This week we saw increased attacks on surplus countries, like China. These attacks typically criticize their excess saving i.e. their saving in excess of investment.
Shang-Jin Wei, of Columbia Business School, recently summed up this thinking when he said that:
When national savings exceeds investment, the excess savings shows up in China’s current account surplus.
This whole idea goes back to a 2005 Ben Bernanke speech, in which he blamed a “global saving glut” for America's current account deficit. That was a costly mistake and we are still paying for it.
In truth, there is no such thing as a saving glut. It's a myth, and this myth leads us to misdiagnose our problems. By obsessing about excess Chinese saving, we miss the real causality and the real problems we need to deal with.
To identify the real problems, we need to start with the fact that only investment can create saving. If you haven't heard that before, it sounds counter-intuitive at first, but it's simple to understand. Think about it this way:
All spending is either for consumption or investment. In both cases, the seller receives income and so immediately saves, because saving is income not consumed. What happens to the buyer, depends on what the spending is for. If it's for consumption, then the buyer dis-saves, because they have reduced their income not consumed. This means that there is no net change in saving between the buyer and seller.
Alternatively, if the spending is for investment, then the buyer is not consuming, so no dis-saving takes place. The net result is that the buyer records an increase in investment and the seller records an equal increase in saving.
This means that, summed up across the world, saving will always equal investment. There is no global saving glut because there never can be. Saving is created by investment. Total saving must equal total investment.
One implication of this, is that attempts to increase net saving without investment, are doomed to failure. One individual's attempt to save, will necessarily result in dis-saving elsewhere. You can get a fuller explanation of this here and in more detail here.
This means that our mental picture of the Chinese, diligently achieving an increase in saving, is false. It is impossible for them to achieve an increase in saving, simply by limiting their consumption. In fact, it is impossible for any country to achieve excess saving by their own efforts. The only way it can be done, is via the actions of other nations. Specifically, it needs another country, such as the US, that is willing to run a trade deficit.
We can see this better, by looking at sector balances. Much of the thinking on sector balances originated from the Levy institute and is being developed by other economists, including some of those mentioned by Edward Harrison on Seeking Alpha.
The key sector identity that helps us here is:
(S – I) + (T – G) = (X – M)
Private sector surplus + Government surplus = Trade surplus
This shows that investment [I] will create an equal amount of private saving [S], but that saving can then be reduced by taxes [T], added to by government spending [G], or moved between countries via exports [X] and imports [M].
As this identity shows, only a trade surplus can result in net saving at the national level. Only a trade surplus will mean that the sum of the private and public sector surpluses, will be greater than zero. This is what China has achieved and is the source of their high savings rate.
It is also the opposite of what we have done and is the cause of so much of our pain. We have run a trade deficit, which has channeled our savings out of the country and into China. We tend to think that high Chinese savings, are created through Chinese efforts to save. That is false. Those savings were created by us! They were created by our domestic investment. The problem is that we have subsequently taken those savings and sent them to China, in exchange for TVs and sneakers.
This analysis suggests that we won't get very far by asking Chinese citizens to lower their savings ratio, and the data backs that up. Most of the surge in Chinese savings, is in corporate, rather than personal saving. As exports have surged, wages haven't kept pace with revenues, so corporate saving has increased dramatically. Corporate saving raced up from about 15% of GDP a decade ago, to over 25%.
Because wages haven't kept up with corporate profits, household consumption has fallen in relative terms. It's down to about 35% of GDP from 45%, but this is only a relative fall. Consumer spending has accelerated about as fast as it can, given the constraints on wages. It's growing at a rate of about 8%, which is something US consumers can only dream of.
The problem is not excess Chinese saving. That is a symptom not a cause. Their saving is not the result of a decision to save, it's the result of a very successful trade strategy, which sucks saving out of deficit nations like the US. To resolve our problems, we need to focus on trade, not saving.
Finally we are starting to see some action on this. Now we need to see some results. Long term, the results can only mean one thing, the yuan (CYB) will increase in value. For the US, that will be helpful but insufficient. We will only resolve our problems by closing the trade deficit, of which Chinese trade is only a part. That means that we will either see a revolution in US competitiveness, or more likely, a long term decline in the dollar.
In the long run, emerging market stocks, gold and precious metals will gain against the dollar, while Treasuries and other dollar based assets, will see real declines.
Disclosure: Author is long emerging market stocks and precious metals. He is also long, but underweight, Treasuries