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March 03, 2013

The Savings Glut Explanation: Why It Might Be Wrong and Why It Matters

Posted in: Financial Crisis

Fed Chair Ben Bernanke

In the wake of the Great Crash, we were treated to raucous discussions among economists offering explanations for how such a thing could have happened and who was to blame. Let’s ignore the wingnut explanation that the Government caused the disaster by forcing defenseless banks to lend money to poor people to buy houses. A common view among less insane conservative economists is the Savings Glut theory, that all that money from trade surpluses from China and OPEC nations drove down interest rates and encouraged too much risk-taking. Fed Chari Ben Bernanke strongly supports this view.*

But Bernanke isn’t the only one. The decidedly not conservative Paul Krugman and Robin Wells wrote an article for the New York Review of Books, arguing that Great Crash was primarily the result of the housing bubble, which in turn they attribute to the savings glut, along with out of control financial innovation and the utterly disastrous failure of US and other financial sector regulators.

That view is challenged by economists at the Bank for International Settlements. I described one paper by Claudio Borio here. The essential point of this paper, available here, is that financial models used by macroeconomists ignore the impact of finance on the real economy.

Borio and Piti Disyatat wrote another paper in 2011 directly addressing the savings glut. Yves Smith gives space to Andrew Dittmer to translate it from economese to English here, and I won’t try to compete with Dittmer’ explanation. Here’s the short version from Borio and Disyatat’s 2012 paper:

The core objection to this view is that it arguably conflates “financing” with “saving” –two notions that coincide only in non-monetary economies. Financing is a gross cash-flow concept, and denotes access to purchasing power in the form of an accepted settlement medium (money), including through borrowing. Saving, as defined in the national accounts, is simply income (output) not consumed. Expenditures require financing, not saving. The expression “wall of saving” is, in fact, misleading: saving is more like a “hole” in aggregate expenditures – the hole that makes room for investment to take place. … In fact, the link between saving and credit is very loose. For instance, we saw earlier that during financial booms the credit-to-GDP gap tends to rise substantially. This means that the net change in the credit stock exceeds income by a considerable margin, and hence saving by an even larger one, as saving is only a small portion of that income.

The paper argues that unrestrained extensions of credit and the related creation of money caused the problem. This emphasis on the financing side of the economy edges the 2011 Borio Disyatat paper towards the Modern Money Theory side, but they don’t take that step. They claim that the problem was policy elasticity, by which they mean that bank regulators did nothing to control the credit booms in the financial sector, which they could have done.

The Fed responded to Borio and Disyatat and others who agree in a paper entitled ABS Inflows to the United States and the Global Financial Crisis. The paper explains that global current account surpluses (the savings glut) “increased the supply of capital”**. It turns out they also include a huge pile of other financial assets under at least nominal control of bankers: “currency, deposits, and debt securities held by all domestic sectors”. This money was looking for a safe return. Its managers decided that investing in the US housing boom through real estate mortgage-backed securities was just the thing. The Fed helpfully provides a lovely chart:

That’s $99.7 trillion in accumulated financial wealth in the third quarter of 2007, just before the Great Crash. This isn’t capital, invested in productive activity to hire people to produce goods and services, and earning its return by risking loss of capital. It is a giant pile of debt. It’s sucking our future productivity out of us.

I think that there is too much capital in the form of financial assets, piled up in corporations, hedge funds, foundations, Sovereign Wealth Funds and the entire gamut of money-hiding banks, put there by dictators, drug lords, and other species of hyper-rich people. Some of it may benefit the average person, because it is in pension plans, but it’s a drop in the bucket compared to the financial assets owned by the hyper-rich.

Why does this matter? The simple savings glut explanation, current account surpluses of China and OPEC nations, makes it look like external forces were behind the Great Crash. It supports the false Obama administration line that Wall Street was greedy, not criminal. It enables the regulators to claim that it wasn’t their fault that Wall Street was stealing money from the real economy before and after the Great Crash. It tells us that we stupid borrowers are at fault, not the banksters who shoved money at anyone who could breathe. It pushes the blame to the Chinese and to OPEC nations, convenient scapegoats for neoconservatives. It enables the Administration to complain about the trade policies of the Chinese and thus to push for some trade deal worse than NAFTA for the workers of this country but great for the hyper-rich. It points to a set of fixes for the economy that work out great for the hyper-rich but suck for everyone else. It points to a set of regulatory changes that don’t fix anything, but make banksters richer and more dangerous. In other words, it is just about the worst possible explanation.

An alternative explanation, perhaps supported by the Fed paper, that adds to the Simple Savings Glut theory the massive accumulation of financial assets by a tiny minority of hyper-wealthy people, suggests a completely different set of solutions.

No wonder the Simple Savings Glut theory has so many supporters.

*See bibliography in this paper.

**Here is the relevant paragraph:

Our research builds on a number of papers linking the emergence of the global financial crisis to international imbalances. This research has followed two distinct strands. The first of these is the story sketched out above, in which current account surpluses in the emerging market economies increased the global supply of capital, reduced interest rates in the United States and other advanced economies, and thus encouraged the emergence of the bubble in subprime housing mortgages. Caballero, Farhi, and Gourinchas (2009), Jagannathan, Kapoor, and Schaumburg (2009), Obstfeld and Rogoff (2009), and Rajan (2010), among others, all discuss variants of this argument. Members of the official sector, such as Bernanke (2009) and Bini Smaghi (2008) have also highlighted this line of causation.


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