Michael Pettis — Why Increasing Savings Does Not Bring Wealth

Debate about the global savings glut hypothesis is mired in confusion, a fundamental one of which is the seemingly obvious but false claim that a global savings glut must lead to higher global savings. Here, for example, is a recent piece by one of my favorite economists, Barry Eichengreen: 

There is only one problem: the data show little evidence of a savings glut. Since 1980, global savings have fluctuated between 22% and 24% of world GDP, with little tendency to trend up or down.

As surprising as it might sound, global savings gluts do not result in higher global savings except under specific, often unlikely, conditions.

What is a savings glut?

There is no formal definition, but whenever market conditions or policy distortions cause the savings rate in one part of the economy to rise excessively (itself an ambiguous word), we can speak of a savings glut. There are at least two main causes of a savings glut. 

1. A rise in income inequality. We see this in Europe, the US, China, and indeed in much of the world. As wealthy households increase their share of total income, and because they tend to save a larger share of their income than do ordinary households, rising income inequality forces up the savings rate. 

2. A decline in the household share of GDP. We’ve seen this mainly in China and Germany over the past fifteen years. When countries implement policies that intentionally or unintentionally force down the household share of GDP (usually to increase their international competitiveness) they also automatically force down the consumption share of GDP. Because savings is defined as GDP minus consumption, forcing down the consumption share forces up the savings share. There are many policies and conditions that do this, and I discuss these extensively in my book, The Great Rebalancing, but the main ones are low wage growth relative to productivity, financial repression, and an undervalued currency. 

Notice that in both these cases, and completely contrary to the popular narrative that praises high savings as a consequence of household thrift, and so as morally virtuous, the rise in the savings rate does not occur because ordinary households have become thriftier. In the former case household savings rise simply because the rich increase their share of total income. In the latter case national savings rise without households in the aggregate increasing their savings....

Quotes Marriner Eccles, too.

EconMatters
Why Increasing Savings Does Not Bring Wealth
Michael Pettis | Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University

Jeremy Smith — Krugman on inflation, “financial repression” and the 1%

Krugman: “Carmen Reinhart has argued, persuasively, that highly indebted countries normally work off their debt in large part through “financial repression” — keeping interest rates low while inflating part of the debt away. The thing is, although this sounds bad, it actually isn’t — for the vast majority of people. Britain did far better through financial repression after World War II than it did through orthodoxy after World War I.

But there is one small but influential group that is in fact hurt by financial repression: again, the 0.1%”

Jeremy Smith: “Financial repression”, alas, has entered the day to day vocabulary even of progressive economists as if it were a mere “technical term” – as indeed Carmen Reinhart had the chutzpah to describe it in an interview with Der Spiegel! But it is in no way politically neutral, and Ms Reinhart’s own writings demonstrate ample evidence of its ideological bias. Paul Krugman has it right on financial repression. It is a concept that only serves the interests of the 1%.

PRIME
Krugman on inflation, “financial repression” and the 1%

Jeremy Smith

Jeremy Smith — Financial repression – myth, metaphor and reality

If you've heard of financial repression being used as a buzzword and are not quite sure what it is, financial repression is the antonym of financial liberalization. The connotation of both is normative — financial liberalization (private sector freedom) is good and financial repression (government controls) is bad. This is another key norm of neoliberal ideology.

Prime
Financial repression – myth, metaphor and reality
Jeremy Smith

Michael Pettis — Monetary policy under financial repression

In order to understand much of what is happening in China I believe it is crucially important to understand how financial systems operate under condition of financial repression. Because most of what we know about economics is derived from economists whose operating environment is the classical “anglo-saxon” economies (I stress “classical” because for much of the 19th Century, operating under the so-called “American System”, the US itself was not, in my opinion, a classic anglo-saxon economy), there is a tendency to assume that what happens in those economies is somehow the default position in economics, and this not only causes us to underrate important economists that don’t follow this tradition, like the German Freidrich List or the American Albert O. Hirschman, but it also leads us into mistaken assumptions, like the belief that higher interest rates lead automatically to higher savings rates.

We do know some things about financial repression. Two of the first important texts to discuss financial repression comprehensively are Edward S. Shaw,Financial Deepening in Economic Development and Ronald I. McKinnon,Money and Capital in Economic Development. There is, however, a lot more to it than what is generally known, and even this is largely ignored by most economists. It seems to me that many of the mistakes we make when we think about the relationship between cause and effect, for example the impact of monetary policy on China’s economy, arise because we assume that relationships that hold in the US economy are universal and must hold in the Chinese economy too. So to return to the assumption that higher interest rates must lead to higher savings rates, I would argue that this is true mainly under two unstated assumptions, neither of which holds for China.

China Financial Markets
Monetary policy under financial repression
Michael Pettis | Professor of Finance at Peking University's Guanghua School of Management

Warren Mosler: Financial "repressionists" painting fraud

Got this email from Warren Mosler today. As usual, he puts the entire profession of mainstream economics to shame.

Conclusion: The financial repressionists have it all backwards

So the idea is the govt. is 'pushing rates down' through qe and the like, thereby keeping rates below the rate of inflation, and that without this active 'financial repression' rates would otherwise be higher and not 'repressed.'

That is, the govt. is interfering with the 'free market' by said pushing of rates down, and this 'distortion' adversely affects all kinds of things, as happens with any interference in said 'free markets.'

Well, to begin with, interest rates are subject to market forces with fixed exchange rate regimes, like a gold standard, currency board arrangement, or other such 'peg' where the govt. by law exchanges the currency to some 'reserve' thing at a fixed rate. So today this would, at best, apply to HK, for example.

However, it does not apply to floating fx regimes, where the currency has no conversion features at the govt. of issue, like the $US, yen, pound, euro, etc. etc. etc. contrary to the claims of the repressionists.

Either way, the currency is a public monopoly, with taxation a coercive, non market 'interference'. And, of course, monopolists are 'price setters' rather than 'price takers'.
With a gold standard, for example, the govt. sets the price of gold and in theory allows all other price to express relative value as they continuously gravitate towards floating indifference levels.

This includes interest rates (the 'own rate' for the currency) which then fluctuate based on 'storage costs' of the object of conversion which includes govt. default risk with regard to conversion. The same holds for other fixed exchange rate arrangements.

With floating exchange rate policy, without govt. interference, the 'risk free rate' is permanently at 0%, as there is no conversion option, and therefore no conversion default risk. 

In this case, the only way rates can be supported at higher levels is by 'govt. interference'. This includes paying interest on reserve balances at the Fed, issuing Treasury Securities, and open market operations where the Fed buys and sells Treasury securities directly or via repurchase agreements and other such arrangements. All of these function as 'interest rate support' to keep rates higher than otherwise. 

So once again, and another 'who would have thought', it seems the mainstream has it entirely backwards. Yes, govt. is 'interfering' in the interest rate markets, but rather than engaging in 'repression' via 'pushing rates down' it's instead engaging in 'rentier support' by pushing rates up. 

So if these 'free market types' want to make the case that govt. isn't sufficiently interfering to push rates up to adequately support holders of various financial assets, fine. Bring it on! But more likely the realization of what they've actually be purporting should be embarrassing enough to cause them to back off for at least 3 or 4 minutes, don't you think?

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Michael Pettis— What is financial reform in China?

On financial repression:

This is very clearly the case for China, as I have discussed many times in this newsletter. Normally under these circumstances we would expect the losers in the system, the depositors, to opt out of depositing their savings in local banks, but it is extremely difficult for them to do so. There are usually significant restrictions on their ability to take capital out of the country and there are few local investment alternatives that provide similar levels of safety and liquidity.

Depositors foot the bill

Depositors, in other words, have little choice but to accept very low deposit rates on their savings, which are then transferred through the banking system to borrowers, who benefit from these very low rates. Very low lending and deposit rates create a powerful mechanism for using household savings to boost growth by heavily subsidizing the cost of capital.

The ones who lose under conditions of financial repression are net depositors, who tend for the most part to be the household sector. The ones who win are net borrowers, and in most countries in which financial repression is a significant policy tool, these tend to be local and central governments, infrastructure investors, corporations and manufacturers, and real estate developers. Financial repression transfers wealth from the former to the latter.

Read it at China Financial Markets
What is financial reform in China?
by Michael Pettis | Senior Associate at the Carnegie Endowment for International Peace, Professor of Finance at Peking University’s Guanghua School of Management, and Chief Strategist at Guosen Securities (HK), a Shenzhen-based investment bank

Lots of good stuff in this post.

Max Keiser interviews David Graeber

Keiser Report: Oh My Gun! (E281)

(h/t James in the comments)

Blather from Mather

Financial repression is any public policy that is designed to influence the market price of financing government debts, either through government bonds or the nation’s currency. Direct methods of repression include things like setting target interest rates, monetizing government debt or implementing interest rate caps. Indirect methods include polices designed to change the amount of debt or currency at a given price. Examples include requirements to hold minimum amounts of government debt on bank balance sheets or establishing minimum requirements for government bonds in pension funds.

Governments may take these steps to improve their ability to finance public debt and forestall more painful adjustment processes, though there can be other motives, and because these methods are less transparent, and thus less controversial, than direct tax hikes or spending cuts. Investors should be wary of financial repression because it is primarily a tool to redistribute wealth from creditors (citizens) to debtors (governments) to the detriment of creditors, fixed income investors and savers....

It is important to realize these methods as practiced are only partially effective and cannot go on forever, as advanced economies continue to add significantly to their public debts despite low financing costs. Some intensification of financial repression, fiscal austerity, or stronger growth must occur to lower the likelihood of a future debt crisis.

Scott A. Mather, PIMCO Economic Outlook, Game Change for Bond Investors?

Note:

1. "Governments practicing financial repression may be transferring wealth from creditors (citizens [bondholders]) to debtors (governments) to the detriment of creditors, fixed income investors and savers [rentiers]."

Bond holders are clearly upset by the prospect that QE3 (if it comes about) will target price instead of quantity, thereby capping interest rates. Fed bond purchases also transfer the interest on those securities to government, reducing the non-government net financial assets that would have accrued.

PIMCO is apparently concerned that Bernanke has figured out how to neuter the "bond vigilantes" by taking control of interest rates along the yield curve, a control that naturally falls to government as the currency monopolist.

2. "It is important to realize these methods as practiced are only partially effective and cannot go on forever, as advanced economies continue to add significantly to their public debts despite low financing costs. Some intensification of financial repression, fiscal austerity, or stronger growth must occur to lower the likelihood of a future debt crisis."

Mather does not seem to get that sovereign debt crisis is an oxymoron for countries like the US that are monopoly providers of a nonconvertible floating rate currency. This also accounts for the hissy fits that Bill Gross has recently been throwing.

Obviously, this will not "go on forever." It is an attempt to turn the economy around, although perhaps a misguided one, or else a hail mary pass since Congress refuses to act fiscally.

But it won't end because "it can't go on forever." The Fed already sets the overnight rate, and there is no contradiction in its setting the yield curve, too.

(h/t Zero Hedge)