Who’s Doing The Saving?

This recent paper from the World Bank confirms something I’ve suspected and been concerned about for a long time (abstract):

What are the causes of the growing trend of excess savings of the corporate sector in developed countries ? an empirical analysis of three hypotheses
Leandro Brufman, Lisana Martinez & Rodrigo Perez Artica

Summary: This paper analyzes annual accounting data for a sample of 5,000 publicly traded manufacturing firms from Germany, France, Italy, Japan, and the United Kingdom. The analysis uses data from 1997 to 2011 and finds an increasing trend of excess savings (defined as the difference between gross saving and capital formation) and a gradual decline of gross capital formation. This trend is accompanied by a steady deleveraging process and a decrease in the share of operating assets in total assets. This process is more acute among the more credit constrained, the more volatile, and the less dynamic firms.

Wages and GNI

From the latest round of NBER working papers (abstract):

Declining Labor Shares and the Global Rise of Corporate Savings
Loukas Karabarbounis, Brent Neiman

We document a 5 percentage point decline in the share of global corporate income paid to labor from the mid-1970s to the late 2000s. Increased dividend payments did not absorb all of the resulting increase in profits, and therefore, the supply of corporate savings increased by over 20 percentage points as a share of total global savings. These trends were stronger in countries experiencing greater declines in the relative price of investment goods. We develop a model featuring CES production and imperfections in the flow of funds between households and corporations. These two departures from the standard neoclassical model imply that the labor share fluctuates and the sectoral composition of savings affects macroeconomic allocations. We calibrate the shape of the production function and the capital market imperfections to match the cross-sectional variation in the two trends. In response to the observed global decline in investment prices, our model generates more than half of the observed changes in labor shares and corporate savings. The non-unitary elasticity of substitution between capital and labor interacts with imperfections in the capital market to jointly shape the economy’s dynamics.

The Determinants of Saving

In my inbox today, from the NBER (abstract):

The Determinants and Long-term Projections of Saving Rates in Developing Asia
Charles Yuji Horioka, Akiko Terada-Hagiwara

In this paper, we present data on trends over time in domestic saving rates in twelve economies in developing Asia during the 1966-2007 period and analyze the determinants of these trends. We find that domestic saving rates in developing Asia have, in general, been high and rising but that there have been substantial differences from economy to economy and that the main determinants of these trends appear to have been the age structure of the population (especially the aged dependency ratio), income levels, and the level of financial sector development. We then project future trends in domestic saving rates in developing Asia for the 2011-2030 period based on our estimation results and find that the domestic saving rate in developing Asia as a whole will remain roughly constant during the next two decades despite rapid population aging in some economies in developing Asia because population aging will occur much later in other economies and because the negative impact of population aging on the domestic saving rate will be largely offset by the positive impact of higher income levels.

There Is Too A Point In Dropping Interest Rates

In today's business editorial in The Star, P. Gunasegaram clearly doesn't understand monetary policy:

"If Bank Negara decides to lower interest rates next week, as many people expect, there is little that it is likely to achieve but it will further erode returns to savers already, very low at around 2%...And the lower interest rates will weaken the already weak ringgit in the short term as those holding ringgit will get lower returns and, therefore, might opt to move into other currencies...Will there be any benefit from such a rate reduction? Not likely. Recent evidence is that interest rate reductions do not do anymore to stimulate the economy beyond a certain point. An example is Japan where interest rates have been around zero for many years with little effect on the economy."

The first point of misunderstanding is that what matters is the real interest rate, not the nominal interest rate. Japan's ZIRP didn't work not because nominal interest rates were low, but because first under conditions of deflation the real interest rate (nominal interest rates less inflation) was still positive. The zero interest rate bound puts a limit on the reduction of the nominal rate, but does not put a limit on the real interest rate. Monetary policy can still be net contractionary under those conditions.

Second, Japan's policy transmission mechanism (i.e. credit creation through the banking system) during the "lost decade" was broken. With zombie banks supporting zombie companies, monetary expansion gets trapped within the banking system, and did not support economic expansion.

Neither point is yet valid for Malaysia. With annual inflation dropping fast and potentially going negative by July, the real interest rate would be rising in the absence of a nominal interest rate cut. Given the current drop in output, higher positive real interest rates are an extremely bad idea. Just to underscore this point, here's average bank lending rates less annual CPI (log annual changes; 2005=100):



Secondly, Malaysia's banking sector is structurally sound, as (ironically) pointed out in this article in the same newspaper. Capital ratios are more than adequate, and non-performing loan ratios are flirting with all time lows. Monetary expansion and lower cost of funds will thus have a positive impact on borrowing and lending.

The second point of misunderstanding is real return to savers. With annual gross national savings well in excess of 30%, I don't think we need to encourage more savings - quite the opposite. With velocity of money already low and falling, reducing velocity further is another bad idea, and just reinforces the downturn in the economy.

The third point about the currency again confuses nominal and real rates, and misses the crucial "flight to safety" narrative of the USD over the last six months. It's true that interest parity conditions would imply, ceterus paribus, that maintaining nominal rates and thus allowing real interest rates to rise would maintain and/or strengthen the value of the MYR.

This is especially true since ceterus paribus doesn't apply - BNM is behind the curve in loosening monetary policy not only against advanced economies, but also regionally i.e. relative interest rates for MYR assets have been rising. On the other hand, demand for USD has been unnaturally high in recent months, as US financials pull back overseas investments as well as from Euro-dollar asset liability mismatches. This trend will reverse as US financial system leverage unwinds.

The billion-dollar question is - with trade suffering and the threat of imported inflation practically non-existent, does a higher MYR make economic sense?

I haven't fully worked out MYR trade/exchange-rate elasticities (something for a future blog post), but a quick regression estimate suggests a 1% rise in the USDMYR rate results in a 0.39% drop in exports and 0.24% drop in imports, both statistically significant. That is, MYR currency appreciation results in a contraction in total trade, which isn't exactly what we need right now.

One point I do agree with is that banks aren't passing on the full marginal cuts in the OPR to borrowers, as I pointed out here. That's something BNM has to work on.

Technical Note:
Source for average lending rates, CPI and external trade from BNM's Monthly Statistical Bulletin. Forex data from Pacific Exchange Rate Service.

Unwinding Global Imbalances

As a quick follow-up to my last post, the BEA last night posted Febuary data on US international trade. There's been a marked improvement in the trade balance:



That's the lowest level in the trade deficit since November 1999. The bad news is that it's been driven by a sharp contraction in trade:




Interpreting this in light of my last post, I don't think there's any question that global trade and savings imbalances are being unwound right now and fairly rapidly, without a big adjustment in the USD (although I think that's probably still on the cards). Right now funding the deficit has fallen to an average of $1 billion a day, rather than the $1.9 billion required last year.

As to how sustainable this is, about half the reduction in y-o-y imports comes from a lower oil bill, and another sixth or so from lower imports of cars. If and when growth resumes, both these categories are likely to pick up again, so we're not out of the woods yet.

iCapital Lays An Egg

iCapital in an article in the Star today talks about the 'perception' that current global imbalances have to be unwound is wrong:

"One of the most often cited global imbalance is the high saving, low consuming Asians and the high spending, low saving Americans...According to this school of thought, the global economy is heading for a serious and protracted contraction because Americans need to save more while Asians are not spending enough...So if Americans save more, where will the global demand come from? If there is insufficient global demand, how can the export addicts of Asia expand?...So, the way to solve the current end-of-the-world contraction is for the global savings/spending imbalance to be rectified. Unfortunately, this would take years. Now you get the drift of why they think the world economy will be down and out for many years to come?...i Capital really does not buy into this argument. When this is all over, when we are over the Lehman panic, for the record, Capital Dynamics, i Capital, and its boss would want to be known as non-bear...Is there any cast-in-stone law that says the global savings/spending imbalance needs to be rectified now? Is there any rule that says Americans must save more now?"

and...

"First, the less than one billion people in the Western economies plus Japan have enjoyed much higher standards of living for a very long time, while the five billion-plus people in the rest of the world have either been in poverty or struggling for a very long time...This global imbalance should have been corrected a long time ago but it has instead persisted for a very long time despite all the aid given by the wealthy developed economies...Second, the imbalance in the perception of the developing countries by the rest of the world and the perception of the developed world by the rest of the world has existed for a very extended period too...This global imbalance in the perception of the developing countries by the rest of the world and the perception of the developed world by the rest of the world needs to be rectified but will it ever be? So do not be surprised if the global imbalance of high saving, low consuming Asians and high spending, low saving Americans persists for a while longer."

What are these guys smoking? I don't have a problem with their conclusion: capital markets are I think forming a bottom and anybody with the capital and patience to invest should find some great medium term bargains right now. But the basis for their view on the other hand is built on a house of cards. There is a real serious global imbalance, which is also right now being unwound.

Comparing the global consumption-savings imbalance to cultural perceptions is disingenuous at best; there aren't any market forces acting on those, but there are on global trade and capital flows. The US savings rate is rising, not because it was underestimated in the first place, but because Americans are actually beginning to save.

The meme iCapital is disputing is high saving, low consuming Asians; low saving, high consuming Americans - how much of this true? Going back to the national accounts identity:

Y = C + I + G + NX

where Y is income
C is consumption
I is investment
G is government deficit
and NX is net exports
In addition I = S (savings)

For a given level of income and government spending, excessive consumption and investment turns up as a negative value for the NX term, and vice versa. In short, a trade deficit indicates excess consumption and investment (or for that matter, excess government spending). The opposite is true for a trade surplus - savings in excess of consumption.

To get a finer understanding of this, it must be understood that I = savings, does not necessarily imply investment must equal domestic savings - international savings can be involved as well. Second, savings covers not just individuals, but also corporate and government savings. Third, international trade and capital flows are zero-sum; the existence of a trade deficit implies a surplus somewhere else, same with capital flows.

With that background, what's the record on the US trade deficit? (1992-2008)



And as a ratio to GDP (1992-2008):



I dare anyone to say there isn't a problem here, but that it is also beginning to reverse. Here are the countries/regions that have the largest trade surplus against the US as of January 2009:

China - 46.9%
Other Pacific Rim countries 17.4%
Canada & Mexico - 11.8%
OPEC - 9.2%
EU - 7.9%

That's pretty clear. It's actually even easier to see than that, because the US actually compiles statistics on personal income, expenditure and savings. Here's personal savings as a ratio to personal income (1947-2008):



So on that score, I think there is no question that over-consumption in the US is true and that the savings rate has been declining over time, and moreover this over-consumption was financed by savings elsewhere including Asia and the Middle East.

The real question isn't whether there will be a redressing of global imbalances, but rather to what extent and in what form it will take. A country can usually sustain an imbalance of the current account, if it is supported by fundamentals like demographics. An older population base, with a significant ratio of retirees, would generally be dissaving, thus inducing an excess of imports over exports (by that argument, Japan ought to be running a deficit - another imbalance waiting to be fixed).

But the US is not in this position. While it’s true that imbalances can and do persist over time, this crisis is likely to cause a structural change in the US relationship with the rest of the world. The shock to the consumer psyche isn't going to disappear even with the flood of liquidity in the banking system, or the massive stimulus package that's already being rolled out. An increase in the US savings rate should be taken as a given. Will it return to the level of the 1970s? Perhaps not - but a complete redressing of global imbalances doesn't require that.

The easiest way to address the US trade and capital flow imbalances is through a change in relative prices i.e. a fall in the USD or equivalently an appreciation of the currencies of trading partners. The harder, more painful way is through balance sheet adjustments i.e. deleveraging.

I think both are happening or will happen in the case of the USD, especially with the pressure on the exchange rate from monetary expansion and government borrowing. And this will cause a retreat in US imports and Asian exports. And neither is this necessarily bearish for capital markets.

Technical Note:
All trade, personal income and GDP data from the Bureau of Economic Analysis