May 11, 2005

Savings Glut or Investment Dearth?

I have been waiting patiently for Billmon at Whiskey Bar to post his 3rd entry on this issue. His first 2 pieces (Part I and Part II) were excellent and I highly recommend them to anyone who did not run across them already.

You'll probably want to read Nouriel Roubini's latest piece first as it is referred to at several points. It also provides context for the savings debate within a bigger economic picture.

Here is a taste of what Billmon says:

Instead, the problem appears to be a variation on the same theme Keynes explored 70 years ago: Private individuals with savings to lend are holding out for a higher price (interest rate) than borrowers are willing to pay - and in America's case, probably higher than it could afford to pay, given the quantity demanded.

By afford, I don't mean America is literally too poor to cover the vig, but rather that the interest rate required to finance the current account deficit solely from private sources would slow the U.S. economy and short circuit the current investment recovery - thus drastically reducing, if not eliminating, the demand for foreign savings.

This state of affairs has forced the ODIC governments to step into the breach and provide the financing that private lenders are no longer willing to offer. In effect, they are forcing the savings-investment market to clear - at an artificially low price. We can assume they are not doing this out of the goodness of their hearts or because of the kindness of strangers. They are propping up the market because they, too, are afraid of the deflationary wolf and so far haven't figured out another way to generate the kind of growth rates they need to stay one step ahead of it.

What makes all this such an interesting variation on the old Keynesian theme is that the recalcitrant lenders and the increasingly strapped borrowers happen to live in different countries with different currencies and different central banks - as well as different cultures, ideologies and geopolitical objectives, some of which may not be reconcilable.

I will probably be back when the series raps up with some thoughts. Until then I am keeping an open mind. This issue is extremely important though and perhaps even urgent. It seems like the next 6 months will see a short-term test of the "savings glut" thesis (a liquidity crisis). How that test works out just depends on where the long-term equilibrium actually is.

1 comment:

  1. The Billmon posts are excellent reads, but I think this whole discussion of a savings glut is almost designed to obfuscate matters.

    It is almost always unclear whether one is talking stocks or flows. For example, in the post itself we have:

    "In effect, they are forcing the savings-investment market to clear - at an artificially low price. "

    But savings and investment are macroeconomic flows - there is no "savings-investment" market as such.

    The bond market is not a market for savings and investment flows - it is an asset market - and assets are a stock quantity, not a flow.

    Now - clearly bond prices have some feedback on consumption and investment, and saving flows (at a given income level). That is clear.

    But there is no particular reason to believe that bonds prices will be such as to ensure that investment and savings flows (at given income) would be equal.

    The reason they end up equal (ex post) is because there are adjustments in income levels that bring them into equality. Income levels change - ceterus is not paribus.