...against fictions and other tall tales

Tuesday 26 July 2011

The myth of the "global savings glut": Excessive risk-taking caused the crisis, not excess savings

Several speeches by central bank officials these days contain statements describing the need to eliminate the so-called global imbalances (the notion that large trade deficits and trade surpluses in different parts of the world are unsustainable).

Of course, re-balancing trade flows would certainly be a positive development, as it would help to unlock the grip that large surplus countries have on world production and enable other countries to more fully partake in the global economy.  Such a re-balancing might even trigger a dispersion of manufacturing and other commercial activities away from China and other surplus countries toward other emerging markets and, hopefully, back to developing countries.

From the standpoint of global fairness and economic development, the need to re-balance is a justified, sensible proposition.

Also, many people (and policymakers) seem to think that a re-balancing is necessary in order to prevent another financial crisis from occurring. At the heart of this belief lies the idea that it was the savings of countries running large current account surpluses (read China) that brought down US interest rates and led to the credit boom that caused the crisis. This is the story of the "global savings glut", as Ben Bernanke depicts it. In my view, the story makes for an interesting theory; however, according to the facts, the story is closer to myth than reality.

I've already addressed here the argument suggesting that low interest rates were responsible for the crisis. However, there are several other reasons to doubt the global savings glut story, many of which are found in this paper by Claudio Borio and Piti Disyatat of the Bank for International Settlement (BIS) entitled "Global imbalances and the financial crisis: Link or no link?". In the paper, Borio and Disyatat present seven key inconsistencies associated with the claim that savings from China and other countries running current account surpluses had a role in causing the crisis (p. 4).

First, the authors question whether there is a strong link between current account balances and US dollar long-term interest rates. For instance, the paper shows that, while long-term interest rates were increasing between 2005 and 2007, there was no apparent decrease in the US current account deficit.

Second, the authors note that the depreciation of the US dollar during the last decade is inconsistent with the claim that there was increasing demand for US assets from non-residents.

Third, the authors present evidence demonstrating that the link between the US current account deficit and global savings isn't as strong as commonly suggested. For instance, Borio and Disyatat show that, while the deficit began its deterioration in the early 1990s, the world savings rate actually trended downward to the end of 2003. Also, the paper shows that, while the savings rate in emerging markets has been increasing since 2006, the US current account deficit has tended to stabilize or narrow.

Fourth, the authors show that real world long-term interest rates have trended downward since the early 1990s, irrespective of changes in the global savings rate.

Fifth, the authors note that the rise in the savings rate of emerging markets is inconsistent with the strong growth that occurred between 2003 and 2007. If anything, the authors argue, the rise in savings should have instead depressed aggregate demand and slowed global growth.

Sixth, Borio and Disyatat argue that credit-fueled growth was not associated solely with deficit countries. Countries with surpluses, such as Brazil and India, have all had their bouts of credit booms recently.

Lastly, the authors point out that the countries viewed as responsible for the crisis (read again China) were those least affected by the crisis.

While all seven of these explanations are meant to refute the hypothesis of the global savings glut, it is the last two that provide the biggest clues for understanding what really caused the crisis. According to Borio and Disyatat, it's not the large current account deficits but rather the increasing gross capital flows since the 1990s that are to blame. Conceptually, the authors object to the focus on current account balances as an explanatory variable because it fails:
...to distinguish sufficiently clearly between saving and financing. Saving, as defined in the national accounts, is simply income (output) not consumed; financing, a cash-flow concept, is access to purchasing power in the form of an accepted settlement medium (money), including through borrowing. Investment, and expenditures more generally, require financing, not saving. The financial crisis reflected disruptions in financing channels, in borrowing and lending patterns, about which saving and investment flows are largely silent. (p. 1) (original emphasis)
In other words, the problem with using current account statistics, the authors claim, is that they capture the net financial flows that arise from trade in real goods and services but exclude the underlying changes in gross flows and their contributions to existing stocks, including those transactions relating to trade in financial assets consisting of the overwhelming majority of international financial activity. Also, the current account is silent about the extent to which domestic investments are financed from abroad.

Borio and Disyatat demonstrate these points by showing how gross capital flows rose from approximately 5 percent of world GDP in 1998 to over 20 percent in 2007, with the bulk of this expansion reflected in flows between advanced economies despite a decline in their share of world trade (p. 13).

Also, the authors show that the most important source of capital inflows into the US before the crisis originated in Europe, not emerging markets (p. 15). Finally, the paper shows the extent to which European banks were prominent in global banking during the last decade:
Since 2000, the outstanding stock of banks’ foreign claims grew from $10 trillion to a peak of around $34 trillion by end-2007, an expansion that is striking even when scaled by global GDP [...]. European banks accounted for a large fraction of this increase. (p. 16)
As a result, Borio and Disyatat argue that the causes of the financial crisis cannot be properly understood by looking at changes in national savings rates or real economy indicators such as current account balances. The fact that these indicators do not capture the underlying trend toward increased risk-taking on the part of banks and their involvement in supporting the expansion in the US housing market make them meaningless for understanding the true causes of the crisis.

Instead, the authors conclude that a large part of the blame lies with the banks, as well as the inadequacy of the financial system's regulatory regime and its inability to prevent excessive risk-taking and the development of credit and asset price booms.

Borio, C. and P. Disyatat, "Global imbalances and the financial crisis: Link or no link", Bank for International Settlement Working papers No. 346.


  1. Great piece, circuit. On the Nail. Great idea to put Borio-Disyatat in evidence. You're one of a very few master columnists that also cites and credits so profusely. Borio is ahead-of-his-time. Check BIS WP158.

  2. My hat goes off to you, Jorge. You do a pretty good job yourself in citing references and sharing your knowledge. I follow Borio and Disyatat quite closely. They're definitely near the top when it comes to mainstream views. I don't always agree with some of the details in their work, but I think these authors are doing a fine job in trying to shift the paradigm in monetary econ.

  3. Were I three score younger, and a pinch of salt on my every scar, I would enjoy the exponentials that appear daily in the field. Alas, I now restrict myself to the better proponents. Continue laying it out so clearly, lest minds get tangled. Best to your work circuit

  4. You would need salt mines to cover your scars. Old keynesians never fade, they linger on, especially those that followed the wagon trains west.

  5. To G. Those who portend against authentic K are actually revisionist walrasian classicists short of ideas, disenchanted monetarists looking for a coroner to bribe and deconstructed institutionalists. Need I say more also on the neos and posts. I am old but we ( I et al) took the train and made the trip even with scars built up during the 60 & 70's.

    Policy seniors from New England are still waiting for the NEXT train to the promised land. But the lot are actually all rolling on K-rails. There are no trains on non-K-rails. Recall, Milton (he was good)reneged in the end, Joe S and Paul K (both are good) are patching up theories, and they realise there isn't a NEXT train to the promised land not on K-rails. All trains must travel on K-rails. Paul S almost made it: but he crashed his engine.

    We need another inspiring Music Break.

  6. Your account on BB's 'global savings glut' as a myth is right on.

  7. Jorge. «pleasure» to nod. No one diagrees that K laid the rails for modern economics, but there's a great deal to say about the contributions of neo-K and post-K to the issues emerging after Kennedy and Johnson-some are conceptually leading edge. Circuit theory as this column demonstrates has much analytical depth and relevance.

    As you suggest-get some music.

  8. It's nice to come back from holidays and read these exchanges. Jorge, I like the train analogies. I wonder, however, whether it is correct to say that there are no trains on non-K-rails. As this post shows, it appears to me that econs like Borio and Disyatat (and others, such as Ulrich Bindseil at the ECB) seem to be pushing (monetary) economics in an interesting direction. My own impression is that they don't see themselves as Keynesians (another train perhaps...). However, IMO the avant garde elements in their work vindicates much of the post-Keynesian monetary economics of the last decades (e.g. endogenous money, monetary analysis...). Too bad they don't attribute it as such.

    Goffredo, in a sense, Jorge may be right in criticizing the early post-Keynesians. I think Jorge is saying that its lack of unity and focus made it a weak alternative to the mainstream.

  9. It's always important to step back and look at the big picture. It's easier after a vacation. Conceptually, modern economics is built on rails Keynes laid. Everyone else is a footnote-pro or con. B&D are excellent but they're not foundational thinkers and they are not as esoteric as others make them out to be. As you correctly perceived-they ride another train on K-rails, and they engineer another train also on K-rails. Their focus on balance sheet policy, private and public is enlightening but a niche mechanism. As far as Bindseil, his interest in risk management and emphasis on modus operandi of Central banks is keynesian in overtones but again very niche. But they all are good economists.

  10. It may be nice for some to return from holidays, but I spent yesterday trying to save the little left on my 401(k). At least I had stocked up on Baby Powder.

    May I suggest Mozart's Requiem (D-minor) esp the Dies Irae.

  11. Yeah, my buddies at J&J were quite pleased. Excellent music suggestions for the times.

  12. For your retirement or your kids, goffredo

  13. @Tony 'circuit' that's my portfolio you're giving away. @keynesp, two are retiring in 5 an 7 years. Circuit's research department knows the details.

  14. Who's Tony? Not me, sorry! The good news is that your portfolio is still well under wraps. Perhaps you're referring to Tony Montana who said "Every dog has his day!".

  15. I know, I wrote Tony an email threatening to sue him on breach of confidence, and he told me the only circuit he followed was the closed circuit ??? Better that way. Otherwise I'd have had CPAs and attorneys settling on alimony with the losses I'm incurring from this nightmare of a market. At my age, who needs the headache.

    The appropriate description is Dog Day Afternoon, and that's been market for the last few weeks.