The Global Savings Glut revisited
What’s at stake
A large part of the exercise during the recent Ministerial G20 and the discussion on macro policy coordination and global imbalances was to put enough pressure on China to move on the exchange rate without upsetting it enough to cripple other policy coordination outcomes. Hence a number of the touchy issues are avoided, circumvented or presented in way to distract from the actual problem. In the meantime, Fed Chairman Ben Bernanke presented a new paper on the role of the role of global imbalances in the run-up to the crisis. Noteworthy are also two recent policy reports, inspired by the Bernanke thesis, which put forward proposals for reducing the demand and increasing the supply of safe assets.
The policy context: G20 finance ministers and the imbalances toolkit
On February 19, the G-20 finance ministers and central bank governors met in Paris in a difficult economic context which continues to see increasing divergence as the IMF outlined ahead of the meeting. The agreement reached in Paris lays out a list of indicators that will be monitored to judge the progress made by member countries in reducing imbalances. The indicators include public and private debt levels, private savings rates and trade balances. Reserves, current accounts and exchanges rates have been removed from the list of potential first level indicators to assess imbalances.The ministers agreed as well to devise “guidelines” (not targets) for each indicator against which this progress can be measured. These guidelines are supposed to be formalized by the next Ministerial G-20 in April.
Michael Schuman writes that getting this agreement was the diplomatic equivalent of having your wisdom teeth pulled out. The agreement conspicuously fudged the matter of exchange rates. But eventually, Beijing's negotiators accepted a compromise. The result is a sentence in the communiqué that no high school English teacher would allow on a mid-term exam: “While not targets, these indicative guidelines will be used to
assess the following indicators: (i) public debt and fiscal deficits; and private savings rate and private debt (ii) and the external imbalance composed of the trade balance and net investment income flows and transfers, taking due consideration of exchange rate, fiscal, monetary and other policies.”
Olivier Blanchard presented back in an August post the modus operandi and the outlook for the Mutual Assessment Process. It appears that nothing much has been achieved since. If anything, the list of indicators to measure imbalances has shrunk which is likely to make policy coordination more difficult to assess and to improve. Yves Tiberghien argues in Telos that this small victory is essential as it defuses the Sino-American tension around the renminbi and makes it possible to open the play on the other essential subjects of G20 in 2011: financial and agricultural systemic risk management, review of the system international currency, and standards on controls of capital.
Masaki Shirakawa - Governor of the BoJ – gives some backing to the inappropriateness of the current account as a comprehensive measure of external imbalances. He argues that the current account may have been an indicator of “imbalances”, but does not provide sufficiently granular information to make an effective assessment. He recalls the Japanese experience of the 1980s which led to the Plaza Accord (one of the first global policy coordination effort) and concludes that the policy mix agreed to by Japan in the interest of global policy coordination in the late 1980s delivered and asset bubble of the worse kind which eventually led to the Japanese crisis of the 1990s making a good case for the inappropriateness of what appeared to be then a fairly effective global policy coordination initiative.
Bernanke’s global savings glut hypothesis, part 2
Chairman Bernanke gave a speech at the Banque de France where he presented his most recent work in global imbalances (Full paper here) where he develops upon his original work from 2005 on the savings gluts hypothesis. He nuances the language such that the blame for the crisis is no to be put exclusively on the inflows from surplus countries themselves but also on the breakdown in U.S. financial intermediation due to the poor performance of the financial system and financial regulation in the US. Sources of poor performance included misaligned incentives in mortgage origination, underwriting, and securitization; risk-management deficiencies among financial institutions; conflicts of interest at credit rating agencies; weaknesses in the capitalization and incentive structures of the government-sponsored enterprises; gaps and weaknesses in the financial regulatory structure; and supervisory failures.
Free Exchange notes that Bernanke seems to have modified his tune about the “global savings glut” generated in Asia that supposedly kept American long-term interest rates unnaturally low and helped to propagate reckless mortgage lending. The Fed chief now acknowledges the extent to which Europe – despite not running a current-account surplus – nonetheless gobbled up loads of duff American asset-backed securities by borrowing and thus leveraging up its international balance sheet. Bernanke writes that “European investors appear to have targeted a portfolio that was riskier than that held by the surplus countries and, indeed, broadly similar to the mix of U.S. securities outstanding.” FT Alphaville notes that what this meant, of course, (although it’s not a point that Mr Bernanke is trying to make) is that when the music stopped the Europeans lost out massively on their AAA-rated US assets while the Asian central banks did just fine.
Mark Schieritz writes in Herdentrieb that Europe was basically a giant hedge fund. Real Time Economics notes that Europe had a balanced current account and thus had to borrow large amounts of dollars to fund its purchases of U.S. securities. This borrowing would prove highly problematic for them during the crisis, and led the Fed to develop swap programs with central banks abroad to help get needed dollars into the hands of foreign banks.
Bernanke smack down
Naked Capitalism as well as Calculated Risk argue that Bernanke’s obsession with the savings gluts hypothesis only serves the purpose of shifting blame to China and to a lesser extent to regulatory failures but not on the US monetary policy as a contributor to global imbalances.
Macro and Market Musing challenges the revised savings gluts hypothesis: (i) First, some of the excess saving coming from the emerging economies was simply recycled U.S. monetary policy (a point which Janet Yellen has made recently upon returning from Asia), (ii) Second, the Fed itself create some of the increased demand for safe assets by pushing short-term interest rates super low and promising to hold them there for a "considerable period”, (iii) Third, the savings glut hypothesis doesn’t fit the data after 2005 (how is it that the saving glut could fuel low rates in the early-to-mid 2000s but not thereafter as shown by the behaviour of the 30-year mortgage rate which stabilizes in 2004 and starts increasing in 2005?), (iv) the U.S. economy wasn’t a slave to the emerging economies during the early-to-mid 2000s and could have responded by a tighter policy mix to this wall of emerging economies’ savings.
Reducing the demand for safe assets and increasing the supply of safe assets
Twenty-Cent Paradigms argues that there are some important closely related issues that Bernanke did not touch on this time. In particular, the demand for US assets was partly due to the fact that the dollar is the most widely used "reserve currency". This periodically generates complaints from the rest of the world (and for the US, its a mixed blessing), but Bernanke did not point to any alternative. Nor did he suggest that it gives the US any special responsibility. Also, one significant motive for reserve accumulation is self-insurance. A better international insurance mechanism would reduce that need. In theory, that is part of what the IMF is supposed to provide.
Pierre-Olivier Gourinchas, Emmanuel Fahri and Helene Rey present a series of proposals to decrease the demand and increase the supply of safe assets in a recent report. On the supply side, they recommend developing alternatives to U.S. Treasuries as the privileged reserve asset, so as to accelerate the inevitable transition toward a multipolar system. In particular, they recommend the issuance of mutually guaranteed European bonds. On the demand side, they recommend making permanent the temporary bilateral swap agreements that were put in place between central banks during the crisis; strengthening and expanding the IMF facilities as well as expanding the IMF’s existing financing mechanisms; and establishing a foreign exchange reserve pooling mechanism with the IMF that will provide participating countries with more liquidity and, incidentally, allow reserves to be recycled in the financing of productive investments.
Michel Camdessus, Alexandre Lamfalussy, and the late Tommaso Padoa-Schioppa assembled a group 18 thinkers from 15 countries to lay out a cooperative approach to reform the IMS for the 21st century. As noted by Edwin Truman, the report also recognizes that the IMF has an important role to play in this area of global liquidity. In light of the experience of the recent crisis, further steps should be taken to make the IMF more akin to a global lender of last resort ready to act in a reliable, rules-based fashion, and with appropriate protections to limit moral hazard. This would provide the membership with a stronger financial safety net at a lower cost for the countries and for the system itself than through reserve accumulation. On the supply side, and contrary to the Gourinchas-Fahri-Rey report, the authors consider that it might be useful to re-explore the potential role the SDR may have in addressing some of the new needs that arise in a multi-polar world, e.g. demand for a complementary reserve asset or for an international numeraire not directly affected by the domestic policies of one economy.
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