Foreign Saving Gluts And American Financial Imbalances

The idea that trade imbalances are more likely to be the result of credit imbalances than of savings imbalances ignores the role of savings imbalances in creating credit imbalances. When a surplus country demands to be paid for its trade surplus with claims on American assets, the U.S. economy must adjust to create these assets—and one of the most common ways it does so is by expanding credit.

On November 27, 2020, I sent out a rather long tweet in response to a very good article in the Economist called “Why It Is Misleading to Blame Financial Imbalances on a Saving Glut.” I later received a lot of positive responses asking me to expand my discussion further. Because Twitter was obviously not the right forum in which to expand what was already a long tweet, I decided to do so in this short blog post.

The Economist article illustrates just how much confusion there is over the accounting identities that describe the balance of payments. The piece starts out by reminding readers of a reference Ben Bernanke made in 2005, when he was chair of the Federal Reserve, to a “remarkable reversal in the flows of credit” to emerging economies, particularly in East Asia. These countries had begun to save more than they invested at home, morphing into a “net supplier of funds” to other parts of the world. He called this a “saving glut.”

The article then cites a number of economists, including Michael Kumhof of the Bank of England and Andrej Sokol of the European Central Bank, who were dissatisfied with the concept and called for, as the Economist put it, “a careful distinction between flows of saving and flows of finance.”

“The two are not the same,” they continued. “They need not even move together. The implication is that Mr. Bernanke may have got things the wrong way around.”

The article goes on to stress the difference between the use of the word “savings” to mean “money accumulating in a bank account” and “saving” as “the opposite of consumption.” It then notes:

By producing something that is not consumed, the economy is saving. Thus someone who spends all their earnings on home improvements is saving, however, stretched they may seem, because a house is a durable asset, not a consumer trifle. Similarly a farmer who stores his harvest in a barn, rather than eating it, is saving—even if he never deposits money in a bank.

WHAT DOES SAVINGS MEAN IN AN INTERNATIONAL SENSE?

The problem, the author asks, is how savings, properly defined, can flow across borders. The article suggests that perhaps excess savings is not necessarily the right causal starting point:

Any output that is not consumed meets one of two fates: it is either invested or exported. It follows that anything that is neither consumed nor invested at home must be exported. (A farmer might, for example, export wheat to a barn overseas.) What flows across borders are the unconsumed goods and services themselves. “Other countries are not sending saving to America to give it ‘funds’ to finance their imports,” argue Mr. Kumhof and Mr. Sokol. “Their net exports are the saving, by definition.”

The rest of the article goes on to discuss the problem of conflating financial flows with capital flows, and it asserts that confusion over the two can easily lead to confusion over the meaning of a saving glut. The piece is well worth reading. It concludes:

For many people (including some economists), it is natural to think that saving must precede investment and that deposits must precede bank lending. It is therefore tempting to see saving as a source of funding and the prime mover in many macroeconomic developments. Mr. Kumhof and his co-authors see things differently, giving banks a more active, autonomous role. They give less credit to saving and more to credit.

This issue has come up repeatedly in discussions I have had about savings imbalances and in reviews of my last two books, Trade Wars Are Class Wars (with Matthew Klein) and The Great Rebalancing. Yet I think it poses a false distinction between saving and credit when it assumes that the two act separately. As we show in the book on trade wars, when a country like Japan exports its excess savings to a country like the United States, these excess savings have a financial impact on the United States even though the saving glut takes the form of an overproduction of goods. This flow of excess savings must manifest itself as a diversion of assets or a creation of assets, including most commonly an increase in credit. In such cases, it makes no sense to separate the two.

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