Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.
There is this question:
Does the Chinese trade surplus have a "global recessionary impact"?

And this question:

That is, does the savings glut theory have any merit?

However, the savings glut theory rests upon a distinctive understanding of the three balances that requires us to turn cause and effect on its head, and have what is largely a consequence take a leading role as a cause.

The three balances are, recall ...

Expenditure (breaking consumption down between income-financed consumption C_y and externally-financed consumption C_f) is Income-finance consumption, externally-financed consumption, gross domestic investment in productive capacities (including capacity to provide residential services), government spending, and exports.

Cy + Cf + Ig + G + EXP --> GDP

That expenditure provides national income, which is divided between taxes, income-financed consumption, saving in the period, and imports ...

GDP --> Y --> Cy + T + S + IMP

... where the system is in a stable state if the level of Cy that is helping to cause income is the same as the level of Cy that is caused by income.

As a matter of accounting, those injections and leakages can be organized by sector:

Cy + Cf + I + G + EXP = Cy + T + S + IMP =>

Cf + I + G + EXP = T + S + IMP =>

(Cf + I - S) + (G-T) + (EXP-IMP) = 0

or, in the internal/external breakdown:

(Cf + I - S) + (G-T) = (IMP-EXP)

Net new private creation of financial assets from debt-financed consumption and investment in productive capacity plus net new public creation of financial assets from government deficit spending can occur if there is a net finance of a trade deficit, as those financial assets are held overseas.

Now, is that financially sustainable? It very much depends on what is being purchased with the external finance.

Take the "crowding in" scenario: government is spending heavily on productive infrastructure that is acquiring a sustainable ability to harvest resources, plus increasing the efficiency of the economy through increasing the efficiency of resource use. That increase in availability and efficiency of domestic resources leads to private investment in productive capacity. Strong income growth combined with effective regulation of consumer finance to ensure the prudence of the lending means that there is strong saving than externally-finance consumption, and private investment is greater than the balance between the two:

(I - (S-Cf)) + (G-T) = (IMP-EXP)

Provided the average rate of growth of the economy over a business cycle that results is greater than the average trade deficit as a percentage of GDP that results, that could well be sustainable external finance (assuming appropriate terms on external finance, match in maturity of obligations and pace of income growth, etc.).

Now, by contrast assume that Income growth is sluggish, much increase in consumption spending is externally-financed, investment in productive capacity is sluggish, and the government deficit is a pure consumption expenditure, such as spending on aggressive and reckless overseas military adventures.

(Cf - (S-I)) + (G-T) = (IMP-EXP)

In this case, external finance of reckless military adventures and unsustainable debt-financed consumption seems less likely to be sustainable over the long term ... the external finance is not being invested in sustainable economic growth, and therefore an escalating amount of foreign finance may be required over time to sustain the same growth rates, eventually leading to a trade deficit that is a larger share of GDP than any projection of likely economic growth, even the optimistic ones.

OK, call the second case the "WJClinton/GWBush Economic Model". What would the role of the "savings glut" be?

If the US is engaged in the borrowing, clearly the role of the Chinese here is in accommodating, not in causing, the long term unsustainable GDP growth model. And that accommodating entails finding a mechanism for providing the external finance so that the US could continue to purchase Chinese exports, even though the US was on a growth path that is unsustainable in the long term.

Now, is this recessionary? Compared to what alternative? The Chinese have simply been in no position over the past two decades to dictate to the United States that is must adopt a sustainable GDP growth path. The only choices that it has had have been to either accommodate the growth path, putting off the day of reckoning, or refusing to accommodate the growth path, bringing forward the day of reckoning.

Given their own position of riding a massive demographic transition from the insanely unsustainable  pro-population-explosion policies of Mao to the population-control policies of Deng, instituted in 1979, the Chinese really had no choice but to accommodate.

The only side with actual freedom of action in the bilateral relationship was the United States, and our political elite choose to pursue a financially unsustainable GDP growth path.

Of course, under the savings glut model

Now, if you pretend that those accounting balances represent competitive markets, and that participants in those competitive markets are fully informed as to the long-term implications of their choices, and make all other manner of counter-factual suppositions, one can build a model in which the Chinese forced the US to import by manipulating the terms in the finance markets ... you can turn the driving flows of the income stream on their head and turn saving from a consequence into a cause.

But that would be silly. The aggregate amount of saving in the economy is the amount that is compatible with the equilibrium level of national income, and the injections, average tax incidence, and propensities to import and consume out of income that drive that equilibrium national income. People can "try" to save individually, but an increase in saving "effort" reduces consumption and results in the first instance in a reduction in income, rather than in an increase in aggregate savings.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 02:48:50 PM EST
[ Parent ]
So what you're saying is that even if the Savings Glut model were correct and Chinese forex policies forced the hand of the US economy (which you think is nonsense, but let's roll with it for the sake of the argument), Washington could have killed the vicious cycle dead by - say - enforcing margin requirements on all these funny derivatives instead of permitting banks to take them "off-balance-sheet?"

Because this would have limited the American consumer's ability to take on unreasonable debts, which in turn would have limited C_f in your model, which in turn would have limited Chinese saving by not having as big a current account deficit?

The algebra seems pretty simple, so I assume that Wolf knows this, right? Does he have a reason to assume that the US government didn't have the necessary tools to curtail C_f?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 03:09:53 PM EST
[ Parent ]
... glut model makes sense, then the people taking on risk exposure through complex derivatives already correctly know the risk of a financial system collapse, and interfering with their decision making is going to lead to a less good result.

And in the savings glut universe, if there were these things that the government could do to facilitate the sustainable harvesting of domestic resources, the private sector could do it too (and more efficiently), unless the government were to interfere with their ability to put deals together.

The fact that government can plan complex systems and implement strategic infrastructure permitting new activity to take place ... that fact is of no relevance in a universe where you assume that all complex systems of use are sitting somewhere in a book of blueprints and that innovation is simply a matter of copying the appropriate system out of the book.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 03:17:02 PM EST
[ Parent ]
So the Savings Glut model makes sense if and only if you assume that Markets Always Know Best?

Because then anything the government might do to regulate derivatives would already be anticipated by the market and priced into the derivatives?

Meaning that a form of derivatives that would pose a significant risk of systemic collapse (i.e. a risk that isn't thermodynamically small) would be priced prohibitively?

Meaning that what we're seeing right now before our very eyes Cannot Happen(TM), any more than all the air molecules in my living room can spontaneously gather under my table, thus choking me of air?

Now, if something actually happens that your model has assigned a thermodynamically small probability... Normally, you'd chuck that model out, right?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 03:45:00 PM EST
[ Parent ]
Its in the universe of a well-connected complete market system, including implicit valuations of what would be happening in the complete network of forward markets if they existed, that savings and investment as an equilibrium process makes sense.

In the real world, an equilibrium between aggregate saving and aggregate investment then proceeding to drive national income just doesn't make sense ... out here, investment is one of the drivers of income and income one of the drivers of saving.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 03:56:02 PM EST
[ Parent ]


Occasional Series