It has been a while since the worst financial crisis occurred (2007/2008), yet the economists still seem to not have reached a consensus on its causes. Explanations for the crises seem to focus on two main branches of reasons: subprime mortgage crisis and global imbalances. Bernanke, in 2005, address this matter in a speech entitled “Global Savings Glut” where he argued that excess savings in China (as well as oil exporting countries and developing Asia) were the main cause for USA trade deficits and low long-run interest rates. As he stated, “during the past few years, the key asset-price effects of the global saving glut appear to have occurred in the market for residential investment, as low mortgage rates have supported record levels of home construction and strong gains in housing prices”, which seems to make a bridge between the two sources of reasons economists fight about. This seemed to be a warning for the western world of what was about to coming. In this post we will argue about the failure of adaptation by the Western countries to China’s massive saving glut.
In the past, China’s savings accounted for less than 1 percent of total global savings. Nowadays, China holds a quarter of the world’s savings. Moreover, large economies conventionally generate gross savings of about 15/20 per cent, while China owns now around 50 per cent. At the moment, Western economies are suffering great distortions given the large scale of savings.
Bernanke used this idea when explaining the United States current deficit. Some Asian countries, especially China, save more than what they invest. This has led to the generation of current account surpluses, which could not be absorbed by investing only in their own countries. Thus, this created the glut to lend abroad to countries in deficit, like the US and other Western countries. A large amount of these foreign savings were channelized mainly at the US government bonds and, like in June of 2013, China was holding US government bonds worth about $1.3 trillion. As a result of this capital inflow, interest rates became lower, which over time generated higher investment and excessive risk-taking, creating the asset price bubble in the US, which end up being the fuel of the crisis.
Aside from creating the framework for the financial crisis, there are other effects that can be pointed out as regards to China’s savings glut, mainly because western governments made mistakes. There was a belief that this glut permitted them to spend more in boom periods and then to count on deficits and taxes from expanding financial services, but as it turns out the results were drastic, leaving governments with high and still rising ratios of debt to GDP. Moreover, it is likely that there will be a settlement of the global assets that China holds close to its share of worlds GDP, as China’s growth slows down. This means that half of this country’s assets will be outside the country itself (given that its savings ratio is twice as large that the world average).
However, it is noticeable that the global savings glut hypothesis suffers from two obvious flaws. First of all, the reduction in USA’s current account deficit only occurred after the collapsing of the housing bubble. And usually the collapse of booms is caused after a sudden stop, not before. But China continued to have huge dollar reserves until 2011. Moreover, the house market prices and current account deficit were not particularly well synchronized. While the prices went down, the deficits reached their peak, at which time it was hopped that the foreign capital were doing some pressure for prices to rise. Second, the imminent focus on net capital flows rather than gross forms misperception. According to Treasury data, the higher source of foreign capital in the US was not Asia but European banks. The main problem for the US was that financial outflows to the rest of the world declined drastically, generating the same current account deficit in 2007 and 2008 even with the different flows exhibit in those years.
With this, we can conclude that saving countries like China are not to be blamed for saving what they have earned. Indeed, it was the failure of adaptation from western countries that caused the problem. Central banks must also be responsible for this, since they are the true originators of the crises because they are printing money, handling their currencies and corrupting the global economy.
Andreia Parreira 646
Rita Azevedo 625