PHILADELPHIA — U.S. “Fed” Governor Ben Bernanke has blamed net inflows of capital from the rest of the world, especially China, for a global savings glut that is driving up the U.S. current account deficit. Unfortunately, some commentators have echoed this seemingly plausible but outrageously silly idea.
For example, an HSBC economist in Hong Kong, Qu Hongbin, bought into this foolish analysis to identify China as harming others and itself by having so many thrifty people. And the co-head of European economics at Bank of America in London believes that savings are providing excess liquidity that has pushed up prices of nonfinancial assets. When central bankers offer analysis that ignores the effect of an ultraloose monetary policy, financial institutions require their highly paid analysts to be more vigilant.
In all events, the observations cited above reflect a belief that China must lower its domestic savings rate to fuel its economic growth and correct its trade imbalance. Doubtless, part of their credulity is based on China’s domestic savings rate — 46 percent of earnings.
But Bernanke and his followers confuse cause and effect in suggesting that an “excess” amount of global savings has caused the U.S. current account deficit despite low interest rates. As it is, their macroeconomic analysis is blind to basic economic realities.
In the first instance, they are unable to unravel why savers continue to pour money into banks despite the ultralow deposit rates offered. It turns out that the inflow of funds into banks is the result of monetary pumping by most central banks that has generated a massive bubble inflated by excessive formation of credit and liquidity.
Bernanke’s assertion is also flawed for implying that “excess” savings can damage an economy since “too much” capital can be accumulated. Capital formation is an essential element of economic growth that drives higher living standards.
As such, the implication of his argument is that there is too much growth and people are too well off for their own good. It is a little shocking that such a notion passes intellectual muster.
In all events, the conceptualization offered by Bernanke conveniently ignores the role played by the U.S. Federal Reserve Board in causing the U.S. trade deficits to rise while the dollar has weakened. (The U.S. current-account deficit in 2004 was $668 billion, or 5.7 percent of gross domestic product, with further rises expected.)
In fact, these arguments are redolent of the warmed-over “paradox of thrift” notion of John Maynard Keynes. Similarly, Bernanke confuses the demand for money (hoarding) with savings and suggests that large cash balances reduce overall demand. But increased savings remain available in the financial system to be lent to investors.
As such, the inflows of foreign funds into the United States are not savings; nor can they be fully explained by a strong domestic U.S. capital market. Nor can it be said that the strength of the U.S. economy is pushing up the current-account deficit into record territory. If this were the case, the value of the dollar would not have recorded the general weakening trend that only recently was reversed. (The U.S. dollar is up by about 7 percent against a basket of major currencies so far this year.)
Concerning the growing U.S. current-account deficit, it has been driven by an ultraloose monetary policy. America’s central bankers oversaw an increase in the money supply (measured as M1) by 27 percent from January 2001 to December 2004.
As such, the accumulated dollar reserves held by central banks in countries with trade surpluses with the U.S. reflect a type of hoarding separate from increased savings. These trade surpluses are temporary since they eventually will be used to purchase imported goods or dollar-based assets such as Maytag and Unocal.
The cheap credit policy of the Fed has created an excess supply of dollars domestically and internationally. Low U.S. interest rates led to higher spending and nominal incomes that drove up the demand for imports, causing the trade deficit to balloon. With the dollar pouring relentlessly into foreign-exchange markets, the trend has been for it to depreciate against other currencies and many commodities, like oil and gold.
So it is that this flood of cheap credit, courtesy of U.S. central bankers, has created and kept afloat a gigantic, global Ponzi scheme. Like all pyramid schemes, there is a false sense of shared prosperity. Americans get cheap imports that hold down domestic consumer prices. And foreigners are happy thinking that they are enjoying export-driven growth while accumulating more dollars or paper debt mostly denominated in dollars.
Eventually, foreigners will find that their addiction to green money in exchange for their own hard work is damaging their economies rather than boosting them. Presumably, China will recognize this before it is too late. But this would require that it abandon the neomercantilist logic that supports the obsession with a “weak” currency to promote exports.
Artificially low interest rates have spawned a global credit bubble that has caused various “imbalances.” These include a global housing boom and a U.S. trade deficit that is responsible for the massive foreign-exchange holdings in economies with trade surpluses.
In the case of China, the rates have generated an unsustainable and temporary burst of growth in export-oriented industries. The excess liquidity is also responsible for higher asset prices, especially gold and oil.
History shows that all “bubbles” either deflate or burst. In either case, an economic slowdown occurs that requires the liquidation of misguided investments that involve unsupported productive capacity.
It is troubling to recount the history of Asia’s export-led powerhouses. The bursting of Japan’s bubble in 1989 ended a long period of high economic growth that was followed by a long period of low growth that continues to this day.
East Asia’s “miracle” economies hit a wall in 1997-98 that burst their bubbles. It should be rather clear that China is next; the most pressing is question is, when?
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