In its April monthly bulletin, the European Central Bank correctly stated that the reduction in the imbalances between chronic savings in developing nations and chronic excess spending in the developed nations had reversed in the last two years only due to natural economic cycles and not due to deliberate policy decisions. It anticipates that these imbalances would return once the global economic recovery gathered strength. It is coming true. Improvement in the US savings rate has stalled and even reversed. Private consumption in the first quarter picked up in the US and the savings rate declined.
This imbalance—excess saving and excess spending in developing and developed nations, respectively—has one common factor. That is the policy of keeping real rates low enough to be unrewarding to savers. While it is understandable (not necessarily excusable) that debt-burdened nations are locked into low interest rates, it is hard to fathom the same attitude in savings-rich nations. They continue to repose faith in exports and undervalued currencies. Recent growth recovery in the developed world could settle down at lower rates, rendering export-driven growth strategies of Asia obsolete.
Asia needs sustainable domestic demand growth. Sustainable domestic demand requires monetary policy autonomy that is not captive to global pressures. Monetary policy has to focus on “overheating” in a broad sense rather than in the narrow sense of consumer price inflation—headline or core. Savings are being allowed to be eroded by inflation and, on top of that, are “rewarded” with low interest rates. The result is that savers in Asia tend to save more. Global imbalances thus remain unaddressed. The two rising Asian economic powers—China and India—are guilty of perpetuating these imbalances in their own ways.
In China, the state-capitalism model continues to subsidize borrowers at the expense of lenders (banks) who, in turn, are subsidized by the household. Household savings are captured by the state through the banking system. Real deposit rates are negative. In other words, banks provide no compensation to savers against inflation eroding their savings. The other alternatives are speculative investments in real estate and stocks. These go through periodic booms followed by busts. In the 1990s, households bailed out banks and in 2011-12, they would be doing so again to recapitalize banks from their loan binge in 2009.
China would continue to churn out high growth rates on the back of investment funded by bank lending. While attempts to boost household consumption have begun, these are still in their initial stages and reforms to pensions, healthcare and education take considerable time to help raise private consumption. When recent new investments come on stream, it is unclear whether household consumption can rise to the challenge of absorbing all the new capacity created. Consequently, exports will continue to remain critical. This sets up with future conflicts with developed nations who are looking to boost their own exports in the years ahead.
The problem, as economists such as Jahangir Aziz and Li Cui have pointed out for some time, lies in financial repression. A key reason why China’s household consumption has not kept up with gross domestic product growth is that disposable income has consistently fallen. Not because wages have not kept up but largely because household investment income has declined. Therefore, the easier and more effective solution to raising consumption lies in raising investment income by eliminating financial repression. Of course, this will come at a cost, namely, reduced corporate profits and reduced investment, which is what rebalancing demands.
Ironically, India too practises financial repression to appropriate household savings, though by different means and for different ends. In India, it is state spending that household savings finance and not private investment. Indeed, as Aziz pointed out in a different paper, while the financial repression in China acts like a subsidy to investment, in India it works like a tax. Both countries would achieve a far better and more sustainable balance in their growth processes if they eliminate financial repression.
In the developed world, the less said the better. Since the start of the New Millennium, the subsidization of spending and borrowing by savers has reached new heights or plumbed new lows (depending on how one sees it) with nominal interest rates at or near zero everywhere. In its most recent monetary policy meeting, the US Federal Reserve refused to introduce even a modicum of uncertainty about the future path of monetary policy by changing the language.
It is the certainty of low interest rates for a long period that encourages speculation and excessive risk-taking. Fed up with erosion of savings to bank fees while earning inadequate interest rates, savers wade into risky investments when bubbles are overripe and lose them as they inevitably bust. One could not have designed a better system to discourage thrift and prudence.
That policymakers are still at it is the biggest testimony against the theories of rational expectations (human beings learn from mistakes) and that independent economic institutions optimize long-term economic welfare.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at email@example.com