Sunday, January 31, 2010

Savings match lending

Savings match lending

Consider this recent quote: "Rising savings in the US will collide with stubbornly high savings in China." (Financial Times: "Why trade war is very likely to break out this year" By Michael Pettis. Published: January 26 2010 20:20.

Let's suppose that there is then too much saving. What does that mean?

In principle this means that interest rates will drop until people get less willing to save and borrowers get more willing to borrow. And that is what happened in the GFC lead up. All those petrodollars and sinodollars had to go somewhere and the price of borrowing them got so low that the developed world went on a debt spree.

But once the debt spree ends then we get in a situation where the people with the dollars don't want to spend them (on consumption). So they look for investments and you get bubbles.

It is essential, and eventually unavoidable, in such circumstances for the government to soak up the excess savings by issuing bonds. They also need to punish the savers by causing inflation. And this is particularly desirable and necessary in the American case where so many of the savers are foreigner rather than voters! However these two objectives are very hard to reconcile.

Pumping money into the economy by buying national debt just moves the money to people looking to invest rather than consume. These people will then go off and invest in a bubble, due to the lack of productive investments in a downturn. To put it another way: keeping interest rates low encourages investment, at a time when there is excess capacity and thus nothing much to invest in, so the investment is attracted to bubbles.

And the way to get inflation is, perhaps, to put less of the printed money into keeping interest rates down, and send money to the people (as Rudd did at the start of the GFC in Australia).