the IMF is supposed to provide.

Update: A nice response to the gold standard analogy from Free Exchange.

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