1. What is the argument about why there is a worldwide “savings glut?”
2. What are the arguments about why America’s “spending glut” is good for the US and the world?
3. Do these arguments seem reasonable? Explain.
Savings Glut: The self-serving explanation for America's bad habits.
By DanielGross
June 16, 2005, Slate.com <http://www.slate.com/id/2121017/>
Why are there imbalances in the global economy? Until recently, conventional economic wisdom has held that the U.S. has a huge trade deficit, a gaping current account deficit, and large federal budget deficits because Americans consume too much and save very little. Newly emerging conventional wisdom takes the opposite view. The problem in today's global economy is that the rest of the world, in particular people in Asia, consume too little and save way too much.
Signs of this meme can be seen all over. The lead article in today's Wall Street Journal speaks of a global housing boom spurred by a "saving glut." An op-ed in today's Financial Times by Ricardo Hausmann of Harvard notes that "excessive savings are at the root of the imbalance in China." Elsewhere, the FT applauds a tentative sign that the Japanese—"who control the world's largest pool of savings," some $1.28 trillion—are showing signs of spending and investing more.
The savings-glut meme, which could soon become an important part of our monetary policy, has emerged from economists' efforts to come to grips with what Federal Reserve Chairman Alan Greenspan has labeled "the conundrum." In a speech to a conference in China last week, Greenspan offered an uncharacteristically concise précis. Given the pace of growth in the U.S., the current account and budget deficits, and the sharp spikes in short-term interest rates, long-term interest rates should be higher. But they've fallen—in the U.S., Europe, and even in developing economies.
Ben Bernanke, the Princeton economist and former Federal Reserve Governor who was approved yesterday by the Senate to head the Council of Economic Advisers (and who is the odds-on favorite to replace Greenspan next year), has come up with an explanation that he first articulated in a speech in March: There's a "global saving glut." Bernanke identified two main sources. First, there are the rich industrialized countries with graying populations and slow growth, where people need to save more for retirement and yet can't find attractive domestic investment opportunities (think Old Europe and Japan). A bigger and more powerful source of excess savings, however, is found in newly industrializing countries like China. As Bernanke notes, in the past decade the developing world has metamorphosed "from a net user to a net supplier of funds to international capital markets."
China, and other countries in Asia and Latin America, responded to the financial crises of the 1990s by putting controls on capital flows, building up reserves of foreign currency, and encouraging more savings. Add in a rise in oil prices (which sends cash to the developing world) and the stock market bust of 2000 (which made people reluctant to put cash to work in equities), and that's a lot of money sloshing around the developing world. Because the U.S. is such a comparatively attractive place to invest—even after the NASDAQ meltdown—a lot of that capital has found its way to America. By running large budget and current account deficits, then, the U.S. acts like a sponge, soaking up the world's excess savings and providing it with a decent return.
In April, Columbia University Professor Richard Clarida, the former assistant treasury secretary and a candidate to be a Federal Reserve Governor, advanced the meme by arguing that our twin deficits are an example of good global citizenship. When there's more savings relative to investment, he wrote in the Wall Street Journal (here's the link, but a subscription is required), "not only will real interest rates be driven down, but some country or group of countries must run current-account deficits to absorb the excess saving."
In other words, as Martin Wolf, the FT's chief economics correspondent, noted in a big saving-glut takeout (subscription also required) earlier this week, the U.S. is doing the world a favor. "In a global economy with no global government, the most important regional power—the US—has been following the Keynesian recommendation by offsetting excess desired savings elsewhere."
On his blog, economist Brad Setser raises some interesting questions about Bernanke's argument. More curious is what Bernanke—and other saving-glut champions—want us to conclude. He diplomatically noted that, "in locating the principal causes of the U.S. current account deficit outside the country's borders, I am not making a value judgment about the behavior of either U.S. or foreign residents or their governments." But of course he is. Bernanke tells us not to worry so much about the federal budget deficit—reducing it won't affect interest rates significantly. Meanwhile, foreigners should "ease borrowing constraints, to spur domestic consumption." The subtext of the meme is that Asians have to become big spenders and little savers like the British and Americans.
The savings-glut meme changes the terms of the conversation about global imbalances. It's not our fault that we rely on foreigners to fund our desire to spend in excess of our resources. Au contraire. Our extreme consumption and failure to save become something of a virtue. Somebody has to keep the world's factories humming and absorb all the products made in Japan, China, and elsewhere. And until the rest of the world becomes More Like Us in its consuming habits, the imbalances are likely to persist.
The savings glut may be an accurate and subtle take on the world's economic imbalances. But less subtly, it minimizes the impact of the potentially destructive monetary and fiscal policies pursued by the U.S. over the last five years. It also lays the responsibility for change squarely on the backs of foreigners and makes a virtue out of what appear to be our own failings. No wonder Bernanke is so popular at the White House.
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4. In your own words, explain what an inverted yield curve means.
5. What does the inverting yield curve suggest about the US economy and about the world economy?
6. What is the carry trade and how can banks make profits while adding nothing of social value?
Upside-Down Interest Rates: Bad news for the U.S. that is worse news for the world.
By DanielGross
June 3, 2005, Slate.com <http://www.slate.com/id/2120161/>
Here's a bad sign: If current trends continue, we could soon be experiencing an inversion of the yield curve.
Though it sounds like something out of quantum physics, the yield curve is actually a fairly simple concept. It describes the relationship between interest rates on long-term and short-term U.S. government bonds. Interest rates on the shortest-term bonds correlate very closely with the interest rates set by the Federal Reserve Board. Long-term interest rates, by contrast, are influenced by many more factors, ranging from China's purchase of debt to investors' optimism about inflation and growth. Typically, bonds that mature further in the future pay higher yields—compensation for the risk of locking up money for a longer period.
When the difference between long-term and short-term interest rates is large, the yield curve is said to be steep. When the difference is negligible, it's flat. But when long-term rates are lower than the short-term rates, it's inverted. (On Smart Money's great yield-curve primer, you can click through the month-by-month interactive chart to see how the curve has shifted since 1977.)
The yield curve rarely inverts. And when it does, it usually spells trouble for the economy. It means that investors and the Federal Reserve are fretting about inflation in the short term, and that investors are pessimistic about long-term growth. According to Brian Reynolds, chief market strategist at MS Howells & Co., in the last 30 years, periods of prolonged inversion of the curve between two-year and 10-year government bonds have generally presaged recessions. The most recent period of inversion ran from February 2000 through December 2000—just before the 2001 recession.
A year ago, the yield curve was rather steep. But in the last year, the Federal Reserve Open Market Committee has taken the short-term Federal Funds rate from 1 percent to 3 percent in eight straight tightenings, the most recent one in May. (All the Fed's 2005 actions can be seen here.) Today, with two-year bonds at about 3.5 percent and the 10-year bond having fallen to about 3.9 percent, only a few dozen basis points separate the two.
The Fed could presumably ward off an inversion by stopping the short-term rate hikes. Yesterday, Richard Fisher, president of the Dallas Federal Reserve, told CNBC and the Wall Street Journal that the current phase of raising rates might be about done. "We've gone through eight innings here, 25 basis points an inning," he said, lapsing into baseball-ese. "The next meeting in June is the ninth inning."
But Federal Reserve Chairman Alan Greenspan, much more than Fisher, really determines whether the Fed will keep hiking rates. Investors and many analysts apparently expect further hikes, and thus a probable inversion. Investors use the Chicago Board of Trade's Federal Funds Futures to place bets on where they think the rate will be at certain times in the future. Today, traders are saying they believe that the rate will be 3.6 percent by November 2005, and about 3.7 percent by February 2006.
Rate hikes are also likely to continue because the Fed still has more work to do in carrying out its core mission—fighting off inflation. David Malpass, the chief economist of Bear Stearns, today pointed to sharply rising unit labor costs as a reason for the Fed to continue to maintain its vigilance. "We expect the Fed funds rate to end the year at 4.25 percent or 4.5 percent," he writes.
In the past, the combination of higher short-term rates and lower long-term rates has pointed to a nasty combination of higher costs and slower growth—which is bad for pretty much all companies. And an inverted yield curve will be especially bad news for some large financial institutions. Investment banks and hedge funds made out like bandits, with the carry trade borrowing short-term and buying long-term. This won't be possible in an inversion. J.P. Morgan Chase yesterday said its trading revenue—money made from investing the bank's own capital—would fall sharply this quarter.
[Cash and Carry; Greenspan's latest gift to the markets. By Daniel Gross, March 12, 2004: Banks have always used their solid credit to borrow money cheaply and then put it into higher-return investments. Historically, that meant making mortgages, or lending to companies, or lending to consumers through credit cards. Of course, these types of loans expose the lender to credit risks. A borrower can default or get into trouble. So it's easier to lend money to—or buy the debt of—a borrower who will never default, such as the federal government.
And it's easiest of all when you can buy that risk-free debt with money that's essentially free. This, in essence, is the carry trade. The carry trade depends on a nice, steady interest rate for short-term borrowing. Last June, Greenspan slashed the federal funds rate to 1 percent and has vowed to keep it there for a considerable period of time. Here's how the carry trade might work, in its simplest form. A bank borrows money at the federal funds rate of 1 percent, then uses it to buy a security like the 10-year Treasury bond, which yields around 4 percent. The bank pays its tiny smidgen of interest every day—1/365 of 1 percent—and then collects the quarterly interest payments on the Treasury securities. When the difference between short- and long-term interests is great— that is to say when the yield curve is steep—this strategy is golden. And for much of 2003 the yield curve was quite steep. At a time like last year when fewer companies wanted loans, the carry trade was a reliable source of bank revenue.]
But this time around, thanks to increased globalization and the ever-rising tide of international capital flows, an inverted yield curve may not necessarily mean bad news for the entire country. Yes, low long-term rates could signal that investors are pessimistic about the long-term prospects for U.S. growth. But many buyers of long-term government debt are overseas in China, Japan, and Europe. And from where they sit, our 3.9 percent-yielding 10-year bonds are a good deal. Look around the world, says Karina Mayer of ISI Group. Interest rates are trending lower everywhere throughout the developed world. In Japan, Europe, Taiwan, and Singapore, interest rates on 10-year bonds are significantly lower than they are in the United States. Only the United Kingdom, Canada, and Australia offer comparable rates. "Practically everywhere around the world, bond yields continue to trend lower, which is more of a reflection of slower growth," she says.
A yield curve that is becoming as flat as Kansas and threatens to invert may be a sign of slowing growth for the U.S. economy. That's the bad news. The good news: It's a sign that things elsewhere are probably much worse.