I’ve just come back from two weeks on the road, during which time I attended a couple of conferences. The first conference (NBER International Seminar on Macroeconomics) dealt with issues of exchange rates, reserve accumulation and financial crises (more on that later). The second one, a joint Bank of Canada-ECB workshop (not online), focused on exchange rates in the global economy. At the latter, Jeff Frankel delivered the keynote speech, entitled “On Global Currency Issues”, in which he outlined what’s “out” and what’s “in” in international finance (Powerpoint presentation here). One of the phenomena he concluded was no longer relevant was “the global saving glut”.
I still wonder whether there ever was a global saving glut. In part, the question hinges on one’s view of what the nature of the glut. Was it world saving was higher then they it had been before. That patently was not true (and will be even less true as government deficits rise). Was it that saving relative to investment in East Asia and oil exporting countries was higher in the early 2000’s than in the past? That view is more defensible. Yet, it’s important to recall that current account balances are endogenous variables, determined by the interaction of saving and investment in different economies, so one can’t say without further analysis whether the US current account deficit was driven by excess supply of saving from East Asia, or excess demand for saving from the United States. And we for sure know that there was plenty of pull from the US (tax-cut induced public sector ([1] [pdf] and private sector borrowing).
The strongest evidence in favor of the global saving glut explanation, so construed, is that interest rates seemed unnaturally low at roughly the same time the US current account deficit was large. Well, what’s the evidence for that assertion?
Figure 1: Current account to GDP ratio (blue); 10 year constant maturity real interest rates, calculated by using Survey of Professional Forecasters 10 year expected inflation rates (red); and 10 year constant maturity real interest rates from TIPS yields (green). NBER defined recession dates shaded gray. Source: BEA, 2009Q1 GDP preliminary release, St. Louis Fed, Survey of Professional Forecasters, and NBER.
The correlation between real interest rates and the US current account deficit has always been something I viewed as more asserted than obvious in the actual data, and that point becomes apparent in this picture. Even if one saw the correlation for a few years in the mid-2000’s, for certain the alleged correlation has disappeared for now. The US current account has begun a headlong drive toward balance, even as long term rates remain at levels comparable to those in 2004 (if one uses TIPS). The real interest rate is even lower, if one uses expectations data to convert nominal to real rates.
I think this debate is not purely academic. As Jeff Frankel points out in his speech, the question has not been completely resolved as to why the US ran such large current account deficits since 2001. On one side are those who focus on the “push” of saving from East Asia combined with the lure of incredibly sophisticated and sound US financial markets, leading to excess risk taking and leverage in the US, which in turn induced an unsustainable boom and bust episode [2]. As I discussed in this post from January, this is essentially the view propounded by the previous Administration in the last Economic Report of the President (Chapter 2).
However, I think it at least equally plausible — especially after the revelations of the frenzy to abdicate regulatory responsibility and loosening capital requirements in the previous Administration (and the resulting attendant criminal behavior) — that “pulled in” saving from the rest of the world. So my view is that the “saving glut” was more of a typical Kindleberger type of mania, combined with the Akerlof-RoemerRomer (not Romer Paul, not David) type of “looting” behavior.
Whether we will have a recurrence of the US current account imbalance depends in part upon whether you hold the “push” view or the “pull” view. It also depends on whether, if you hew to the latter view, the Obama Administration and Congress can come to an agreement on a regulatory framework which quells the risk-taking and “looting” behavior we have seen over the previous eight years.
So the answer to the question I posed in the title: (1) the saving glut as an idea should indeed be put to rest; in fact (2) the saving glut was mostly a mirage, and the US current account deficit really was much more a function of a typical capital inflow boom driven by an unsustainable fiscal policy (as in Frieden (2006) and Chinn (2005)) and deregulatory disarmament than those much lauded “sophisticated” American securities markets; and (3) The saving glut did not “cause” the current economic and financial crisis; that is largely a result of our own policy errors on macro and regulatory policy of our own making.
However, I think it at least equally plausible — especially after the revelations of the frenzy to abdicate regulatory responsibility and loosening capital requirements in the previous Administration (and the resulting attendant criminal behavior) — that “pulled in” saving from the rest of the world.
Talk about something “more asserted than obvious in the actual data”. Repeated smug, politically-motived comments like this are why I generally ignore Menzie Chinn posts here. Hamilton’s insights and reputation carry the blog.
Anonymous: OK, I give. There was no change in SEC policy regarding leverage at investment banks, the OTS never allowed back-dating of capital levels, the Chinese caused the subprime mortgage mess, and the data plotted in Figure 1 are illusory.
By the way, if you ignore my posts, why are you commenting on something you haven’t read?
Michael Pettis has discussed this at length in his blog. There was neither push nor pull–it is like asking which came first, the chicken or the egg? It just was.
ZING!
The Economist answered this question in 2005.
Unfortunately, the article is premium content, but can be found here http://www.economist.com/finance/displaystory.cfm?story_id=E1_QNSQRJG if you have a subscription. It’s title is Savings versus Liquidity.
Using your basic IS-LM curve, they demonstate quite clearly that theoretically the “savings glut” was really a “liquidity glut.”
Some quotes from the article:
“Over the past couple of years, global saving has risen as a share of GDP, but so too has investment. By definition, global saving must equal global investment; what really matter are ex ante, desired rates of saving and investment which may have caused bond yields to decline. An alternative explanation, preferred by some economists, is that bond prices, like other asset prices, have simply been pushed up by excess liquidity (ie, yields have been pushed down).”
“The point at which the two curves intersect is the only combination of output and interest rates (ie, bond yields) where both the goods and financial markets are in balance. Too much economic commentary seems to assume that the IS curve alone (ie, the balance between saving and investment) determines bond yields. But yields also depend on the LM curve, which represents, in effect, the choice between holding money or bonds.”
“If desired saving increases relative to investment (ie, there is excess saving), the IS curve shifts to the left to IS2. Interest rates fall (to r2), and so also will output (to Y2). This does not fit the current facts: last year the world economy grew at its fastest pace for almost three decades, and this year remains well above its long-term average growth rate.”
“A loose global monetary policy shifts the LM curve to the right, to LM2. Bond yields again fall, to r3, but this time output increases. In contrast to a shift in the IS curve, the economy has instead moved along the IS curve: lower interest rates stimulate global output and hence investment. This seems to fit the facts much more comfortably.”
“As a result, over the past couple of years, global liquidity has expanded at its fastest pace for three decades. If you flood the world with money, it has to go somewhere, and some of it has gone into bonds, resulting in lower yields. Or, more strictly, bond prices have been bid up until yields are so low that people are happy to hold the increased supply of money. In its latest annual report, the Bank for International Settlements suggests that the fact that the prices of all non-monetary assets (including bonds) have risen could indeed reflect an effort by investors to get rid of excess liquidity.”
“In fact, the two theories are not mutually exclusive. Too much saving relative to investment may well have gone hand in hand with excess liquidity, ie, both the IS and LM curves have shifted downwards. Central banks’ monetary easing was, after all, partly in response to a fall in investment after share prices slumped. However, the current rapid pace of global growth suggests that excess liquidity is the prime cause of low bond yields. The snag is that central banks will eventually have to mop up the overhang of liquidity and bond yields will then rise.”
I like this last sentence in particular. Despite the Fed’s (and other central banks’ best efforts), real yields are rising even as central banks hold down rates, CPI and asset prices are dropping making real yields very high.
In the end, a yield is the price borrowers have to pay savers. Price is a signal. Low prices signal abundant supply. Unlike all other prices where price controls set below market prices create shortages, central banks can fool the market for a long time because the cost of printing money relative to its perceived value is minimal. The result is a dearth of real savings.
The savings glut was a mirage masking an increasing rate of indebtedness. The sooner governments and their central banks stop fighting market signals, the sooner the global economy can right itself.
menzie — three points:
a) first, looking only at absolute rates runs the risk of ignoring changes in the economic cycle. relative to say goldman’s model of treasury rates, 10 year treasury rates were lower than expected in the 05-early 08 period and are higher than expected now even though on absolute basis rates are lower now than then. the period when treasury rates were lower than expected does correlate loosely with a rise in savings v investment in the emerging world (bernanke would have been on better grounds if he spoke of an EM savings glut, not a global savings glut) and the surge in reserves. essentially, weak us growth and low policy rates imply that nominal rates should be way lower now in the goldman model than back in 05-06-07, when growth was stronger and policy rates were higher
b) I like the reformulation of the bad us policies argument to include bad regulation (deregulatory disarmament) as well as bad fiscal. that helps explain why the external deficit didn’t come down when the fiscal deficit did. but i am not sure us policies alone can explain why excess us demand from an unsustainable rise in consumption was saved rather than spent. To get that outcome, i would argue that you also need a set of policies outside the US in the main surplus countries, notable a policy combination in china that includes an undervalued exchange rate AND tight fiscal and tight lending curbs (both of which increased nat’l savings v investment).
c) if you plot developing asian savings v world GDP — using the imf WEO data series — there is a very sharp rise, as savings rose v developing asian GDP (driven by the rise in savings in China) and developing asian GDP increased as a share of world GDP. the increase is pretty big — especially given that the increase came even in the face of rising commodity prices that temporarily pushed up savings in the commodity exporters. I would argue that any explanation for the global flow of funds over the past few years needs to explain this rise — as it was big and clearly wasn’t a function of a fall in investment in said economies.
p.s. serious macroeconomists should invite some mere bloggers to your conferences … I would have enjoyed the NBER seminar, and while i couldn’t have contributed to the formal modeling, i suspect i could help avoid some data errors (especially when it comes to the reserves and cap flows data)! let me know if any one there had a good estimate of the dollar share of china’s reserves — or SAMA’s reserves!
Bravo, kashof! Yours is the most intelligent comment of the putative savings glut I have seen. Huge quantities of US & European bonds were bought with freshly created Yuan, Yen, et al. About half of Chinese CB purchases were unsterilized, to wit ‘printed’.
Global liquidity is what it was. All central banks including the Fed are culpable.
The global depression is a lot bigger than the Bush administration. While I can agree that Bush left a lot to be desired, Menzie, you would do a lot for your credibility by ceasing to blame all manner of evils on Bush. Indeed, the SEC made a mistake in loosening leverage ratios for inv. banks, but this was in response to European competition who already ‘enjoyed’ those ratios.
bsetser: Thanks for the comments.
(a) I concur that the argument for an East Asian saving glut is stronger than that for a global saving glut. Still, S and I are endogenous, and in my empirical work (cited in the post), I’ve tried to document the roles for fiscal policy, and financial development. I also agree that it would be better to compare rates accounting for business cycle conditions; that’s a coming paper…
(b) I agree that there’s a role for policies outside the US in determining the US CA deficit. The question is the relative blame.
(c) It’s true that commodity exporters built up big CA surpluses. One question would be how “exogenous” that commodity boom was.
Dale C.: Just because a variable is endogenous doesn’t mean that there couldn’t be exogenous shift variables. Assume CA = f(BuS, r, X), and CA* = f*(BuS*, r, Z), and CA = -CA*, then the resulting CA and r (assume X, Z, BuS, BuS* exogenous) are clearly jointly determined, but will be affected by the exogenous variables.
kashof: The Economist article is relevant; but I’m not sure the open economy version (IS-LM-BP=0 or “Mundell Fleming”) would lead to an equally convincing story. And the US CA deficit is basically an open economy macro story.
Does the Fed’s monetary policy in the early-to-mid 2000s play into the story anywhere?
Algernon: Thanks for your advice. I aspire to attain the level of credibility you have achieved.
Actually, I am happy to say that the Commodity Futures Modernization Act of 2000, and excessively lax monetary policy — events unrelated to the Bush Administration — had roles in the crisis.
David Beckworth: Yes, the excessively expansionary policy (in retrospect) combined with the absence of real interest parity meant that real rates in the US could deviate from RoW rates. Those low rates (at short maturities) were partly responsible for encouraging leveraging.
Thank God somebody is putting this thing in the ash can where it belongs.
Most discussions of it completely obscure the difference between the ideas of a global glut and a regional glut. This difference is so fundamental that it makes the rest of the discussion silly in the extreme.
isn’t the connection between low us interest rates in the early to mid 00s and the rise in the trade/ current account deficits less-than-fully obvious.
low rates encourage borrowing — and encouraged leveraging. they clearly helped get the housing bubble going.
but low rates equally can have an impact on the dollar, and by weakening the dollar, stimulate the export sector.
a priori, is there any reason to think one effect dominates?
obviously to me a big part of the story is that the second effect was short-circuited by asian dollar pegs, so dollar depreciation was limited — and the recycling of asian reserves back into the us market associated with the rise in fx intervention augmented the interest rate channel.
that doesn’t explain the rise in emerging asian saving to be sure — but it may have something to do with the initial nature of the us recovery.
Menzie, the “push” and “pull” explanations are not exclusive explanations but must be taken together, correct?
Lower capital ratios help explain why the fallout of the subprime crisis was so severe, but it does not explain why low quality loans were underwritten in the first place. I would think less regulation and lower capital ratios would encourage better underwritting standards. Perhaps the opposite occurred in the aftermath of Sarbanes Oxley, which implicitly blessed the ratings agencies.
In my opinion, Risk aversion was too low or risk was mispriced.
Hey Menzie,
Actually, I believe the BPEA Looting paper was coauthored with Paul Romer (then at Berkeley), not John Roemer (then at Davis).
Menzie,
Why doesn’t the Akerlof-Roemer “looting” behavior apply to government? If there are such people it seems that they would be much more inclined to follow the Willie Sutton formula of “robbing banks because that is where the money is.” Compared to governmnet business looting is small potatoes.
When the looters find a place in government especially in the regulatory agencies they are in Hog Heaven. Not only can they loot but they are the only enforcers so they are either never caught or if caught by some external watch dog they only receive a tap on the wrist.
Can you say Franklin Raines?!!!!
Then there is the issue of incompetent regulators http://www.youtube.com/watch?v=cJqM2tFOxLQ but then that is another issue.
Jamus: You are right! I was thinking about differentiating between David and Paul. Fixed now.
This is an EXCELLENT blog :
http://newsfrom1930.blogspot.com/
Guess, even better than CR.
To expand :
Further news from 1930 just in – the Labour Prime Minister Ramsey MacDonald has stated he is the right man for the job of leading Britain out of recession which was created in the USA; in Europe, Herr Hitler of the National Socialist Party of Germany has urged for greater European political union, stating that even where nations are opposed to the concept he has ways of persuading them otherwise.
If the US government were to peg the dollar to the Euro and promise to pay US exporters, say, $8.2 for every Euro they brought in, we’d probably build up a large trade surplus with Europe fairly quickly (except for the fact that that would also make the yuan:Euro rate about 56:1, so China would get all the business — but let’s assume for argument that they’re not there). From a European viewpoint, the resulting avalanche of Euros the US government would have to recycle back to Europe would appear there as a savings glut.
Sorry jm but your scenario is nonsense unless the central bank was to accomodate the foolishness.
“(a) I concur that the argument for an East Asian saving glut is stronger than that for a global saving glut. Still, S and I are endogenous, …”
Currency interventions appear to have reinforced savings in China well beyond the market solution. In Japan, implicit threats of currency intervention played the same role by spurring the yen carry trade. In my opinion, Asian currency policies played a very important role in U.S. asset overvaluations.
to make jm’s scenario work (Based on china’s example)
the central bank would need to sterilize the reserve growth
fiscal policy would need to be tightened (helping to offset the surge in exports/ large contribution to net exports to growth)
the banks would need to accept curbs on their loan growth, pushing their loan to deposit ratio down.
And Americans would have to hold their assets in the banking system (in usd), in part because they expected the dollar to appreciate over time (Though the government would reinforce that incentive with capital controls … )
bsetser wrote
“low rates encourage borrowing — and encouraged leveraging. they clearly helped get the housing bubble going.
but low rates equally can have an impact on the dollar, and by weakening the dollar, stimulate the export sector.
a priori, is there any reason to think one effect dominates?”
US loose money policy required the Asian central banks to have to inflate more vigorously (or save more extremely as y’all seem to prefer) in order to cheapen their currencies. The US in effect exported its loose monetary policy but with the interesting twist that Asians disproportionately bought 10yr Treasuries, guiding their inflating toward our housing market.
Brad:
“to make jm’s scenario work (Based on china’s example)
the central bank would need to sterilize the reserve growth
fiscal policy would need to be tightened (helping to offset the surge in exports/ large contribution to net exports to growth)
And Americans would have to hold their assets in the banking system (in usd), in part because they expected the dollar to appreciate over time (Though the government would reinforce that incentive with capital controls … )”
Not sure this wouldn’t work quite well right about now, with the exception of dynamic effects when Europe crumpled under the pressure.
With high unemployment, there may be little need to offset the effect of greater export demand, nor would the Fed need to sterilize reserve growth in a liquidity trap. And Americans appear now to have excess desired saving, so they may well be happy to hold more in banks.
In fact, a much milder version of jm’s scenario appears to be what Ben B is trying to accomplish, but Europe is simply not big enough to carry the strain, especially since to pull up the U.S., it has to pull up China as well, as the renminbi is firmly locked to the dollar.
You don’t mention the obvious: liquidity creation by the Fed, steadily drained by the Chinese government exchange-rate peg.
No real savings at all by anyone.
The explanation is more along the lines of Menzies fraud. There was a classic overextension of credit to the US bubble. But is has new features. these include
1. Securitization of asset backed (ABS), where the accounting is massively wrong.
2. Abuse of insurance type “guarantees” including CDS and Fannie and Freddie.
China and asia are not the only ones funding the US. Look also at the funders who lost their shirts this time. Europe and their banks especially, that bought assorted ABS and US equities that crashed. China has lost very little so far. Nor will they so long as we pony up for Fannie and Freddie. They are insolvent to about $6-700 billion.
In fact the US has been foreign financing, burning its foreign creditors and dissapearing portions of its liabilities for a long time. I will cite the dot-com bust and the property bust of the 80s.
Is it necessary to the global system? Hodge’s Iron Law of international finance is the big creditors always lose money in the end. This has been true for at least the three centuries there has been major international finance. Its a law because low returns force the investors out into foreign areas they know less about. Its an iron law because if they get lucky for a while, the surplus countries earn too much. The system gets even more out of balance.
As far as savings glut narrowly defined, there is no better statement then from the economist as quoted above
The Economist’s static analysis is limited, it seems to me. For example, what about the dynamic interactions between foreign income growth, foreign saving, U.S. asset values and housing investment demand? A virtuous (for awhile) cycle, beginning with forced saving to maintain an undervalued currency, leading to income and saving growth in a high-saving economy, leading to asset overvaluations that kept up aggregate demand in the borrowing countries. (This was the era where people worried about China becoming reluctant to lend to the U.S. and what this would do to mortgage rates and hence U.S. demand and income.) The Fed-generated liquidity can even be called endogenous, enabled and encouraged to some degree by low-inflation and the weak response in aggregate demand caused by the currency misalignments and resultant current account deficits.
There are numerous “pull” and “push” factors creating the Asian savings glut and Western borrowing glut. They all complement and support each other. Sorry, but only an academic would argue whether this is a case of “push” or “pull”; it’s obviously both.
One very important “push” factor is Asian protectionism. The US and Europe accepted unbalanced trade terms with most of Asia, especially China, in order to encourage Asian countries to open up to foreign investment and some amount of western imports. This happened partly because of Asian traditions (especially in China), and partly because Americans and Europeans had more capital and thus were relatively more interested in terms for their foreign investments than in terms for their export markets.
The recent collapse of global trade has wiped out most of the traditional Asian trade surplus, without which there is not much of an Asian savings glut to speak of at the moment. However the US is doing its utmost to get back to the status quo ante, urging China to continue accumulating US Treasuries in order to fund US “stimulus” spending and support US imports from Asia.
But I have a hard time understanding what would motivate China to continue accumulating savings. It already can’t spend its current savings without disrupting the global financial system. China’s recent stockpiling of commodities and burst of political infrastructure spending (which consumes lots of imported commodities) are alternative ways to spend/reduce their trade surplus. Free trade would be better for everybody, but I doubt the Chinese will ever see it that way, and there’s no will in the US to press them.
Tom: When everything matters, and everything complements each other, then there are no “causal factors” in the world. I’m not denying there’s interaction, but there need to be some exogenous factors that drive, for instance saving and investment. If that’s difficult for you, then think in a supply and demand framework, there are weather and income as shift variables.
‘But I have a hard time understanding what would motivate China to continue accumulating savings.’
The same thing that motivated competitive currency devaluations in GD1 – keep the currency undervalued in order to export unemployment. In a world where income is demand-constrained, it can pay to produce goods to be dumped in the ocean.
China’s commodity stockpiling can be viewed as a strategy similar to currency purchases – it spurs exports and impedes imports of manufactured goods by depressing the value of the local currency. Consider: buying gold is similar in effect to buying foreign currency reserves.
As I have said many times before (and as I was delighted to see PK also say, finally), borrowing from abroad to fund stimulus is completely counterproductive, as any stimulus from the U.S. deficit spending is entirely dissipated through the current account deficit. The U.S. has excess desired saving right now, and does not need foreign help to fund its deficit spending. But you’re right – Hillarious and Timmy seem oblivious to this fact. I rather think their positions come from a desire to help the U.S. bank holding companies, rather than U.S. employment.
Menzie agrees with Bernanke and most other economists – ” it’s important to recall that current account balances are endogenous variables, determined by the interaction of saving and investment in different economies”.
I would like to advance the argument that this assumption is in considerable part responsible for the difficulty of understanding the interdependence between the current account deficit and finanical flows.
I my view, both the trade balance and investment are exogeneous variables in the equation Savings = Investment + Trade Balance. Savings is an endogeneous variable in that equation. The trade balance is exogeneous in that its level is determined by supply and demand considerations all over the world any time foreign goods are sold anywhere. The level of the U.S. trade deficit creates financial flows out of the U.S. and a returning flow (formerly called the Capital Account). The outward flow reduces the level of Net International Investment Account in the U.S. The inward flow does not because it is balance by an outward flow of finanical assets, thus no change in the net financial position of U.
S. relative to other countries.
The equation Savings = Investment + Trade Balance can be deduced from the formula for calcuating Gross Domestic Product. Savings is total output (GDP) not consumed. Subtracting Consumption (public and private) from GDP equals both Savings and Investment + Trade Balance.
The two variables in this formulation that are derived from other variables in the equation are GDP and Savings. Thus, GDP and Savings are endogenous variables in this equation.
Investment and the trade balance are both created by ordinary market forces that exist outside the other variables in this equation, thus they are exogeneous.
I don’t care how many economist agree that The trade balance and Investment are endogeneous variable, they are not endogenoeous variables in the relevant equation (Savings = Investment + Trade Balance).
Beginning with a correct view of causation would help the discussion.
Menzie says: “When everything matters, and everything complements each other, then there are no “causal factors” in the world. I’m not denying there’s interaction, but there need to be some exogenous factors that drive, for instance saving and investment.”
In my understanding of the mneaning of words, “exogenous factors that drive” other variables are causal influences. Either we have causal influences or we do not. I agree with Menzie that westerners think in terms of factors that drive other variables (part of the genius of Western thinking that advanced science). But I deny him to luxury of naming that something other than a causal assumption.
Our problem is that causal factors are usual multiple and we (including me) tend to think in terms of single causes.
So, what are the strongest causal influences in a given complex situation?
This is all interesting and I enjoy trying to understand what all you smart people are trying to explain.
So here’s a simple view from a New England farmer.
China made a lot of money exporting just about everything and did so without having to worry too much about paying labor all that well. What to do with all that money?
Buy something safe: US Treasuries. When there’s a lot of anything floating around, you don’t pay too much to get it. If you were the Fed, would you pay more? US interest rates could and did stay “low.” And because that’s the dollar stuff, it pretty much allowed rates everywhere to stay low, not just in the US.
Problem, or if you’re a Wall Street salesman, opportunity. Savers would sure like to get a higher rate of return. And just what crowd is right there to provide it: our Wall Street “innovators.”
Enter stage right, big, big asset backed derivative market. Promising credit manna: Constant income payments, secure return of principal.
OK, so Wall Street lied just a little. It’s happened before, I believe.
Asset prices roll over, enter stage left, Great Recession. Particularly in the US and Europe where bankers couldn’t clear their own balance sheets fast enough of the crap they were selling. Sort of like getting stuck with a car lot full of Hummers.
So, the savings “glut” was regional (primarily, oil is scattered about) but it’s interest rate effect was global.
The glut came first. And it had been building up for more than a decade.
Re: “When everything matters, and everything complements each other, then there are no “causal factors” in the world”
There’s no reason to take what I said to such an impossible extreme. The fact that the number of causal factors is finite does not mean that the existence of “push” factors precludes the existence of “pull” factors, or vice versa. The stereotype of academics tearing down each others’ theories, when actually both are right and complementary, did not develop out of nowhere. But we’re getting off topic.
Back on the topic, don is right: China’s accumulation of Treasuries has been closely linked to one of the mechanisms China uses to suppress imports: obliging exporters to exchange their hard currency income into yuan, restricting the exchange market to suppress demand for hard currency, and then buying up a large part of the hard currency income at artificially low rates.
But step back from the mechanisms and look at the big picture: Most of the major Asian countries, especially China, are traditionally protectionist. To grossly generalize, the West has tolerated Asian protectionism and agreed to Asian-biased terms of trade, hoping that the imbalances would eventually straighten themselves out as Asian economies developed and became more consumer-oriented. But, overall, they didn’t straighten themselves out; instead, the situation came to be regarded as normal and/or untouchable, and huge imbalances developed in global trade, savings and debt, which on one hand are very dangerous for global economic stability, and on the other hand are very powerfully self-perpetuating. The housing and commodity bubbles were just symptoms; the underlying imbalances were the causes.
This recession is market forces’ attempt to self-correct those imbalances. But with the US and Chinese governments so strongly resisting, the self-correction could take a very long time to work through.
Tom says “the West” has tolerated Asian protectionism in the hopes that the imbalances would eventually straighten themselves out”.
Many supporters of free trade ideology have advanced this hope in the past.
However, a strict constructionist of the master (Adam Smith) would argue that trade deficits don’t matter. Since the master has spoken, no need to worry more about the matter.
I think the cold war was the reason for the U.S. tolerating Protectionism on the part of Japan. Then ideology swamped thought, all economist agreed that free trade was the ideal trade policy and the U.S. remained trapped in a 1960’s time warp.
The economics profession has much to brag about in its initial support for free trade (when large trade deficits were non-existent) but much to apologize for when trade deficits became so large in the richest country in the world and they refused to reexamine the committment to free trade.
I like Tom’s view that this recession is market forces’ attempt to self-correct the imbalances. If U.S. officials had smarts they would figure out a way to insure that the imbalances stay corrected, do not reappear, as a consequence of the stimuli applied.
Ray – Yes, speaking mainly here about the US, the defenders of tolerance of Asian protectionism have managed to create the popular impression that they are on the side of “free trade” and that anybody who challenges the tolerance is an opponent of free trade.
Of course, some of those who challlenge the tolerance are opponents of free trade: they want the US to be protectionist as well. But if you actually listen to what a lot of Americans who are speaking up about unfair trade are saying, you will find that a lot of them are not protectionist at all. Most of them are genuinely upset that while they face competition from Asian goods in their domestic market, their own products are hardly allowed into Asia. They’re right. If it’s not fixed the US will stagnate.