The Fed's Wild Imagination
"Global savings glut." You’ve heard members of the Federal Reserve refer to that term lately, but do you know what it really means? Luckily, the Good Doctor is here to explain…
In his testimony to Congress on July 20, 2005, Mr. Greenspan declared it quite likely that the world is currently experiencing a global savings glut. Agreeing with Ben Bernanke, he mentioned this glut as one of the factors behind the so-called interest conundrum, i.e., declining long-term rates despite rising short-term rates.
Having read a lot from the Fed’s luminaries, their inability to distinguish between rampant global credit excess and a global savings glut does not surprise us. In this view, the Federal Reserve has come to the rescue of a world where excessive saving is threatening depression by eliminating savings.
Attracted by superior rates of return on U.S. assets, investors around the world have been scrambling to pour their excessive savings into direct investments, stocks, bonds and real estate in the United States, in this way financing the resulting huge U.S. trade deficit.
While this explanation may seem to make sense, there is one big snag: Not one word of it is true. First of all, in reality, private foreign investors have drastically curbed their investments in the United States. According to the Bank for International Settlement – the international organization of the world’s central banks – Asian central banks financed 75% of the U.S. current account deficit in 2004.
First, private capital flows into the United States have slumped. Without the massive interventions by the Asian central banks, the dollar would have collapsed long ago.
Second, the dollars with which these central banks have been buying U.S. Treasury and agency bonds have definitely nothing to do with Asian savings. Evidently, the central banks are recycling the dollars, no more, no less, which they receive from U.S. trade and capital flows. These dollars have come into the central banks’ possession through their interventions in the currency markets, to prevent a rise of their currencies against the dollar.
Global Savings Glut: "The Height of Insolence and Absurdity"
To speak of a global savings glut as a possible cause of the surprisingly low U.S. long rates in the face of these blatant facts is truly the height of insolence and absurdity. That this opinion comes from the leading figures of the Federal Reserve is more than shocking.
True, Asian countries have very high savings rates. For China, it is reported to be as high as 45% of disposable income. But this does not necessarily imply an existing savings surplus be lent to America. The bulk of available savings in China domestically is locked up in an even higher domestic investment ratio.
Looking at the global financial system, a straightforward fact to see is that central banks have been amassing foreign exchange reserves at an accelerating pace since the early 1970s. Rising in several large waves, their main source is plainly the soaring U.S. trade deficits.
Having no use for dollars in general, the first dollar recipients in the surplus countries sell them to their banks against their own currencies. These banks, in turn, found ready dollar buyers in firms and investors around the world, wanting to acquire direct investments or other assets in the United States, at least until 2000. Since then, though, capital inflows on private accounts into the United States have drastically receded, while U.S. trade deficits have exploded. In order to prevent a rise of their currencies against the dollar, central banks had to step in as buyers of last resort.
Apparently, it is not widely realized that this big shift in dollar recycling from private accounts to central banks essentially has far-reaching monetary implications for the participating countries and even for the world economy and world financial markets. Buying dollars, the central banks credit the commercial banks in their country with interest-free deposits.
Now, the critical point to see is that the banks, on their part, regard these deposits as their liquid reserves to be used for profitable lending or investment. Inundated with liquid reserves by the dollar buying of their central bank, the commercial banks in these countries embark on faster credit expansion. Shifting the rising surplus of liquid reserves between them, they create credit for consumers, businesses and speculators many times the amount of the liquidity injection by the central banks.
Global Savings Glut: China
Our focus in particular is on China. As in the United States, the resulting credit deluge is boosting components out of proportion to the whole economy. In China, however, the specific components are real estate and manufacturing investment, while in the United States, it is consumer-spending excess.
What the Asian central banks truly recycle is the U.S. credit excess. But in flooding their banking system through the dollar purchases with liquid reserves, they transplant the virus of credit excess to their own economies. For U.S. policymakers and economists, this is a reasonable and sustainable division of labor. The U.S. economy runs on wealth creation through asset inflation with a high rate of consumption, while China and Asia run on wealth creation through saving and investment with a high rate of investment.
We are fearful of this development, because it affects more or less all industrialized countries with high wage levels. In this way, overconsuming America is force-feeding the rapid mutation of China’s backward economy into a first-class manufacturing power. When China’s credit and investment boom started, in 2000-01, its central bank had foreign exchange reserves in the amount of $165.4 billion. Today, they exceed $700 billion.
We are wondering what is worse for the whole world, China’s further rapid manufacturing growth or a disastrous hard landing. Observing the same monetary and economic follies as in the late 1980s in Japan, we consider the second possibility highly probable.
A persistent, sharp slowdown in China’s imports strikes us as ominous. The general comforting explanation is inventory liquidation. But how to explain, then, the continuous oil and commodity boom? We suspect speculation far more than economic growth as the reason.
With all the talk about a savings glut, we feel obliged to make some remarks about the subject. First, please take another look at the Wicksell quote on the first page, stating, "The supply of real capital is limited by pure physical conditions, while the supply of money is in theory unlimited." "Supply of real capital" is actually a synonym for available savings.
At an international conference in 1953 about savings in the modern economy, with many heavyweights in economics in attendance, the famous former chief economist of the Fed E.A. Goldenweiser gave a rare precise definition of saving. He said: "Saving means the withdrawal of sufficient resources from the production of consumption and services to have enough for maintenance, expansion and improvement of the plant." Then, he complained, "that ever since Wesley Mitchell’s Business Cycles there has been a tendency to concentrate too much on the monetary expression of economic developments, and it has become reactionary to think in physical terms."
From the macro perspective, "saving" provides the physical resources for the production of capital goods in that consumers abstain with part of their income from consumption. Of course, this also involves money flows, but saving’s decisive distinguishing feature is the partial abstention from current consumption to make real resources available for the production of capital goods.
It is ludicrous, therefore, when American economists claim that rising asset prices, increasing consumption, should be counted as saving. When we read decades ago that Mr. Greenspan, long before he became Fed chairman, had expressed precisely this view, he was once and for all finished for us as a serious economist.
Global Savings Glut: Flooded with Liquidity, but What Kind?
The world economy seems to be flooded with liquidity. But there are two diametrically different kinds of liquidity: earned liquidity and borrowed liquidity. The former comes from surplus income or savings; the latter comes from credit and debt creation.
In a country with virtually zero savings like the United States, any liquidity essentially arises from debt creation. This is really fake liquidity depending on permanent, prodigious borrowing facilities, presently the housing bubble. Once this bubble evaporates or bursts, the U.S. economy loses its chief liquidity source – with disastrous effects on asset prices.
The crucial question concerning the U.S. economy is whether it is slowing or accelerating. As explained in detail, we see a lot of fudge in the recent economic data. Our main critical consideration is that a self-sustaining recovery would absolutely require a strong rebound in business investment. But that is not in sight. On the other hand, the turnaround in the housing bubble is only a question of time. A fairly short time, we think.
The consensus expects that the U.S. economy has the "soft spot" behind it and will surprise positively. We expect shocking economic weakness. All asset prices, depending on carry trade, are in danger, including bonds.
Dr. Kurt Richebächer
for The Daily Reckoning
September 14, 2005
The Fed has remained irrationally confident in the U.S economy – because they can’t afford from American consumers to see the truth – that the basis for this confidence is a shamelessly fraudulent farce of trumped-up statistics. Fortunately, Dr. Richebächer isn’t afraid to tell the truth.
Former Fed Chairman Paul Volcker once said: "Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong." A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as "the man who predicted the Asian crisis."
The world according to The Daily Reckoning
We begin with the proximate financial picture:
In the late ’90s, New York enjoyed a classic stock market bubble centered on technology shares. It did not take a genius to see that it would blow up; they always do. At the time, we expected the U.S. economy to follow Japan’s path with a long, slow, soft slump that would deflate asset prices over the next 10 to 20 years.
Japan’s Nikkei Dow hit a high over 39,000 in 1989. This week we read in the International Herald Tribune, "Japan [finally] roars out of its doldrums." The Tokyo stock market rose to 12,896! If America were to follow the same trajectory – as we guessed it would – in the year 2015 you might read in the paper, "America springs back to life…Dow rises to 4,000!"
If this sounds extraordinarily gloomy, we point out that it is not our fault; it is only typical of the way stock markets work. There are upswings that last from 15-20 years followed by downswings that last 15-20 years. After WWI, stocks ran up to the 1929 high. Then, they crashed and dragged around until the depths of WWII. After WWII began, another big surge to the upside, peaking in 1966. Thereafter, stock prices shilly-shallied around, but generally sank until 1982. That was the year that Business Week famously pronounced that stocks were not just down, but out. "The Death of Equities," its cover pronounced. But the news of stocks’ death was greatly exaggerated. In August of 1982, stocks entered a bull market that lasted 18 years.
America’s stock market bubble exploded in January 2000. But the damage was focused – as was the bubble itself – on tech shares. The Nasdaq has tracked the Nikkei fairly well with a 10-year lag. The economy and the broader market followed a different path. After seeming to sink into a Japan-like decline, the Bush/Greenspan team gave the world the biggest jolt since the invention of the electric chair. The federal budget swung from a surplus to a deficit – a swing of $700 billion. Interest rates were shoved down below inflation and remained there for more than two years. This was more stimulus than the world had ever seen. It produced the biggest bear market rally the world has ever seen, too; this time centered on residential real estate.
We have a friend whose story is probably typical. The man is now in his 50s. He never earned very much money and lived hand-to-mouth all his life. But he bought a small house when he was in his ’30s, and then a larger one when he was in his ’40s. Now, through no effort of his own, he finds himself with a house said to be worth $1 million with a very small mortgage on it.
He is now a millionaire. But where did that money come from? It seems to have come out of thin air. It may be said that it is merely a reflection of changing preferences in the society. Instead of spending their money on fur coats or McDonald’s meals, people choose to spend their money on housing; so, they are paying more money for houses. But we see no evidence in the statistics that fur coat sales have declined, nor have McDonald’s revenues. The property bubble added trillions to the net worth of Americans since 2001. If it were merely a shift of preferences, the figure would have been flat; something else would have had to go down in order for property to go up. But that is not what happened. Property levitated, as if by magic.
People don’t ask questions when they think they are getting rich. The question marks come out later – along with the recriminations and show trials. For now, people happily count their money; they don’t ask where it came from.
Japan’s property bubble occurred almost simultaneously to its stock market madness. Both then deflated: first stocks and then real estate. Property prices fell as much as 80 percent, and are still at their deflated levels 15 years later.
Americans think their houses are actually worth more than they were five years ago, but most of that increase is a puffed up bubble…a delusion…a fiction, just as it was in Japan. We are waiting for the bubble to (finally) pop. When it does, we expect a resumption of the bear market/recession that began in 2000/2001. Asset prices should deflate for at least another 10 years.
But there is a big problem with trying to apply the Japanese experience to the U.S. market. America needs a bear market, to bring stock prices down to more appealing levels. It needs a recession, too, to encourage Americans to save and reduce the trade deficit. America needs trouble, in other words, like white-hot steel needs a hammer, to beat out is fantasies and harden it up. It is too bad Americans are so deep in debt. They cannot take a beating; they can’t afford it.
First, more from our friends at The Rude Awakening:
Eric Fry, reporting from Wall Street…
"If only the Wall Street Journal would produce a ‘Weekly Reader’ version, we might be reading sentences like these in upcoming editions. We might also be reading sentences like, ‘See Oil Prices!…See Prices Fall!’"
For the rest of this story, and for more market insights, see today’s issue of
Bill Bonner, back in London:
*** More of the world according to The Daily Reckoning…
What’s the difference between a Chippendale table and a carrot? Both could be the same temperature. Both are made of plant fibers. Both are found in the dining room. They must be the same thing! But they are not.
Nor is the government of the United States. the same as, say, the government of Switzerland or Zimbabwe. They are all lawfully constituted. They are all sovereign. They all are democratic. But they are very different.
Around the time of the first Roosevelt, America became the world’s largest economy and its fastest-growing empire. Americans grumbled and hesitated; they were reluctant to get into WWI, and dragged their feet at the opening of the Second World War, too. But gradually, they took on imperial attitudes and soon were concerned not only with protecting themselves; but also with protecting people they had never met, whose languages they did not speak, and whose countries most could not even find on a map.
The business of empire, stripped of its vainglorious elements and world-improving pretensions, is essentially a protection racket. The imperial power provides protection. Subject peoples, vassal states, and homeland citizens pay for it. This program worked fairly well throughout the Cold War period when protection was what people wanted. But the failure of the Soviet Union left a vacuum: How can you run a protection business if you have nothing to protect people from?
"The 9/11 disaster changed everything," say the pundits. Of course, it did not really change anything. Terrorists never represented a serious threat to the empire. Much like the anarchist gangs of the early 20th century, groups such as the Bader-Meinhof gang, or t