Wednesday, September 12, 2007

Again with the "savings glut"?

I'm sure by now you've seen or heard Ben Bernanke's latest references to the global "savings glut", the phenomenon that is supposedly responsible for the fabulous demand for U.S. debt and low interest rates.

For those who are in the dark, here's a quick refresher, courtesy of Bloomberg:

Federal Reserve Chairman Ben S. Bernanke said the ``global saving glut'' is still helping to keep interest rates low, and they may not rise much in the event that the pool of excess capital dwindles in coming decades.

While theory suggests that yields, adjusted for inflation, would rise as saving diminishes, ``factors other than the saving- investment balance affect long-term interest rates,'' Bernanke said in a speech in Berlin. ``We are again reminded of the need to maintain appropriate humility in forecasting.''

Nations such as China have invested the proceeds of trade surpluses in U.S. Treasuries, driving yields lower. China has a record $1.3 trillion of foreign-exchange reserves and household savings that amount to almost one-fifth of its economy. Investors abroad hold half of Treasuries outstanding, helping drive benchmark 10-year note yields down to 4.37 percent on average in the past five years, from 6.82 percent in the 1990s.

The theory of a global savings glut was first put forward by Bernanke in a March 2005 speech, which highlighted the shift that turned developing economies from "borrowers on international capital to large net lenders". Consequently, these now prospering nations were said to be holding down longer term interest rates through their outsized demand for U.S. government debt.

This line of reasoning led many to believe that interest rates were low because the global pool of savings was "too large".

But as I pointed it out in a previous article, due to the rampant increases of money and credit supply worldwide, the "savings glut" might more accurately be characterized as a liquidity glut.

Over the past few years, the money supply in most leading nations has increased every single year at a consistent, double-digit pace.

At the same time, leverage created through the financial system increased the availability of money substitutes and created an environment of greater liquidity and enhanced market participants' appetite for risk.

If there's been a glut of anything over the past decade, it's been cheap fiat money, much of it exchanged by the US for foreign bought goods. It works the same way anywhere across the globe; someone prints currency, puts it into circulation, then exchanges that money for goods and services at home and abroad.

All that money has to go somewhere, and this is how it works:

So, in the US recently, the money supply is growing at over 10% per year; in Europe the money supply is growing between 11 and 12% on an annualized basis; and in China the money supply is growing at an annual rate of 18%. So, there are a lot of people saying, “there’s just a glut of savings.”

Well, typically what happens is that through the US trade deficit, we buy goods from foreigners, say Chinese or Japanese, we pay them in dollars, those dollars get deposited in banks in Japan and China. They get converted into their local currency, either Japanese yen or the yuan. What will happen is central banks will come in and mop up those dollars because they don’t want their currencies going down, and then what they’ll do is turn around and sell their own currency and buy, let’s say, US Treasuries.

This idea of a savings glut, put forth by Ben Bernanke and endorsed by then Fed Chairman Alan Greenspan in 2005, is beginning to sound like the Fed's "big lie". Repeated often enough, it just may take on the appearance of truth to many observers.

Please read on for more commentary on this issue, from people who are far more knowledgeable than I am.

1. "Is There a Glut of Saving?" - Frank Shostak.

2. "The Fed's Wild Imagination" - Dr. Kurt Richebacher

3. FSN Big Picture 12-17-05 - Jim Puplava and John Loeffler discuss global money supply and the global "printing glut".