The Coming US Deflationary Depression

Morgan Stanley

Another new theory has been concocted to rationalize unsustainable excesses. The notion of a “global saving glut” has been proposed -- and quickly accepted -- as a new and important excuse for mounting global imbalances. It is also thought to explain why interest rates are so low -- resolving the great conundrum of our time by stressing the mismatch between excess capital and limited investment opportunities. Finally, this theory implies that global imbalances are more benign than malign -- drawing into question the urgency for any rebalancing.

[...]
That the leading apostle of this new theory -- Ben Bernanke -- was, until recently, a governor of the Federal Reserve is all the more curious. In my view, no one has a bigger stake in dismissing the perils of the Asset Economy than its architect, the Fed. This brings up an alternative explanation to the savings-glut thesis: It hinges on the role of the US central bank. By condoning the equity bubble of the late 1990s, a case can be made that the Fed set in motion a post-bubble defense strategy of extraordinary monetary accommodation that all but insured a steady stream of “echo bubbles” -- from bonds and credit to emerging-market debt and property. Given the shortfall of labor income generation evident in this jobless and wageless recovery, US consumers have turned to asset-driven wealth effects as both a supplement to saving and as the principal means to fund the greatest consumption binge in modern history. By anchoring interest rates at the short end of the yield curve at close to zero in real terms, this same excess monetary accommodation not only supports overvaluation in asset markets but also enables homeowners to go deeply into debt in order to extract purchasing power from assets in order to fund the US consumption binge. By focusing on the saving glut, Bernanke conveniently offers a revisionist history and theory that all but exonerates the Greenspan Fed from any culpability in spawning the world’s unprecedented imbalances. Such a mindset ignores the mounting pitfalls of yet another post-bubble shakeout -- this one dominated by the downside of overvalued property markets and the concomitant unwinding of a potentially lethal debt cycle.


All this is not to deny one very important aspect of the global saving glut story -- the surplus of saving that exists throughout Asia and parts of Europe. In my view, this is traceable to a seemingly chronic shortfall of domestic private consumption -- from Japan and China to Korea and Germany. While the reasons behind this trend are as diverse as the economies themselves, the common thread is a lack of job and income security brought about by ongoing restructuring (Japan), reforms (China), or the threat of both on still rigid economies (Germany). But that raises the possibility of an even greater challenge for the United States: As restructuring and reforms run their course in nations with current account surpluses, their excess saving should eventually be absorbed and translated into renewed emphasis on consumption. That would then make it all the more difficult for America to fund its massive current account deficit at today’s asset prices and foreign exchange value of the dollar.


Implicit in the saga of the global saving glut is yet another effort at scapegoating -- in effect, pinning the blame on the world’s savers while exonerating American consumers and the US central bank from fostering mounting global imbalances. Unfortunately, by failing to face up to its own excesses, the United States does itself and the rest of the world a huge disservice. I’ve said it from the start: Global rebalancing is an urgent and shared responsibility. The sooner the world seeks a collective resolution of its problems, the less likely a disruptive endgame.

The Bush Administration is ignoring economic policy. They have a more important agenda of building an American empire to control sufficient oil supplies to keep it's oil hunger happy, transfering past, present, and future business taxes to business to pay back support and to build capital in large multi-nationals that will eventually create jobs. Unfortunately, most of the jobs created have been overseas, so the US has a "jobless, wageless recovery" as Roach calls it. Not only that, the excess savings in Asia, produced by deficit spending in America will eventually be used up. In the US, a massive correction will occur, interest rates will increase dramatically, housing prices will crash, and loan defaults will go sky high. Recession will give way to deflation. Wages and prices will drop. The only people who will benefit are the multi-nationals that will now have a new highly efficient and cheap labor force to invest in.
The US wage earner will find globalization means a sudden loss in purchasing power, huge unemployment, and a labor market very much like Asia in the US. We all know what got us out of the last Depression: WWII. So we'll need a war with China to get a wage recovery.
Doesn't that sound appealing? This is what Bush and his cronies have in mind: a return to the Pre-FDR Hoover economy.


Complete Article
Global: What Global Saving Glut?
Stephen Roach (New York)
Another new theory has been concocted to rationalize unsustainable excesses. The notion of a “global saving glut” has been proposed -- and quickly accepted -- as a new and important excuse for mounting global imbalances. It is also thought to explain why interest rates are so low -- resolving the great conundrum of our time by stressing the mismatch between excess capital and limited investment opportunities. Finally, this theory implies that global imbalances are more benign than malign -- drawing into question the urgency for any rebalancing. I don’t buy the global saving glut hypothesis, and here’s why.
At the heart of this debate is America’s massive current account deficit. Both history and theory tell us that such outsize external imbalances are not sustainable. Yet, so far, the time-honored current-account adjustment has yet to play out. There have been many attempts in recent years to come up with new theories to explain why: The so-called Bretton Woods II hypothesis is one such strain of thinking -- essentially arguing that a mercantilist Asia must now be seen as part of an expanded dollar bloc that is more than willing to provide the external funding for an income- and saving-short US consumer (see M. Dooley, D. Folkerts-Landau, and P. Garber, “An Essay on the Revived Bretton Woods System,” September 2003). More recently, former Fed Governor Ben Bernanke has pushed the debate even further, famously suggesting that a global saving glut is a key factor behind America’s gaping current account deficit (see his 10 March 2005 speech, “The Global Saving Glut and the US Current Account Deficit”). In Bernanke’s view, the US is effectively doing the world a favor by absorbing a surfeit of saving that is sloshing around increasingly integrated global capital markets.
The saving-glut hypothesis has quickly become the rage, endorsed by policymakers, a broad consensus of investors, and the popular media -- the latest press endorsement being the July 11 cover story of Business Week. Experience tells us that new theories such as these almost always crop up during periods of financial market excess. Look no further than the New Paradigm thinking of five years ago. In this same vein, it pays to heed the everlasting wisdom of Graham and Dodd, who some 70 years ago looked back on the excesses of the Roaring 1920s and wrote, “…[T]hat new theories have been developed and later discredited, that unlimited optimism should have been succeeded by the deepest despair, are all in strict accord with the age-old tradition.”
Conjecture about a global savings glut would make Graham and Dodd cringe. In my view, not only is the notion of excess global saving hard to support with empirical evidence, it is also hard to support from a theoretical point of view. IMF statistics provide our best gauge of global saving. In 2004, the IMF’s global flow-of-funds framework put the world saving rate at 24.9% of global GDP. While that marks the second consecutive yearly increase in this measure, it is only 1.9 percentage points above the 23% norm that prevailed from 1983 to 2000. Yes, the global saving rate has edged up from its longer-term average, but this hardly qualifies as a glut. Moreover, this fixation on saving ignores the other side of the macro ledger -- an equally significant increase in global investment. In 2004, the IMF estimates that world investment rose to 24.6% of world GDP -- also a second consecutive annual increase and only 0.3-percentage point below the world saving rate. So where’s the glut? Macro theory, as well as our double-entry macro accounting system, stresses that saving always equals investment. That identity remains very much intact today -- hardly supportive of the notion of an over-abundance, or a glut, of global saving that would both resolve the interest rate conundrum and explain the absence of a US current account adjustment.
Alas, the devil is in the detail -- or, in this case, in the shifting composition of global saving and investment. Two main forces have been at work in reshaping this mix -- namely, a record plunge in the US saving rate matched by an equally large increase in the saving rate of the developing world, especially Asia. On the IMF’s basis, the US gross saving rate fell to 13.6% of GDP in 2004. (Note: Gross saving rates include depreciation charges -- unlike the net saving rates that I have long underscored, which exclude such charge-offs). That represents a 3.3 percentage point plunge from the 16.9% average that prevailed over the 1983 to 2000 period. By contrast, the IMF puts the saving rate in the developing world at 31.5% of its GDP in 2004 -- up a whopping 6.5 percentage points from its 1983 to 2000 norm of 25%. Reflecting the sharp increase in Chinese saving, developing Asia has led the way on the saving front; its overall saving rate is estimated to have surged to 38.2% in 2004 -- up dramatically from the 28.8% norm of the 1983 to 2000 interval.
The mirror image of this pattern shows up in the shifting mix of the global disparities between saving and investment. In 2004, US gross investment exceeded gross saving by 6.0 percentage points of GDP, whereas in Developing Asia, saving exceeded investment by 2.7%, led by China. Surplus saving was also evident last year in Japan (3.7% of its GDP), Germany (3.6%), and, to a lesser extent, Latin America (1.2%). The balance between any nation’s gross saving and investment is basically the functional equivalent of its current account position. Saving deficits translate into current account deficits, whereas nations with surplus saving positions run current-account surpluses. All this simply restates the rather obvious point that I have noted ad nauseum over the past several years -- that the world is now beset by record disparities between those nations with current-account deficits (mainly the United Sates) and those with current-account surpluses (mainly Asia). The problem is not the overall state of global saving or investment, but the tensions that have opened up between deficit and surplus nations. The imperatives for a rebalancing of this disparity remain urgent, in my view.
There may be a deeper and potentially more sinister meaning behind the saga of the global saving glut. In my view, it is being used as a foil to deflect attention from one of the world’s most serious imbalances -- the excess consumption of America’s asset-dependent economy. In his treatise on the saving glut, Ben Bernanke goes on at length to dismiss the connection between America’s saving shortfall and its current account deficit. He stresses, in particular, the seemingly incongruous relationship between America’s fiscal balance and its external shortfall -- noting that the US current account deficit widened in the late 1990s as the federal budget moved into a rare position of surplus. What Bernanke conveniently leaves out of this discourse is the plunge in the personal saving rate over this same period from 4% to 1% on the back of a powerful wealth effect brought about by the equity bubble. In a similar vein, he all but dismisses the even more worrisome substitution of property-based wealth effects for income-based saving in recent years. In fact, he actually reverses the causality of these asset effects -- arguing that they should be treated as “endogenous” by-products of the global saving glut and the associated search for return, or yield. In other words, according to this line of reasoning, America’s asset bubbles are innocent victims of global circumstances rather than visible signs of domestic markets and US consumers that have gone to excess.
That the leading apostle of this new theory -- Ben Bernanke -- was, until recently, a governor of the Federal Reserve is all the more curious. In my view, no one has a bigger stake in dismissing the perils of the Asset Economy than its architect, the Fed. This brings up an alternative explanation to the savings-glut thesis: It hinges on the role of the US central bank. By condoning the equity bubble of the late 1990s, a case can be made that the Fed set in motion a post-bubble defense strategy of extraordinary monetary accommodation that all but insured a steady stream of “echo bubbles” -- from bonds and credit to emerging-market debt and property. Given the shortfall of labor income generation evident in this jobless and wageless recovery, US consumers have turned to asset-driven wealth effects as both a supplement to saving and as the principal means to fund the greatest consumption binge in modern history. By anchoring interest rates at the short end of the yield curve at close to zero in real terms, this same excess monetary accommodation not only supports overvaluation in asset markets but also enables homeowners to go deeply into debt in order to extract purchasing power from assets in order to fund the US consumption binge. By focusing on the saving glut, Bernanke conveniently offers a revisionist history and theory that all but exonerates the Greenspan Fed from any culpability in spawning the world’s unprecedented imbalances. Such a mindset ignores the mounting pitfalls of yet another post-bubble shakeout -- this one dominated by the downside of overvalued property markets and the concomitant unwinding of a potentially lethal debt cycle.
All this is not to deny one very important aspect of the global saving glut story -- the surplus of saving that exists throughout Asia and parts of Europe. In my view, this is traceable to a seemingly chronic shortfall of domestic private consumption -- from Japan and China to Korea and Germany. While the reasons behind this trend are as diverse as the economies themselves, the common thread is a lack of job and income security brought about by ongoing restructuring (Japan), reforms (China), or the threat of both on still rigid economies (Germany). But that raises the possibility of an even greater challenge for the United States: As restructuring and reforms run their course in nations with current account surpluses, their excess saving should eventually be absorbed and translated into renewed emphasis on consumption. That would then make it all the more difficult for America to fund its massive current account deficit at today’s asset prices and foreign exchange value of the dollar.
Implicit in the saga of the global saving glut is yet another effort at scapegoating -- in effect, pinning the blame on the world’s savers while exonerating American consumers and the US central bank from fostering mounting global imbalances. Unfortunately, by failing to face up to its own excesses, the United States does itself and the rest of the world a huge disservice. I’ve said it from the start: Global rebalancing is an urgent and shared responsibility. The sooner the world seeks a collective resolution of its problems, the less likely a disruptive endgame.