Debunking The Global Savings Glut Theory

The global savings glut theory, embraced by no one more prominent than Ben Bernanke, the chairman of the U.S. Federal Reserve, attributes the global imbalances not to a U.S. propensity to overconsume. Rather, the supposed root cause of all evil is the flood of foreign capital into the United States, and hence — perplexingly — the propensity of certain countries to “save” too much.

Traditionally, trade imbalances were understood to be caused by differences in national levels of saving and investment. National savings are comprised of the savings of three sources — the household sector, the business sector and the government sector. Investment is made up primarily of investments in factories and equipment, as well as residential investment, the building of houses and apartment buildings.

The rationale for attributing the trade imbalance to the difference in national levels of savings and investment runs as follows. If a country invests more than it saves, then that country can borrow from abroad to finance that gap.

In that case, that country would have a surplus on its financial account and (since the balance of payments must balance) a deficit on its current account. In other words, a country that invests more than it saves will have a current account deficit.

Investment > Savings = Current Account Deficit

Conversely, a country that saves more than it invests, can lend its surplus savings to other countries. It then will have a financial account deficit (money flows abroad) and (again, since the balance of payments must balance) a current account surplus. Thus, a country that saves more than it invests will have a current account surplus.

Savings > Investment = Current Account Surplus

Bernanke has often used this reasoning to explain the United States massive current account deficit. Some countries like China, he argues, save more than they invest, causing them to have a current account surplus and a glut of savings that they need to lend abroad to savings deficient countries like the United States.

This allows the United States to borrow from abroad and invest more than it saves, which produces the U.S. current account deficit.

Bernanke often used this argument to explain away the U.S. current account deficit, even as it grew to terrifying proportions. It peaked at $800 billion in 2006.

Bernanke liked to explain that countries like China, Japan, Korea and Taiwan had such a high propensity to save that it simply wasn’t possible for them to find profitable investment opportunities for so much savings in their own countries.

This assertion is at least somewhat astounding, given the very high rates of economic growth that most of those countries experienced. Either way, in this view they were compelled to lend to the United States, thereby causing America’s massive current account deficit. That line of reasoning became known as Bernanke’s “global savings glut theory.”

That argument ignores one very important fact: Most of the money those countries invest in the United States is not derived from “savings.” The money those countries invest is newly created fiat money.

When the People’s Bank of China (PBOC), China’s central bank, created $460 billion worth of yuan in 2007 to manipulate it currency by buying dollars, that $460 billion worth of yuan was not “saved,” it was created from thin air as part of government policy designed to hold down the value of its currency so as to perpetuate China’s low wage trade advantage.

That is a very important difference. It introduces a third variable in addition to saving and investment, “fiat money creation.” Therefore, the equations expressing the determinants of the balance on the current account must be rewritten as follows:

(Savings + Fiat Money Creation) > Investment = Current Account Surplus

When a country’s savings when combined with the paper money created by its central bank exceeds the amount of its investment, then that country will have a current account surplus that will force other countries that do not create as much paper money to have current account deficits. And,

Investment > (Savings + Fiat Money Creation) = Current Account Deficit

Thus, it has not been a “savings imbalance” so much as an imbalance in the amount of paper money being created by the world’s central banks that is responsible for the “global imbalances” that destabilized the world.

Seen in this light, it is clear that the paper money creation by the PBOC and other currency manipulating central banks, which amounted to nearly $5 trillion between 1999 and 2007 alone, is responsible for destabilizing the world economy — but not differences in the rate of real “savings” as Bernanke contends.

China’s economy has been growing at roughly 10% a year for two decades. It has the highest level of investment relative to GDP any country has ever experienced (46% in 2009). It is absurd to argue that there are not enough attractive investment opportunities in China to absorb its savings and that China therefore is compelled to lend its surplus “savings” to the United States.

The truth is that China’s central bank prints yuan and uses it to buy dollars in order to hold down the value of the yuan to support export-led growth. It is the dollars that the PBOC accumulates in that manner that are “lent” to the United States.

The money China pumps into the United States has had effects that most U.S. policymakers consider very welcome and are keen to achieve. Chinese funds drove up asset prices, drove down interest rates and made funds available for a wide range of malinvestment, especially in housing.

In the years leading up to the crisis, it fuelled a credit bubble that pacified the Americans who were losing their manufacturing jobs to low-wage Chinese competitors.

Think of the Federal Reserve’s actions since 2008. In two rounds of Quantitative Easing, the Fed created $2.3 trillion. That money is now on the Fed’s balance sheet. It is considered to be part of the U.S. “monetary authority’s” assets.

Is it savings? Did the Fed “save” $2.3 trillion? Of course not. It “printed” that money.

That is exactly what The People’s Bank of China, The Bank of Japan, The Bank of Korea, The Central Bank of the Republic of China (Taiwan) and a long list of other central banks have been doing for many years.

But instead of acknowledging its own complicit — if not actively steering — role in the global money explosion, the U.S. Fed prefers to blame others.

But either way one wants to cut it, there has been a glut. Of that there can be no doubt. But it has been a paper money printing glut, not a savings glut.

Savers should not be blamed for saving the money they have earned. Central banks are to blame and should be held accountable for printing money, manipulating their currencies and destabilizing the global economy.

The paper money that the central banks have created has played a leading role in bringing the world economy to the brink of catastrophe.

The extent to which the U.S. government has been complicit in this arrangement is uncertain. There can be no question, however, that the government found it easier to finance its massive budget deficits as a result of those inflows.

There can also be no doubt that this arrangement is responsible for the hollowing out of the United States manufacturing base, the current high rates of U.S. unemployment and the unprecedented duration of joblessness among those who are unemployed.

In other words, it’s high time, Mr. Bernanke, instead of playing the innocent bystander, to acknowledge the chaos you have wrought.

Editor’s note: This article is adapted from The New Depression: The Breakdown of the Paper Money Economy (John Wiley & Sons) by Richard Duncan. Published by arrangement with John Wiley & Sons. Copyright © 2012 by Richard Duncan.