By Doug Noland
Credit Bubble Bulletin: Revisiting the Global Savings Glut Thesis
“Why is the United States, with the world’s largest economy, borrowing heavily on international capital markets–rather than lending, as would seem more natural? What implications do the U.S. current account deficit and our consequent reliance on foreign credit have for economic performance in the United States and in our trading partners? What policies, if any, should be used to address this situation? In my remarks today I will offer some tentative answers to these questions. My answers will be somewhat unconventional in that I will take issue with the common view that the recent deterioration in the U.S. current account primarily reflects economic policies and other economic developments within the United States itself. Although domestic developments have certainly played a role, I will argue that a satisfying explanation of the recent upward climb of the U.S. current account deficit requires a global perspective that more fully takes into account events outside the United States. To be more specific, I will argue that over the past decade a combination of diverse forces has created a significant increase in the global supply of saving–a global saving glut–which helps to explain both the increase in the U.S. current account deficit and the relatively low level of long-term real interest rates in the world today. …As I will discuss, an important source of the global saving glut has been a remarkable reversal in the flows of credit to developing and emerging-market economies, a shift that has transformed those economies from borrowers on international capital markets to large net lenders. To be clear, in locating the principal causes of the U.S. current account deficit outside the country’s borders, I am not making a value judgment about the behavior of either U.S. or foreign residents or their governments.” Federal Reserve governor Ben Bernanke, “The Global Saving Glut and the U.S. Current Account Deficit,” April 14, 2005
I was flabbergasted back in 2005 with Dr. Bernanke’s “global savings glut” thesis. At that time mortgage Credit was in the process of expanding a still all-time annual record $1.436 TN. National home prices (Case-Shiller) were up better than 14% year-over-year. The California housing Bubble was coming completely unhinged. Nationally, household mortgage Credit was expanding at double-digit rates for the fifth straight year, as a powerful inflationary psychology took hold in U.S. housing markets and throughout mortgage finance. Moreover, overall system Credit continued to expand rapidly following 2004’s 9.2% growth (strongest since 1988). At 2.75%, the Fed funds rate was ridiculously low in comparison to rapidly inflating home prices and generally rising securities and asset prices.
I had a difficult time accepting that Bernanke actually believed that emerging markets were playing such a primary financing role in the U.S. markets and economy. The Fed was in the midst of experimental reflationary policies, and I just assumed the “global savings glut” thesis was sophisticated rationalization and justification (reminiscent of Greenspan’s new paradigm productivity and rising speed limit rationale). Clearly, the Fed was headstrong to avoid tightening Credit even in the face of conspicuous mortgage excess, fearing that it might pull the rug out from under system reflation.
For a long time now, I’ve viewed the unique backdrop in the context of a historic multifaceted Experiment in: 1) Unconstrained global “money” and (market-based) Credit; 2) Unconventional economic structure; and 3) Activist/inflationist monetary management on a coordinated global basis.
There was no doubt in my mind that unfettered finance would foment market and economic instability. Indeed, evidence of global financial dysfunction has been on full display now for well over two decades. As custodian of the world’s reserve currency and champion of financial innovation, the U.S. has all along been the global leader with respect to Credit excess, speculation and monetary management. The financialization of the global economy has been integral to the U.S.’s unique capacity to run persistently large trade and Current Account Deficits.
Why not de-industrialize and instead use new financial claims in exchange for imported manufactured goods? The experiment in a services and consumption economic structure then took on a life of its own, fueled first by Wall Street finance and then by government debt and central bank Credit.
Unfettered global “money” and Credit coupled with a world flooded with U.S. financial claims (largely IOUs) was a recipe for extreme financial instability. Never did I imagine such an experiment could be sustained for so long. I simply did not contemplate the extent to which central bankers would be willing to underpin unsound global finance.
It’s not as if this great Experiment hasn’t been at the brink a few times: 1997, 1998, 2002, 2008, 2012 and early-2016. At this point, markets are understandably convinced that central bankers have no alternative than to always come immediately to the rescue.
Granted, QE retains the capacity to incite speculation and levitate markets. Yet monetary inflation’s myriad effects on societies and democracies are at this point progressively – and openly – corrosive. Rising anti-establishment sentiment and anti-globalization movements reflect mounting frustration with the existing world order. I believe the Brexit and Trump movements are indicative of the unfolding failure of this Global Experiment. I had assumed that the Experiment’s downfall would be marked by a crisis of unstable markets. At this time, the world is at monumental crossroads in terms of social, political, market and economic instability.
November 21 – Wall Street Journal (William Mauldin and David Luhnow): “Rather than kill Nafta, Donald Trump and his advisers appear set to push for substantial changes to the treaty governing U.S. trade with Mexico and Canada, an effort that could prove difficult to negotiate and perilous to the regional economy. The president-elect vilified the North American Free Trade Agreement during the campaign and threatened to pull the U.S. out of the trade deal—but only if Mexico doesn’t agree to substantial modifications. The U.S. trade deficit with Mexico rose 9.5% in 2015 to $60.7 billion, while the deficit with Canada fell 57% to $15.5 billion. Mr. Trump hasn’t released a blueprint for his new vision of Nafta, but his comments and those of his advisers suggest they want big changes. Among the likeliest would be special tariffs or other barriers to reduce the U.S. trade deficit with Mexico and new taxes that would hit U.S. firms that moved production there, according to Trump advisers.”
The Trump campaign was built upon a platform of economic nationalism and the imperative of major change. Trade deals must be canceled or significantly revamped. Jobs and manufacturing must be brought back to the U.S. America must come first to be great again. In the view of Trump and his advisors, The Experiment has clearly failed. Donald Trump often referred to the “Bubble.” He lashed out at Federal Reserve policymaking and the massive U.S. debt. With indices sprinting to record highs, it’s the nature of markets to forget why the Trump campaign received scant support from the business community and was viewed with contempt by Wall Street (and global markets).
James Carville famously quipped back in 1993: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”
In his acceptance speech, President-elect Trump avoided slamming Yellen, the Federal Reserve or deficit spending. Bypassing confrontation, he chose instead to trumpet a revitalizing $1.0 TN infrastructure spending program. Such a priority undertaking would require close cooperation, both from the Federal Reserve and the financial markets. Détente. Wasting no time, markets immediately relegated Trump’s focus on trade and the displaced American worker to the realm of campaign bluster. No need for antipathy or fear – not with markets retaining firm control. Better yet, if the Trump administration seeks a successful Presidency, all roads must pass through all-powerful Wall Street. Incredibly, surging U.S. markets stirred the imagery of Ronald Reagan.
The general election presented an epic battle between deeply conflicting perceptions of reality. One sect held a more constructive view of a generally sound economic backdrop. With Washington’s assistance and commanding oversight, things were under control and on a definite uptrend. The opposing view held that it was all largely a mirage: the economy and markets were a Bubble illusion. Underpinnings (financial, economic, social and geopolitical) were disturbingly unsound, a product of years of gross Washington mismanagement. Only radical change would reverse our nation’s accelerating downfall.
U.S. markets have thus far been content to focus on prospects for financial deregulation, lower corporate taxes and infrastructure spending. Comforting and not so radical, no doubt. Yet the bedrock of the Trump movement is about putting American jobs and manufacturing first. And only radical change in trade relationships (and global finance?) will reverse the (experimental) course that has placed our economy, finances and society in peril. Begin immediately with TPP and NAFTA – then move on to China and Asia.
There’s a huge issue: The world – economy as well as financial “system” – is addicted to enormous U.S. Current Account Deficits. America has for two decades simultaneously flooded the global economy with purchasing power and international markets with cheap liquidity. Over years the upshot has been massive overinvestment in manufacturing capacity and incessant global financial instability. Central banks then moved to mitigate this troubling backdrop with a now protracted period of unprecedented reflationary measures. This only accommodated greater economic maladjustment and financial excess – while deepening global addictions.
From my analytical framework, it was never “the chicken or the egg” issue. It was loose monetary policies, financial excesses and associated U.S. Current Account Deficits that were the core of the so-called “global savings glut.” U.S. trade deficits ensured massive financial flows abroad, especially to rapidly growing China, Asia and EM. These dollar balances were then recycled right back to U.S. securities markets, in large part through EM central bank purchases of Treasuries and agency securities.
Moreover, EM, flush with dollar reserves and booming economies, enjoyed a self-reinforcing and destabilizing boom in “hot money” inflows (which could also be recycled into U.S. securities). This dynamic went into overdrive after the 2008 crisis and the introduction of QE. Virtually unlimited cheap liquidity on a global basis incentivized “carry trades” and all varieties of leveraged speculation. So long as yields continued their historic decline, central banker, the leveraged hedge fund operator, sovereign wealth fund manager, derivative player and Joe Public could all just keep buying debt and relishing the spectacular windfall.
A rapidly changing trade backdrop now risks significantly altering the global financial landscape. A focus on making America great again will ensure a radically different view of trade and “globalization.” I’ve always believed in the important distinction of trading goods for goods– as opposed to creating endless quantities of new financial claims to pay for boundless cheap imports. Fiat for goods may have appeared miraculous – with central bankers happy to Credit themselves for whipping inflation. But at the end of the day the world is left with destabilizing economic imbalances and unstable finance. In short, too much finance, overcapacity and inequality. And, as we’ve witnessed of late, there’s an alarming amount of angst and social division, along with a democratic majority demanding an end to the status quo.
Understandably, global bond markets are on edge. Already beginning to percolate, the combination of trade frictions and fiscal stimulus potentially creates the most nurturing inflationary backdrop in years. EM is under pressure, with fears of shrinking trade surpluses, weaker currencies, declining reserves and the specter of self-reinforcing “hot money” outflows. Instead of reliable buyers of U.S. Treasuries and other securities, EM appears more likely persistent sellers. And a faltering EM only fuels a powerful self-reinforcing king dollar dynamic. If EM central bankers are no longer backstopping Treasuries and bonds more generally, these instruments become a lot less attractive instruments for leveraged speculation. So will central bankers – and others – keep buying even as previous windfalls morph into mounting losses?
The S&P500 gained 1.4% this week to join the small caps, midcaps and DJIA at all-time highs. How is it possible that U.S. equities surge to record highs in the face of such a troubling unfolding backdrop? Right now, the U.S. “Core” is winning big at the expense of the faltering “periphery.” And with global QE continuing at an astounding $2.0 TN annualized pace, today’s prevailing market worry is missing out on “Risk On” flows rather than fretting some nebulous brewing “Risk Off.” Moreover, markets by now have become well-conditioned to see heightened risk as ensuring that central banks keep liquidity spigots wide open.
The “fiat for goods”, services/consumption economic structure, activist central banking, and accommodate financial innovation/leveraged speculation experimental regime created the illusion of a golden era of low inflation, booming securities markets and unending economic growth. Central bankers enjoyed the luxury of easy decisions. Inflation was trending down, while bond prices trended up – seemingly forever. Central banks saw no pressing reason to tighten policies, irrespective of booming securities markets and/or Bubbles.
Going forward, the world could experience a new paradigm of inflation trending higher and bond prices lower. This would entail great uncertainty, including who will step up and fund rising deficits in a new era of declining bond prices. There is today as well great uncertainty as to how U.S. economic nationalism will play out globally. Trade and currency wars are a very real possibility.
In the near-term, central banking is about to turn a lot more difficult. All this QE in the face of rising bond yields and general uncertainty will stoke inflation fears. Already, the surge of liquidity into equities is drawing funds from fixed income, while exacerbating general flow instability. Liquidity flooding into king dollar exacerbates EM fragilities. Increasingly apparent EM trouble then spurs more flows into hot “Core” securities. “Melt-up” stuff. Do central banks come to view QE as destabilizing for inflation expectations and overall market speculation and flows? Or do they see the backdrop as too risky to begin reining in global monetary stimulus, again turning their backs on increasingly dangerous speculative excess? Might views begin to diverge, a likely scenario that would usher in a less straightforward – and less market-comforting – policymaking paradigm.
A few weeks back I argued the case for Peak Monetary Stimulus. This week it’s Past Peak “Global Savings Glut.” I suspect liquidity conditions worldwide will react poorly to any retreat from global QE.Subscribe to NFTRH Premium for your 50-70 page weekly report (don't worry, lots of graphical content!), interim updates and NFTRH+ chart and trade ideas or the free eLetter for an introduction to our work. Or simply keep up to date with plenty of public content at NFTRH.com and Biiwii.com. Also, you can follow via Twitter @BiiwiiNFTRH, StockTwits, RSS or sign up to receive posts directly by email (right sidebar).