Fast growth, huge current account “imbalances”, low real interest rates and risk spreads, subdued inflation and easy access to finance characterise the world economy. Is this party about to end? Probably not. But to identify the risks we must first decide what drives the strange world economy we see around us.
The two interesting alternative explanations are the “savings glut” and the “money glut”. Both share common themes: globalisation; the revolution in finance; the rise of China; low inflation; and macroeconomic stability. Beyond this, however, they diverge. In particular, they reverse the role of victim and villain: in the savings-glut story, the thrifty are the villains and profligate the victims; in the money-glut story, it is the other way round. This is a contemporary version of the old Keynesian versus monetarist dispute.
The “savings glut” hypothesis is associated with Ben Bernanke, now chairman of the Federal Reserve. But the idea was floated earlier by others. Brian Reading, of Lombard Street Research, lays out the line of argument in a recent note*. A substantial excess of savings over investment has emerged, he says, predominantly in China and Japan and the oil exporters (see chart). This has led to low global real interest rates and huge capital flows towards the world’s most creditworthy and willing borrowers, above all, US households. The short-term effect is an appreciation of real exchange rates and soaring current account deficits in destination countries. To sustain output in line with potential, domestic demand in those countries must also be substantially higher than gross domestic product. A country must choose fiscal and monetary policies that bring this result about.
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