GFC confusion, part 3: caused by savings glut

There is a theory running around some quarters that the financial crisis and world recession were caused by too much savings from countries like China and Japan. The theory runs that this excessive savings had to go somewhere so it wound up in a property boom in America, which eventually was unwound, giving us the crisis.

But this diagnosis totally fails to explain the main problem.

First, there is nothing bad about having lots of savings in the world economy. A higher level of savings will lead to lower interest rates and allow more marginal businesses to raise capital for their marginal projects. For example, if the world interest rate is 5% then only businesses with an expected return above 5% should get finance. But if the world interest rate drops to 3% then all of those business plans with an expected return between 3% and 5% should now be able to access finance.

None of this is a problem.

So to complain about too much savings still leaves the main question unanswered – why did the money go to the wrong place? There is nothing in inherent about Chinese savings that makes that money want to go into an American property boom. It could have gone anywhere. So the “too much savings” thesis fails to answer the main question.

It is true that low interest rates exacerbated the housing bubble. Once the money started flowing the wrong way, when you turn up the tap you get more money flowing the wrong way. But even then, it is unfair to blame savers for that. You need savers in financial markets and there is no objective right or wrong level of savings. The right amount is whatever is good for the savers, and the borrowers will adjust to that.

If we want to blame anybody for “turning up the tap” then the blame rests with the US federal reserve. Between 2003 and 2007 they kept monetary policy too loose and interest rates too low, allowing inflation to build up in the economy. At least the Chinese savings was real money. The extra money pumped in by the federal reserve was never sustainable and would always require a correction.

(For the previous articles in this series, see here and here)

7 thoughts on “GFC confusion, part 3: caused by savings glut

  1. So we need a good balance. The stimulus shows that Australia can stay out of trouble by judicious spending- but not too much.
    Small items would be better, especially if they also improved the mind.
    What every Australian should do is buy a good magazine, and read that magazine! A magazine devoted to current affairs, say, or policies. Wait a minute! There’s such a magazine on the shelves right now! With some rivetting items about income taxes!
    Go out and buy ‘Policy’ magazine right now! And read the informative articles!

  2. All correct, sir.

    Blaming Chinese savings also ignores the fundamental issue of where China got the money – their savings is primarily in US dollar denominated assets after all. This was achieved solely through the sale of mass quantities of produced goods to the United States, since we no longer have any kind of manufacturing base. But that also means that the vast majority of Chinese savings was acquired through trading things of tangible value to Americans.

    Whereas, the Federal Reserve’s artificially-created explosion in cash in the monetary base was backed by… NOTHING.

    Point being, the Chinese savings boom was real and, while not indefinitely sustainable, most assuredly not any artificial bubble (and thus would not have required a correction… certainly not a painful one). The Federal Reserve bubble however is just fraudulent, currency devaluing idiocy.

  3. I suppose I should also note that, whatever of the Chinese savings came from the Fed’s printing press would technically “not” be real wealth either, but I think it’s safe to assume that the majority of reason we (the US) sent them so much money over the last few decades is because we’ve systematically destroyed our own ability to produce competitive goods…

  4. The price of credit (ie interest rates) ought to be deregulated. This idea that central banks should fix interest rates, even if via the current crawling peg policy, is fundamentally flawed. They ought to simply fix the value of currency relative to gold or some such tangible natural commodity. Or even better they should exit the market entirely and cease to be.

  5. Pingback: GFC confusion, part 4: blame derivatives « Thoughts on Freedom

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