Why a savings glut does not increase savings

Debate about the global savings glut hypothesis is mired in confusion, a fundamental one of which is the seemingly obvious but false claim that a global savings glut must lead to higher global savings. Here, for example, is a recent piece by one of my favorite economists, Barry Eichengreen:

There is only one problem: the data show little evidence of a savings glut. Since 1980, global savings have fluctuated between 22% and 24% of world GDP, with little tendency to trend up or down.

As surprising as it might sound, global savings gluts do not result in higher global savings except under specific, often unlikely, conditions.

What is a savings glut?

There is no formal definition, but whenever market conditions or policy distortions cause the savings rate in one part of the economy to rise excessively (itself an ambiguous word), we can speak of a savings glut. There are at least two main causes of a savings glut.

  1. A rise in income inequality. We see this in Europe, the US, China, and indeed in much of the world. As wealthy households increase their share of total income, and because they tend to save a larger share of their income than do ordinary households, rising income inequality forces up the savings rate.
  1. A decline in the household share of GDP. We’ve seen this mainly in China and Germany over the past fifteen years. When countries implement policies that intentionally or unintentionally force down the household share of GDP (usually to increase their international competitiveness) they also automatically force down the consumption share of GDP. Because savings is defined as GDP minus consumption, forcing down the consumption share forces up the savings share. There are many policies and conditions that do this, and I discuss these extensively in my book, The Great Rebalancing, but the main ones are low wage growth relative to productivity, financial repression, and an undervalued currency.

Notice that in both these cases, and completely contrary to the popular narrative that praises high savings as a consequence of household thrift, and so as morally virtuous, the rise in the savings rate does not occur because ordinary households have become thriftier. In the former case household savings rise simply because the rich increase their share of total income. In the latter case national savings rise without households in the aggregate increasing their savings.

How does the economy balance?

An economy’s total production of goods and services (GDP) can be defined either from the demand side (consumption plus investment) or from the supply side (consumption plus savings). By definition, in other words, savings is always exactly equal to investment.

An economy experiencing a savings glut must maintain this balance. It is consequently just a matter of logic that a savings glut must be accompanied by a balancing adjustment – either by an increase in investment or by a reduction in savings in another part of the economy – and this adjustment must occur simultaneously. The necessary implication is that whatever causes the savings glut must also cause one or both of these balancing adjustments.

There are only two ways investment can rise and two ways savings elsewhere can drop. This means that a savings glut must result in one or more of the following, enough fully to offset the savings glut:

  1. If productive investment has been constrained by the lack of savings, productive investment will rise.
  1. Nonproductive investment can also rise. Excess savings can cause large speculative flows into real estate or other assets, perhaps even setting off asset “bubbles”. When this happens it can create additional investment outlets for excess saving in the form of projects, including most often real estate projects, whose economic value can only be justified by rising price expectations.
  1. Rising asset prices can unleash a consumption boom if it causes ordinary households to feel wealthier and so increase their consumption (the “wealth effect”). This increased consumption creates what I will call, perhaps clumsily, a “consumption glut”.
  1. If less consumption caused by the savings glut is not matched by higher investment or by a consumption glut, total demand drops, resulting in higher unemployment. Unemployed workers stop producing goods and services but do not stop consuming. Because savings is simply the gap between production and consumption, unemployment causes the savings rate to drop.

Economists almost always miss this point. A global savings glut must be accompanied by one or more of the four adjustments listed above. It can result in higher global savings if the economy rebalances in the form of higher productive or unproductive investment, or it can result in no change in the global savings rate if the economy rebalances in the form of a consumption glut or a rise in unemployment. Nothing else is possible.

The best outcome is if a savings glut is accompanied by higher productive investment. This is often referred to as “trickle down economics” when both the rich and the poor benefit from productive investment, with the rich benefitting more.

If there is a savings glut, will productive investment automatically increase? If productive investment has been constrained by low savings it will, but productive investment tends to be constrained by insufficient savings mostly in undeveloped countries. Most excess savings, however, have originated or flow into rich countries.

In rich countries there are often many productive projects that desperately await investment, but this failure to invest is driven by other factors, and usually not by the lack of savings, so that a savings glut is unlikely to lead to higher productive investment*. Former Fed Chairman (1934-48) Marriner Eccles even argued that a savings glut could reduce productive investment. “By taking purchasing power out of the hands of mass consumers,” he wrote, “the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants.”

More commonly when excess savings are high they flow into real estate and stock markets, perhaps even setting off bubbles, with overinvestment in real estate an almost inevitable consequence of rapidly rising housing prices (we saw this most obviously in peripheral Europe, the US and China). These speculative flows have another impact that allows the economy to balance savings and investment. The real estate bubble makes households feel wealthier, which encourages a consumption glut, so that between the real estate boom and the consumption glut, the savings glut is fully absorbed.

But this is temporary. When the asset bubbles burst, the resulting surge in unemployment brings down the savings rate enough again to maintain the balance between savings and investment.

Savings must balance

The point here is that a savings glut need not result in an overall rise in savings. It can just as easily cause a consumption glut elsewhere whose positive impact on total demand fully mitigates the negative impact of the savings glut. The idea however that a savings glut can simultaneously create a consumption glut seems to be one of the most difficult things for many economists to understand, perhaps because it seems at first so counterintuitive.

Of course the other way a savings glut need not result in an overall rise in savings is through higher unemployment. In fact because neither an asset bubble nor a consumption glut is sustainable, unless productive investment has been constrained by a lack of savings, the only long-term consequence of a savings glut is a rise in unemployment and no rise in total savings.

In that case there might be only two sustainable ways to address the resulting unemployment. Either the savings glut is reversed, or governments act to eliminate whatever were the previous constraints on productive investment (perhaps by liberalizing constraints to investment or even by initiating a kind of “new deal” in infrastructure investment). The third way, although not sustainable, is for another asset bubble to be inflated so as to encourage another consumption glut, which seems currently to be the preferred way of US and European governments.

Which way is the causality?

It is just a matter of logic that unless investment rises substantially, a savings glut must combine with a consumption glut or with a surge in unemployment so that there is no net increase in savings. But logic only tells us that the two must occur simultaneously. It implies no obvious direction of causality. Does a savings glut cause a consumption glut, or does the consumption glut cause the savings glut? To put it in contemporary terms:

  1. Did Chinese policies aimed at forcing up domestic savings (by forcing down the household income share of GDP) set off a consumption glut in the US, or did profligate US consumption require that Chinese savings rise to accommodate it?
  1. Did German policies aimed at restraining workers’ wages force up the German savings rate, with excess savings pouring into peripheral Europe, setting off real estate bubbles, which then set off consumption gluts, or did over-enthusiasm about the euro cause overly confident citizens of countries like Spain to embark on a consumption binge, which could only be balanced by a rise in the German savings rate?

One way of resolving these questions might be to examine the cost of capital. Pulling capital from low-savings to high savings parts of the economy might seem to require high interest rates. Pushing capital from high-savings to low-savings parts of the economy might seem to require low interest rates.

There is so much misunderstanding about the savings glut hypothesis that much of the debate has verged on the nonsensical. Unless it unleashes a truly heroic surge in investment – productive or nonproductive, although the latter can only be temporary – a savings glut must always be accompanied either by a consumption glut elsewhere or by a rise in unemployment. No other option is possible. This is why savings gluts rarely result in higher overall savings.

This is also why any serious discussion of the savings glut must eschew moralizing and must focus instead on the direction of causality. Did distortions that created a savings glut force the creation of a consumption glut, or did distortions that created a consumption glut force the creation of a savings glut? Any analysis that does not recognize that both must occur simultaneously, and so must be resolved simultaneously, cannot possibly be correct.

 

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* Perhaps in cases in which investment has been constrained by high interest rates, higher savings can unleash more productive investment. It may also be, although I cannot prove it, that when income inequality is low, higher savings associated with further increases in inequality can lead to more productive investment in part because interest rates might be high. In that case it would seem that when income inequality is high, higher savings associated with further increases in inequality will not lead to more productive investment.

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  1. P.S. There may be many reasons to dispute the argument and the reasoning in this essay, but in a fractious political climate in which groups are defined by the positions they unalterably oppose, I suspect that this essay is likely to be disliked for reasons that often have nothing to do with the actual logic of the argument:

    • Libertarians reject the implication the income inequality can lead to unemployment.
    • Statists reject the implication that a disproportionate government share of GDP can lead to unemployment (either at home or, although this is not fully explained in this essay, abroad if the savings are exported).
    • One faction of Euro supporters rejects the implication that the European crisis was caused by Germany’s forcing down wages.
    • Conservatives reject the claim that trickle-down economics works only under very specific, and often unrealistic, conditions, and they especially reject the claim that a government–led infrastructure investment push is one of the ways trickle-down can work in developed countries.
    • Liberals reject the implication that income inequality can under certain conditions sustainably increase growth, either in undeveloped countries or in developed countries in which interest rates are high enough to constrain productive investment.
    • Monetary doves reject the idea that monetary expansion might be reducing unemployment in the US and Europe mainly by reigniting asset bubbles and consumption gluts.
    • Many people reject as immoral any suggestion that more savings is not better for an economy or that more consumption can be good.

    Any discussion of the savings glut presses too many hot buttons for the discussion to be useful.

  2. Dear Michael, There is a hot topic being debated that fiscal actions need to be boosted when not enough investments are forthcoming from the corporate sector. But is it not true that the stock of savings is fixed, if the government wants to make infrastructure investments, it must issue debt that would make savers divert part of their savings to these instruments thus drawing down on the savings that would have otherwise moved to other investments and consumption. So effectively government fiscal actions actually crowds out private investments or consumption by drawing down on existing savings that are earmarked for these.

    Am I right?

    • I think there are conditions under which government investment can crowd out private investment, but it seems to me that this would occur only if investment is constrained by savings, which it clearly is not in the US as long as unemployment is high or foreigners are eager to invest in the US. It is easy for me to find periods in US history when there were high levels of both government and private investment, with the latter often piggy-backing off the former, for example much of the 19th Century. The classic case is probably the building of the Erie Canal, but there are many others.

      In fact the whole issue of “crowding out” strikes me as one of those economic issues that have become moral issues. We seem to think that either government investment is always bad because it always “crowds out” more productive private investment, or that there never is a problem with crowding out. I suspect that both positions are wrong, and that we can easily work out quite logically the specific conditions under which crowding out must occur.

  3. I have no idea of how you are able to keep taking the same old things that we have all seen a thousand times and explain them in ways that are so fresh, illuminating and imaginative. The mark of one kind of great thinker is his ability to understand things so profoundly that he can make complex things seem simple and obvious. I wish every policymaker would read this. I have always been on the side of the monetary “doves”, but you place their actions, in almost an aside, in such clear relief that now I understand exactly what they are doing. They are attempting to reflate the consumption bubble, but free trade means that they cannot do so except a tremendous cost to their economies. This makes some of Krugman’s monetary recommendations wrong. But at the same time I think you complete corroborate his argument that American trade policies are harmful. Am I right?

  4. “Monetary doves reject the idea that monetary expansion might be reducing unemployment in the US and Europe mainly by reigniting asset bubbles and consumption gluts”

    To be fair, a portion of economists that fall in the “monetary doves” category given their enthusiastic support for QE do recognize that unemployment is being reduced (if not so much under-employment) by reigniting asset bubbles.
    For instance, received by email on 24 November 2013 from a well established Wall Street economist: “Judging by 2000 (tech) and 2007 (housing), the US economy may be unable to reach full employment without creating an asset bubble.”

    These economists simply don’t have any better idea.

    In reality, they don’t try to have any better idea. Their compensation is a % of assets under management of their firms or of the clients of their firms, such assets growing with QE. So it doesn’t pay for them to have any better idea, they would in fact be shooting themselves in the foot. That’s the point: a significant portion of what is called “economic research” is badly conflicted and a lot of the apparent confusion in the debate is sometimes deliberate as a convenient way to hide specific interests. Many economists are not paid to find a way to create jobs for the many unemployed nor to generate income growth for the employed. They are paid by the finance industry, which sides with capital owners in its interest for high asset valuation. That explains why none of their “research” ever finds that big imbalances between capital share and labor share is unhelpful and counter-productive past a certain point. This will sound quite conspirational but the gap – witnessed over many years – between what these economists write publicly and what they say privately make it clear that this is indeed the case. Sadly.

    To your point, it is true that very fee people start from observable facts and build theories that make sense of them and are in accordance with them. The vast majority start from pre-conceived ideas and try to make the facts fit into their narrow box, often using convoluted explanations as necessary.

    • Not conspiracy at all DvD. Well recognized in the industry. It is in part what has given rise to “independent” research firms; eg those that write research but don’t manage money. But the independents have clients too who, like all of us, like to have their own prejudices and biases confirmed. If you are writing for rich people you don’t want to inquire too deeply into the system that delivered their wealth.

      “governments act to eliminate whatever were the previous constraints on productive investment (perhaps by liberalizing constraints to investment or even by initiating a kind of “new deal” in infrastructure investment).” or by understanding and reducing the misallocation of resources that results from corruption in developed countries.

      Tying the two previous paragraphs together I submit that the reticence of business economists to address the impact of pervasive corruption springs from an unwillingness to bite the hand that feeds them.

  5. Carlos Londoño

    In regard of which came first, the chicken or the egg (savings glut or consumption glut), how about the argument by Daniel Alpert in his book the Age of Oversupply, in which he states that the end of the iron and bamboo curtains together with technology developments integrated a huge number of workers to the global economy creating a labor glut. This huge number of workers were low wage workers, which in turn created a savings gluts in their home countries (like China) and in their market countries (like USA) by appropriating the gains of lower production costs. Subsequently the consumption gluts followed it.

    So from the point of view of causality, if this view is correct: Labor glut –> Savings glut –> Consumption glut.

    Does any of this make any sense at all?

    Thanks.

    • Carlos, I think you are quite right. Bernanke’s own thesis on “the Great Moderation” was based on this, except that he preferred not to linger on the “oversupply of labour force”. The one catastrophe that will bring this economic system undone is “the reserve army of unemployed” which requires capitalist industry to keep down its only measure of social antagonism – inflation – by producing excess population (they call it the NAIRU, after Milton Friedman). Lower wages in China have been met with lower real wages in the West (because worker consumption goods were substituted with “cheap” imports from China). The influx of capital in the West has then resulted in the twin bubbles of asset appreciation and credit-induced consumption. The problem is that the excess savings “refluxing” in the West cannot be used to expand employment because this may cause inflation to spike. This reflects also the “degree of monopoly” of Western capitalism. So we have another set of twin dangers: asset bubbles on one side (including credit bubbles) and deflation on the other, given that high unemployment rates lead necessarily to falls in the price level.
      I may find time to comment on what I believe is another aspect of Michael’s characteristically excellent treatment here – the role of “the State” or governments, particularly with regard to infrastructure investment (both productive and unproductive). I could refer to a study by one of Schumpeter’s most talented pupils and one of Italy’s best-known economists, Paolo Sylos-Labini called “Oligopoly and Technical Progress”. Cheers.

      • The founder of Tesla Coporation (ticker symbol TSLA) Elon Musk and I may have solution to this sticky wicket. Based on the comment “I have absolutely no doubt in my mind that there will be a space hotel within the next ten years, in orbit around the Earth,” Elon Musk said in October.

        For people that can afford it, it might be a good idea to release a pandemic here on earth and hole up there in the space hotel with an entourage and other essential staff. After everyone is dead, its safe to come back to the planet and begin repopulating .

    • It might be true, Carlos, but I am not sure that the household share of GDP in China had to fall, a least at anywhere near the speed with which it did. If interest rates had not been so low for example, (and these were set by the State Council), Chinese growth would have been lower, but it would have also been much healthier and households would have retained a much bigger share, which would have driven down the country’s saving rate.

      More generally I am not comfortable with the arguments that either technology or globalization necessarily had to lead to income inequality. I am more impressed with the view that historically income inequality has been the result of a political process and that effectively we can decide on how much income inequality we want.

      • Income inequality might very well be the result of a political process but not sure at all that any government of any individual country can effectively decide how much income inequality is desirable within its own society (including reputedly “democratic” society) and how much is too much. Precisely because of the constraints of globalization on individual countries policy levers. Yourself said as much in your article on Economic Consequences of Income Inequality. You wrote: “But redistributing income downwards is easier said than done in a globalized world, especially one in which countries are competing to drive down wages. The first major economy to attempt to redistribute income will certainly see a surge in consumption, but this surge in consumption will not necessarily result in a commensurate surge in employment and growth. Much of this increased consumption will simply bleed abroad, and with it the increase in employment.” So, the distinction between globalization and political process as factor leading to income inequality looks largely semantic to me. In practise, globalization is dictating sovereing countries political process as no individual country wants to see unemployment and deficit skyrocketing at home.

      • As an end result technology or globalization do not lead to income inequality, but technology and globalization are transformative processes and the intermediate steps may no look anything like the end result, right?

        Is not the world in the middle of a transformative process of integrating China to the global economy? Where the first part (the imbalance act) was to increase the supply side of the equation and now the second part (the rebalancing act) is the demand side of the equation. IF they succeeded in creating a consumer economy, will not that trigger a virtuous cycle that will rebalance the world economy?

        A rebalanced world economy will mark the end of this transformative process of integrating China to the global economy. At that point we could see clearly that globalization and technology do not lead to income inequality, right?

        • Globalization started in earnest 35 years ago when the Tokyo Round of the GATT concluded in 1979.

          Income inequality and global debt have been soaring ever since as each participating country gradually learn that to prosper in such a system it has to improve international competitiveness, ie., among other things, reduce labor share and consequently allow demand to keep up with rising production by increasing debt even faster than production.

          How much longer do you propose that this 35 year old “intermediate step” last?

          With a growing contingent of unemployed / over-indebted / over-taxed people, the street can sweep public order in many countries at no notice and in no time.

          So, not sure you have the luxury of much more time before your happy end result.

          Of course, there is also that little chance that the end result is not the one that has been expected all along but rather something completely different. Then what? We just say hooops an move on?

          • It does seem that things will move.
            The Pickety book (although he is being positioned by some as a new Marx, so that the illucid right, Conspiratorial theorists, others who will fondly confound his argumentation for their value based ideological interests and similar to test matters) will frame the dialogue around Inequality. The book has risen, because the consciousness is existent; both of those who tend toward a Libertarian, true Conservative, Liberal, and Social Democrat background. The receptivity of the book will frame dialogues regardless of the attacks of some in the US in the 2014 and 2016 elections; nothing will prevent that.

            These things, like all run on a pendulum. The mass of those participating in the current systems institutions, with no alternative. generally and generically, in that, create need for a new global condominium, accommodation. Superficial financial narratives, will necessarily yield to changing, ethos, demographics, zeitgeists, weltanschaungs, and similar as the impacts of the process, and limitations of theory continue to be exposed (if only each camp weren’t to confound, to push to the extreme, to ensnare the similarly minded, as they isolate the open-minded).

            Inevitably, the tide has turned, and the real meat of the future, is how to ensure that growth in the periphery doesn’t impede that which rationalized and enabled growth in the periphery. The Asian Development Model is dead on the back of China’s super-sized application which has skewed investment patterns globally, skewed the health and functioning of the Chinese Economy for more then a decade, and inhibited a more balanced global growth; depriving a mix of healthy growth stories, not one merely based upon infrastructure and assembly in China, along with Asset bloat and money printing, and Natural Resource investment and sales to China, which could only happen during a limited period of time, insofar as the construction and nature of certain types of commodities. Some Chinese Pundits, Ironically may be applying Japans WWII co-prosperity sphere, into 3rd and 4th tier cities, but globally there is always divergence between areas bordering Oceans and those far inland, and naturally in China there will be so as well, if infrastructure does strengthen central power insofar as the territory is now physically linked and politically more manageable by being able to move resources to quell, respond or initiate to internal and external conflicts due to better transportation and communication infrastructure.

            Inevitably all will change and advanced countries will respond, turning the tide, and developing countries will need to respond similarly.

            Inevitably while people are using dated, aged, and largely irrelevant to the times, notions, based upon simplistic frames, often on sports and gaming terms, the real nature of what must involve will slowly come to the fore. Essentially, the terrain for cooperation, will expand, because rather than lighting anew way for developing world modernization, China has drowned the process in a mass of excess, not allowing for a patient longer-term, stronger evolution of its own poli-socio-econo interests, nor enabling room for others to evolve, while swampign those who provided the rationale for a fair amount of its investment, as it undermines the ability of its own people to take such a force in their own economy.

            Globally, we are working through asset bloat which got ahead of the real economy, where rather than turtles it is income and wealth all the way down, as the price of assets largely are unrelated to reality, and stymie the functioning of more rational markets, and economies.

            With all this and technology, as the manipulation of markets, and some grat impact of such on the global economy continues, a good question is what is the effect on the future of the worlds economic, social, political relations, stability and similar of a great many of underdeveloped, populous countries entering the state, nature and experience of post-industrial societies, before the modern, build healthy and stable institutions and create the healthy internal supply and demand mechanisms.

        • On a more theoretical note, it sounds highly dubious to me that the path towards a situation of maximum economic efficiency could involve value-destroying incremental moves (by that, i mean debt growing faster than production, hence net worth growing more slowly than production at a particular iteration of the economic process), followed by a miraculous value-creative catch up towards the end. Much more plausible is the scenario whereby the path towards maximum economic efficiency involves value-creative incremental moves.

          And then, there is the small question of wealth distribution. There is not one wealth-maximizing end result but an infinity, each corresponding to a particular distribution of ownership of assets.

          Ultimately, it is not possible to conclude which economic situation is optimal without taking into account the expression of collective preferences of societies as to which distribution of wealth – or which level of wealth inequality – is deemed desirable.

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  7. Would you please elaborate on your “trickle down” comment relating to productive investment? I can’t quite get my head around it. I understand the theory that if there is need (i.e: a developer constructing buildings to cater for an increase in immigration when a bubble is not present – a la London) & that at some point such an investment no longer becomes productive when the only way it stacks up is when sales prices are high enough to make a profit.

    With regards to trickle down effect, the assumed rich developer makes money & the less wealthy contractors make money, but I assume that theres also more that I can’t get my head round fully.

    I come from a libertarian viewpoint, but understand your savings arguement.

    • There are many caricatures of trickle-down, Thomas, and I don’t want to deal with these because of course they are easy to ridicule. The “good” version of trickle-down, however, makes sense. An economy might be poorer than it need be, with higher unemployment, mainly because it does not have enough savings to allow it to invest in a number of productive projects. In that case taking steps to force up the savings rate is positive because this will lead to higher investment, to more wealth creation, and to less unemployment.

      One way of increasing savings is to increase income inequality. In that case the rich get richer, but their higher savings unleash more productive investment which benefits everyone else, even if it benefits the rich more.

      • Many thanks,

        That has clarified my thoughts. I arrived at your books & website having read various “libertarian” style books that made sense, such as various Peter Schiff books – reading from the perspective that understanding the workings of the world will give me better hindsight as a private investor (albeit a small one!).

        I am an advocate of free markets with minimal government involvement to protect peoples rights only. But, I do whole heartedly agree with your theories (more so than the libertarian viewpoint that we’re all better if we all save). I was drawn to the libertarian arguments as I found them more understanding of the way the world works vs. say the liberal way of thought in general.

        However, I feel that your teachings are more insightful than the libertarian teachings, although there is a lot of crossovers in my opinion. However the libertarian argument that everyone saving is a good clearly doesn’t work…the woodcutters pile of wood is only worth anything if there are customers who need wood for their fires!

        • Rubbish! You didn’t mention what libertarian arguments you were drawn to. Guess what? There aren’t any.

          Let me tell you how the world works, Buddy. The free market creates winners. The winners then act and organize politically to cement special relationships with government to promote barriers to entry and eliminate competition.

          And importantly, the winners move to eliminate inheritance taxes so that powerful dynasties are created. Over the millennias, societies have erected and developed around the preservation of these dynasties from Tut to Kaiser.

          What moves the procession from egalitarianism to oligarchy is very smart people that promote the ascension of the Oligarchs. The Oligarchs are beholden to these highly effective and resourceful managerial class of people.

          As the procession to oligarchy progresses, the people behind the scenes promoting the dynasties might be, say, the head of the security apparatus. However, in the nascent stages, you might find these people working as tax lawyers. Before the oligarchs have completely infiltrated the government, tax lawyers lobby the legislature to make the tax code so complex, the super rich billionaires have to hire the tax lawyer’s agency to attain the loop holes that greatly reduce the taxes owed to the government. The billionaires get out of paying taxes to government but only by paying off the tax lawyers. Its actually a big incentive for the super rich to thoroughly infiltrate the government and reposition themselves from tax dodger to tax collector.

          Meanwhile, the milksop Libertarians advocate for free markets and small government oblivious to the fact that nothing is more subversive of free markets and small government than free markets and small government.

          On the other hand, mayhaps the Libertarians and the promoters of inequality are one and the same. Libertarianist propaganda gives the movement cover while these libertarian promoters of oligarchy enjoy the privilege of modestly tapping into the the obscene concentrations of wealth vis a vis there special relationship with the oligarchs.

          • That’s crony capitalism & in my opinion is a different matter. this is a situation where governments don’t protect the rights of its citizens.

            I do believe that free markets is the most efficient method of capital allocation, however they have a flaw in that they are operated by & serve humans.

            That being said, the controlled markets of Maos China & Societ Russia illustrate that they’re far more efficient than controlled markets (mainly due to the collective brainpower of free markets.

            Yet, communism & liberalism is great at providing short term fixes that aren’t deliverable in a free market.

            I’m pretty confident that the general system that most people now live under actually works as it’s the middle ground. China, aside from Prof. Pettis’ comments is moving closer to the right, whereas the us perhaps needed a nudge to the left a a la Obama & his policies.

            Also, gold IMO is going to rise & a return to the gold standard would over time resolve out current difficulties…apart from that it would be tampered with.

            But, with regards to your comment above, Crony Capitalism in my opinion is the worst of all possible scenarios as it is to a certain degree communism in the shadows.

            To repeat what I said earlier, governments cannot create wealth, only redirect it from one sector of the economy to another (or destroy it). Therefore it should in my opinion only be in place to protect rights, not try to help as all it is doing is robbing Peter to pay unemployed Paul. If Peter was going to otherwise use the money to creat a job for Paul, then the govt has shot in the way of progress & wealth creation.

          • It does seem that things will move.
            The Pickety book (although he is being positioned by some as a new Marx, so that the illucid right, Conspiratorial theorists, others who will fondly confound his argumentation for their value based ideological interests and similar to test matters) will frame the dialogue around Inequality. The book has risen, because the consciousness is existent; both of those who tend toward a Libertarian, true Conservative, Liberal, and Social Democrat background. The receptivity of the book will frame dialogues regardless of the attacks of some in the US in the 2014 and 2016 elections; nothing will prevent that.

            These things, like all run on a pendulum. The mass of those participating in the current systems institutions, with no alternative. generally and generically, in that, create need for a new global condominium, accommodation. Superficial financial narratives, will necessarily yield to changing, ethos, demographics, zeitgeists, weltanschaungs, and similar as the impacts of the process, and limitations of theory continue to be exposed (if only each camp weren’t to confound, to push to the extreme, to ensnare the similarly minded, as they isolate the open-minded).

            Inevitably, the tide has turned, and the real meat of the future, is how to ensure that growth in the periphery doesn’t impede that which rationalized and enabled growth in the periphery. The Asian Development Model is dead on the back of China’s super-sized application which has skewed investment patterns globally, skewed the health and functioning of the Chinese Economy for more then a decade, and inhibited a more balanced global growth; depriving a mix of healthy growth stories, not one merely based upon infrastructure and assembly in China, along with Asset bloat and money printing, and Natural Resource investment and sales to China, which could only happen during a limited period of time, insofar as the construction and nature of certain types of commodities. Some Chinese Pundits, Ironically may be applying Japans WWII co-prosperity sphere, into 3rd and 4th tier cities, but globally there is always divergence between areas bordering Oceans and those far inland, and naturally in China there will be so as well, if infrastructure does strengthen central power insofar as the territory is now physically linked and politically more manageable by being able to move resources to quell, respond or initiate to internal and external conflicts due to better transportation and communication infrastructure.

            Inevitably all will change and advanced countries will respond, turning the tide, and developing countries will need to respond similarly.

            Inevitably while people are using dated, aged, and largely irrelevant to the times, notions, based upon simplistic frames, often on sports and gaming terms, the real nature of what must involve will slowly come to the fore. Essentially, the terrain for cooperation, will expand, because rather than lighting anew way for developing world modernization, China has drowned the process in a mass of excess, not allowing for a patient longer-term, stronger evolution of its own poli-socio-econo interests, nor enabling room for others to evolve, while swampign those who provided the rationale for a fair amount of its investment, as it undermines the ability of its own people to take such a force in their own economy.

            Globally, we are working through asset bloat which got ahead of the real economy, where rather than turtles it is income and wealth all the way down, as the price of assets largely are unrelated to reality, and stymie the functioning of more rational markets, and economies.

            With all this and technology, as the manipulation of markets, and some grat impact of such on the global economy continues, a good question is what is the effect on the future of the worlds economic, social, political relations, stability and similar of a great many of underdeveloped, populous countries entering the state, nature and experience of post-industrial societies, before the modern, build healthy and stable institutions and create the healthy internal supply and demand mechanisms.

          • Bravo, but no so fast. These are complicated matters.
            The invisible hand of the market, did have greater import than mere monetary relations when it was briefly mentioned by Smith.

            It was related to the mysterious complexity of the world (and a a link to God, in the transition from Axial to Enlightenment thinking). The problem is, during the heady and exciting time, of the flourishing of thought in the enlightenment, we got a great flourishing of thought that was necessarily infused with ideals. 19th century German Idealism, intermixed with the Ages of Romance and Revolution, lead to a great many conflicting and contradictory notions that are poorly considered if descendant within our popular understanding of the world we experience around us.

            So while, your notions sound correct, and in many ways insightful, they are the normal action of Man in his environment; under conditions of Zeitgeists that wax and wane, and Worldviews that alter with reappraisal of the world we see around us.

            The Libertarians have Liberty right, where equality is necessarily an assumption taken at the individual level, the Social Constructionists, Social Engineering types hold too little faith in the capability of other Humans, with their heightened heart felt ideals enabling them to justify jettisoning of others prerogatives, but outside the world of Men’s thoughts we live in a world of elements and interactions with attributes and impacts, forces that lead States to different amalgamations that alter the truth and reality of what is, has been, and will be.

            So, while these soico-politico-economico structures may exist, they alter future terrains, as others elements and forces alter what the future will hold.

            This is the time of the rise of a more Self-Empowered human, and outside of mere economic and financial relations, structures, and strictures, the future moves past many of these 19th century pre-occupations.

            The pendelum will have to swing back, as any who has walked the streets of the developing world can note, the financial economy moved past the real economy, and time will need to see that worked out, as asset bloat is merely a fictitious drag on the evolution of economies, if their is not income and wealth generation otherwise to support it.

  8. If a global savings glut cannot increase global savings then would Mariner Eccles characterisation of the problem as one of monetary velocity be better?

    • If we follow the logic of the previous Economic Consequences of Income Inequality article, if there is a savings glut but we can’t see any evidence of the overall savings rate increasing, it must means that savings decrease in other parts of the economy, ie. the non-rich are drawing on their savings to maintain their consumption, or unemployment is increasing, or financial investment is increasing or any combination thereof.

      Looking at the current situation in the US, unemployment is decreasing (if not so much under-employment which is unemployment + part time employment for economic reasons + drop in labor force participation unrelated to demographics), overall household savings is declining as % of disposable income and return on aggregate financial assets are by far exceeding nominal economic growth. It seems we are indeed in the scenario of unsustainably financed consumption combined with speculative investment. Thank you QE for playing that movie yet again but we have already seen it several times and by now everybody (except FOMC members it seems) knows how it ends.

  9. What if we aren’t talking about anything other than an over extension of credit? Someone has to hold the cash.

  10. Dear Michael,

    I really enjoy your posts and your books, but I do have one small comment. You use the word savings so often that it can become a bit confusing as to which you mean. Since you have previously written that misunderstanding of this word is one of the things hamstringing current economic understanding of the situation, could I humbly suggest that you consider modifying your formulation to something more specific for each situation? For example, always saying ‘household savings’ to refer to when a household is sending more money to the bank, and ‘national savings’, ‘GPD savings’, ‘fiscal savings’ or something else, when you are referring to GDP minus consumption. Any extra clarity would be particularly helpful to economic neophytes such as myself.

    • Good point, Andrew. I would also prefer a more specific wording. I find a “One-Word-Fits-All” approach rather confusing. By way of example, trying to apply the investment/saving paradigm to the case of Japan does not easily explain that country’s deteriorating trade balance. One needs a more refined tool. Hope prof. Pettis is reading your comment.

  11. Great piece, there are quite a few people I have to share this with. Have to agree with Andrew above always great info here!

  12. From the perspective of an economy like China’s for example, in the event of a savings glut in its GDP, its productive investment could be exported to developing economies like the Euro Asia regions and Africa in exchange for commodities and natural resources – thus increasing or maintaining China’s overall GDP and employment. In return from the Euro Asian and African nations, these imported productive investment from China translates to the development of essential infrastructure such as roads, ports, power plants, dams, office buildings, etc. – resulting in urbanisation, higher productivity and employment. Consequently, this translates to higher GDP and savings rate. Under this scenario, it would appear that productive investment doesn’t have to become unproductive whenever there is excessive savings particularly in China when its SOEs could secure such politically-motivated jumbo deals and export its productive investments/savings, isn’t it? In this regard, the 2 parties’ ‘global’ savings rate would also increase over time.

  13. “Did Chinese policies aimed at forcing up domestic savings (by forcing down the household income share of GDP) set off a consumption glut in the US, or did profligate US consumption require that Chinese savings rise to accommodate it?”

    A good article. But too many, includign yourself, seem to think it is China’s fault or now, Germany’s fault. Why is it never the excess consumer’s fault, ever? US has been running deficits since the time of the Vietnam war. After decades of over consumption, and blaming the Europeans, the Japanese, the Chinese, in turns – at some point, the rest of the world is not wrong. You have to ask how much the US has been abusing our reserve currency status to over consume. I know it is anathema to economists. But come on. In 2005, when the US is consuming 82% of rest of the world’s savings, it is our problem. not theirs.

    • The traditional opposition of the US consumption glut and the Chinese savings glut, while entirely correct, misses a far broader and much more concerning issue, which is not properly appreciated:

      Since China entry in the WTO in 2001, the total debt of both the US and China has grown exponentially faster than production. In the US from 2001 to 2009, and in China since 2009. In the relatively short 13 years period since China joined the WTO, the solvency of both economies has markedly deteriorated, actually to a surprisingly similar extent, irrespective of the fact that one has been a net beneficiary of international trade and one a net loser. The wealth of both nations has materially decreased relative to production (by wealth, i mean net worth after deduction of debt).

      So, far from being mutually beneficial, as we are brainwashed to believe (and as was the initial intention of the GATT as explicitly stated in the introduction to the 1947 agreement), the evidence is rather that the current world trade and monetary system is mutually value-destructive and mutually detrimental to the wealth of nations.

      Which must be why its reform has been on the agenda of precisely 0 international meetings, conferences or working groups for the past 5 years.

      The world economy increasingly rests on an ever more shaky pyramid of global debt which keeps growing faster than global production. That makes GDP growth numbers less and less meaningful. What matters more is that the net wealth generated by the global economic process has now turned negative. The question therefore is: do we act now or do we wait until there is no equity left in the system?

      The correct answer seems obvious. Yet, the answer we get from our respective “representatives” at the G20 is the opposite one.

      • Of course, exactly the same that is now happening to China happened to Japan 20yrs ago when the accumulated monetary reserves arising from trade surplus multiplied themselves through Japan domestic fractional reserve credit system until Japan found itself one of the most indebted country on earth. It is no exaggeration to say that Japan never recovered from it. You might call that the winner’s curse in the dysfunctional world trade and monetary system. If you are a net beneficiary of international trade flows, the second step of the double credit spiral will bankrupt you. If you are a net loser of international trade flows, negative free cashflows and rising unemployment will trigger the first step of the double credit spiral that will bankrupt you. It is a lose – lose system for everybody, except the country which happens to have as domestic currency the reserve currency of the entire system and can therefore finance its persistent deficits for ever. That’s why the “temporary” decision by Nixon in 1971 has de facto become permanent and was of course always intended to be.

        This makes a practical solution very easy to implement: all nations that together share the lose – lose seat in the system just need to all resign their seat from all international organisations (this might be done tomorrow Sunday 18 April 2014, nobody will get hurt apart the global “petit fours” industry) and together found a fair and balanced trade and monetary system where large and persistent surpluses and deficits are not allowed. The US will have no choice but to join the new system.

        Shall we?

        • Generally your perspective is incorrect, because you only look at fictional numbers as if more real than build out in infrastructure, development of markets and institutions, advance in human capital, advance across braod ranges of socio-economic indicators, advance in the sophistication and expectation of consumers, of producers, etc… Certainly, had it been able to be done otherwise, it would have been done; but the USSR couldn’t feed itself, with all that territory from the mid to late 60’s, only the accumulated USSR is an exporter after its dissolution, India, only embarking on reform from the mid 1990’s, still only produces 605 of the beans it consumes, after recently becoming much more efficient and productive in these, and so on and so forth..

          Otherwise, I believe the exorbitant privelage is a burden, but one, were the world to shift to SDR’s, would simply shift the burden to many countries used to taking the benefit. I think this direction is wrong, the US might make it more difficult for others to use it’s currency for trade and FOREX purposes as Kindleberger notes, it had been in its interest during the Cold War, but as things become more muddled, the material capabilities of people and countries advance, it might no longer be in its interest. This is a fundamental mistake, that still surprises me, when people make it. Bernanke proved it. If China can print 4 times as much as the US, when the only country with a wealth to income ratio lower then the US is Germany, why couldn’t the FED step in and do the same, Michales thesis about savings imbalances and capital flows, proves that the world ought to understand what is happening, what is in play, how it has benefited, and how it could change. Regardless the ability to produce and store energy is right around the corner, as are the tools to make the things desired, and the zeitgeist among millennial and others for this, I would be careful what you wish for, especially when such great and vast overcapacity exists globally. Nobody can stop the Self-Empowered Human for long, as the NIC points out.

          • Thank you for your remark. I don’t know to what specific part of my comments you refer to as “incorrect perspective” but may be it’s worth trying to clarify:

            – If you refer to the comment that China total debt to GDP has increased exponentially despite being a surplus country in international trade, and that the same had previously happened to Japan, please note that this is not my own perspective but simply an observation based on the official statistics of the countries concerned.

            – If you refer to the “exorbitant privilege” for the US of having its domestic currency also used as world reserve currency, it is indeed debatable. The international role of the $ is only sustainable for the US if its economy is a growing share of the world economy, which is no longer the case since the mid / late 1960’s (hence the timing of the 1971 decision following gold outflows out of the US). If the US is a declining share of the world economy, such a system necessarily means that US debt / income ratio will deteriorate, hence the argument that it is in fact a burden. I agree, but still believe that the international status of the $ has made this burden so light that it has been more than acceptable in comparison to the associated benefit of boosting US economic growth beyond what would have been possible otherwise. At least as long as the US had available debt capacity. Ultimately, this is indeed a matter of judgment and everybody can decide whether it is correct or incorrect from their own perspective. But, despite its importance, this is a second order issue. The heart of the matter is that – regardless of what is being used as its base – a world monetary system which results in both deficit and surplus countries having exponential debt-to-income ratio is clearly unsustainable. It means that the apparent prosperity seemingly generated by globalization for some countries / some groups of people is likely to prove illusory or temporary. That’s the critical issue to recognize and resolve.

            – If you refer to the “lose – lose” comment, it is true that globalization has had positive effects for several groups of people. For instance, it probably accelerated job creation for an extra 550 million people in developing countries over the past 13 years alone, as well as probably accelerated income growth for over 1 billion people in developing countries. Presumably, this is what you mean by “development of markets, advance in human capital, advance across broad ranges of socio-economic indicators”. I agree. In my comments to Economic Consequences of Income Inequality, i noted that “average living standards have converged across the globe at the benefit of poor people”, adding “in that sense, global inequality has decreased. Great!”. First, you have to attribute all of these positives developments to globalization, while it is in fact likely that the faster growth of developing countries was also, if not largely, a function of their relatively less advanced starting point, irrespective of whether globalization has been pushed further during that time period. But, even if you attribute all of these positive developments to globalization, the fact that globalization has had positive effects for some groups of people is not the same as saying that these positive effects are sustainable and that they don’t rest on an ever more precarious pyramid of global debt. Nor is it the same as saying that globalization has been “mutually advantageous” to all, as was intially explicitely intended by the GATT in 1947 (see p.9 of the following document, which is page 1 of the actual agreement after the preface and the table of contents : http://www.wto.org/english/docs_e/legal_e/gatt47_e.pdf). Nor that it has not been largely a zero-sum value transfer from people of developed countries to people of developing countries with global businesses (many of them headquartered in developed countries) and their owners / investors taking their cut by systematically arbitraging labor costs. If the price to pay for these positive effects to these groups of people is global debt rising exponentially faster than global production, then there is a high chance that some or all of this apparent prosperity will prove illusory and / or temporary. After all, those who benefited the most from international trade expansion are the same who have the most to lose in case of international trade contraction, which is inevitable if imbalances keep adding up and global debt keeps outpacing global production. If these groups who benefit do so at the expense of those groups who lose out, then ultimately all groups will lose as and when the postponed adjusments to the accumulated imbalances crystalize and compound in a disorderly fashion. In that sense, the world trade and monetary system, in its current set-up, is a lose – lose system. Hence the urgent need to change it in a way that trade imbalances have a chance to correct and that the global debt snowball has a chance to decrease relative to income.

    • US consumption is a gift to Chinese factory workers. The US has chosen the path of cheap goods and high unemployment, while China has chosen low unemployment and expensive goods. It’s hard to describe this as a “problem” because different people benefit. Personally I like the fact that stuff in the US is much cheaper than Europe or even China. But I imagine those in the US manufacturing sector feel differently.

      Look at European/Japanese/Chinese trade policy, and how much more restricted it has been than American trade policy. France says they get to decide who is allowed to buy their private companies. Good luck trying to buy a major Chinese firm.

    • The US has consumed 50% of final end user products.
      The US has long offered the most opened markets.
      As kindleburger noted, the US offered its currency for Trade and FOREX purposes (as it pushed an integrated multi-lateral institutionalized world) to increase shared interests and lessen Traditional Conservative Territorialist state based interests of bygone era’s (reversed experientially most recently by Russia in the Crimea; opening the door for other incursion sin the future?)

      Each of the nations you mentioned had open US markets to rationalize investment, which enabled employment savings and welath creation more broadly. At a point, these countries would transit the territory of the middle income curse, and have to build out the domestic institutions, and demand driven domestic economies that would then enable further development to occur more braodly. The problem is, none, have done so, completely as America, which is the thing that will undermine the system of increasing shared interest, multi-lateral relations, and peace as all now participate and hold expectations for development.

      At some point your Gaullist and Eichengreenian Exorbitant Privelage, will be rescinded, as and when it is realized that immaturity in these matters do not yield to greater responsibility, and, this will be to the detriment, of those who a resource poor, population rich, with contiguous territorial land borders, who have allowed their elite to graze to long, and too comprehensively.

      So, anyone can produce, can supply what is demanded, demand is the issue, dispersed, diverse demand, more healthy and sustainable. Soon, we will be able to supply much more of our demand at home.

      Michael has handled the savings issue (thousands of times), am not sure what you don’t realize, this is not a place to post such obtuse non-sense, few here could recognize such a contribution.

  14. Dear Michael, In your books and previous posts, you have commented on how the deposit rate that Chinese banks offer to retail customers is capped well below where the market would naturally allow in such a fast growing economy. What developing economy would be a good comp to use in order to get a feel for where exactly the natural rate would fall? I recently looked up deposit rates in Vietnam, and saw rates well north of 7%. Is this in the ballpark of where deposit rates should be in a fully rebalanced Chinese economy? Also there have been reports stating that deposit rates will be completely liberalized in China by 2016 at the latest. I am highly skeptical of such a potentially rapid elimination of the rate caps, what are your thoughts?

  15. Careful. The four “balancing adjustments” do not “accompany” a savings glut. They’re, rather, logically implied by the concept of savings (defined, as you suggest, as GDP – household consumption) – that is, they’re possible instantiations of the very concept of savings glut. Also, it’s false that “a savings glut must result” in one of the four adjustments; for example, consumption may increase as a proportion of GDP in another part of the economy as a result of market forces totally independent from the savings glut of interest.

  16. If I remember it right savings is net investment while GDP is consumption plus gross investment?
    So Michael what kind of investment and saving are you talking about when you say that GDP=saving+consumption?

    • Not sure what you mean, K.Ramm. Savings is postponed consumption, so from the supply side everything produced (GDP) is either consumed or saved. On the demand side in a closed economy (the world) all demand comes from either consumption or production, so these too define GDP. That is why
      Savings + Consumption = Investment + Consumption = GDP

  17. “By definition, in other words, savings is always exactly equal to investment.” I’m not sure if this definition holds true in times of central bank extravaganza. We have for example a situation where banks now hold excess reserves, the central banks urging them to accept money that has no real function except for re-percolating states’ bond issues. No one really seems sure why. These “reserves” make little sense economically (or so it seems, again within conventional banking theoretical frameworks). I think savings cannot be discussed in a static framework. Rather we should wonder if in a world that may face inflation in the near future, savings at a time point of “future minus x” that have not been invested but “parked” and later evaporate are savings in the sense that one would assume them to be in a more reliable economic framework. Also savings figures are distorted by all kinds of bookkeeping shenanigans in social security.

  18. Dear Mr. Pettis,
    I have some questions about this article and not only it. I am a finance undergraduate student, so it’s very possible for me to make mistakes or to ask for stupid questions.

    You wrote that a savings glut is consequence of economic inequalities, a decline in the household share of GDP and of bad policies by governments (like China, Germany…). Never in these situations the glut was consequence of a thrifier population. But in this last case (thrifier population) is there a possibility for the creation of high imbalances as happens for the former written causes? And second, financial innovation, that probably doesn’t increase saving rate but it allows to an increase in credits, could create high imbalances i.e. using in a better way capital, the consequent capital lack decrease could create trade umbalances (I m speaking about historical evidence)??
    Last question is about to solve umbelances, mainly in south-europe (where I come). You wrote about big german account surplus determinated by a riduction in real wages, but was it possible that also real productivity matters? And so, could be possible for South countries, like Italy, traying to resolve umbulances implementing reforms increasing real productivity to became more competitive (liberalizing goods, services, financial markets, implementing a more meritocratic society trying to defeat corruption, creating what you call “social capital”…)? Or necessary we have to wait for a policy change in Germany/UE? I know that changes in real wages (and so creating savings glut) is a middle/long run problem…but are also corruption, few competition, inefficient financial systems so important in the long run to allow Italy starting by itself and not only waiting for other countris decisions?

  19. Great post. One (large) quibble I have, though, is that it seems to me the idea of housing being a bubble is simply asserted. I look at the whole issue much as you do, but these effects, including the price of real estate related to long term real interest rates, seem to be functioning in a perfectly sustainable way. The popping of the bubble was unnecessary. Real estate prices need to be high, and the problem is that nobody, including the Fed, is comfortable letting them be. A related quibble is that part of the savings glut isn’t due to income inequality, but is instead the result of a vibrant middle class of baby boomers who have a problem of mismatched personal production and consumption, and they need a large amount of low risk savings in order to consume in 30 years when they will not be productive. Real estate might not be perfectly efficient for bridging this gap, but it may be the best we can do. The fact that this gap is being bridged through low interest rates and related high real estate prices seems perfectly reasonable, and sustainable, to me.

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