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Savings Glut or Investment Spree?

By Kevin

Are we doing it right?

As I previously mentioned, I'm working on a piece on global imbalances once again (fact is that I feel like I've done countless stuff on this but then it is always just some other topic that obliquely references to it somehow). I guess I'm a little behind times on reading about this issue but the more I looked into Bernanke's earlier arguments about the 'Global Savings Glut (GSG)' and his subsequent 'revisions', the more I find it difficult to swallow the notion that 'it's not just the US who is at fault'. Of course, he has softened his stand from a while back in 2005, when he actually believes that the current account deficits were hardly within the control of US and if you need someone to blame, you got to blame the rest of the world. There are many flaws in the speeches he delivered in 2005 (here and here), especially with the benefit of hindsight and additional data. Hence, I would not be launching an attack on those ideas.

In any case, as John Taylor suggested to anyone who would care to scrutinize the statistics (I actually bothered; macroeconomic data on the World Bank Database is particularly handy for looking up stuff that are two years old or earlier), there was no significant rise in world savings (in the recent years). World savings fell from 22.25% of world GDP in 2000 to 20.88% of world GDP in 2003. In that sense, there wasn't really a savings 'glut' to push down interest rates at least during that time (I refer to the beginning of 2005 when the speeches were made). In fact, during that period US investments fell from 20.58% to 18.35% of GDP - a great chance for correcting the current account deficit. But no, the chance was wasted because savings in the US declined even more, from 16.72% to 13.80% of GDP, thus increasing their current account deficit from approximately 3.8% to 4.5% of GDP. Granted, I'm looking at a selective time period and being a bully but that is just a distraction from my main point that if the 'GSG' idea continues, US will forever think they are simply a victim of circumstances when they are clearly not.

Daniel Gross characterized the idea of a 'savings glut' as a meme on Slate when it was first introduced. And I think he can't be more right. It is a matter of perspective but there is this notion of sacrificing current consumption when it comes to the idea of 'savings' but reality is that these 'saving glut' countries were pushed to purchase 'safe' investment products by none other than the deep, sophisticated financial system of the United States. In what WSJ terms as an expansion on his 'saving glut' research, Bernanke supposedly places the blame on US' mismanagement of the capital inflow but, I quote the Luca from WSJ:

The paper’s main focus, however, is on the intense foreign investor demand for what seemed at the time like safe U.S. assets in the years before the crisis.

The paper appears to be suggesting that US is merely giving investors what appears to be products they wanted - the mortgage-backed securities (MBS), safe from the rating perspective, backed by the government somewhat, and also offering the returns. In fact, it goes on further to imply that financial engineers were being efficiently responding to market demands with innovations that would generate the supply to quell this demand. I quote from various segments of the paper:

"...we verify that the “GSG countries”—that is, emerging Asia and Middle Eastern exporters—did indeed evince a strong preference for the safest U.S. assets. On the margin, this preference most likely helped push down yields on MBS relative to other assets, as most MBS were either guaranteed by the Agencies or sold as tranches carrying AAA credit ratings."

"In fact, the strong preference of the GSG countries for Treasuries and Agencies appears to have pushed Europeans and other advanced-economy investors, including U.S. investors, into apparently safe “private-label” MBS."

"Finally, the demand for safe assets by investors, both domestic and foreign, appears to have engendered a strong supply response from U.S. financial firms. In particular, even though a large share of new U.S. mortgages during this period were of lower credit quality, such as subprime loans, Agency guarantees and financial engineering in the private financial services industry resulted in the overwhelming share of mortgage-related securities being rated AAA."

I'm going to use a rather extreme analogy here and say that this is really no different from a doctor saying, "Wow, so many patients only trust me and they would only take medication I prescribe to them, so never mind if the drug is effective, I'll prescribe as long as I get paid really good commission from the drug firms. In fact, let me just prescribe these pills I just found in the cabinet here though I don't even know what they are." Granted, the financial engineers probably really believe that they have managed to tuck risks away and that the instruments were really safe, how about those pushing NINJAs to take up loans they can ill-afford? John Cassidy's How Market Fails is a collection of such stories. There appears to be a culture of absolute irresponsibility - the financial institutions couldn't care less about the fate of clients on both sides (people who took out mortgages and investors who bought MBS).

I guess the 'GSG countries' are just too eager to save they didn't practice their due diligence just like many of their counterparts in US and the finance system only mean all good and no harm. Maybe. But maybe, if the financial system was more responsible, if the culture was not all that screwed up and money was rejected on the basis that there was no more good quality investment opportunities in US and savings were allowed to 'go home' to these 'GSG countries', then things won't be so bad. For goodness sake, if investment opportunities are dried up, then curb excesses. Leave the punchbowl and you get a bust. There you had it.