Revisiting the Global Savings Glut Thesis

By: Doug Noland | Fri, Mar 27, 2009
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For the week, the S&P500 surged 6.2% (down 9.7% y-t-d), and the Dow jumped 6.8% (down 11.4%). The Transports advanced 10.5% (down 21.4%) and the Morgan Stanley Cyclicals rose 12.9% (down 15.6%). Consumer stocks were quite strong, with the S&P Homebuilding index up 25.0% (up 16.2%) and the Morgan Stanley Retail index up 13.2% (up 10.2%). Technology continues to perform well. The Nasdaq100 jumped 5.4% (up 3.3%), the Morgan Stanley High Tech index 4.0% (up 8.4%), the Semiconductors 9.8% (up 13.1%), and the InteractiveWeek Internet index 5.9% (up 13.0%). The broader market rallied sharply this week. The S&P400 Mid-Caps jumped 7.4% (down 7.3%), and the small cap Russell 2000 gained 7.2% (down 14.1%). The Utilities increased 1.5% (down 12.0%), and the Morgan Stanley Consumer index gained 4.3% (down 8.6%). The Biotechs rallied 4.2% (up 0.4%). The Broker/Dealers surged 11.5% (up 3.5%), and the Banks shot 12.0% higher (down 34.2%). Although Bullion dropped $28.50, the HUI Gold index slipped only 0.4% (up 7.6%).

One-month Treasury bill rates ended the week at 3 bps, and three-month bills were at 14 bps. Two-year government yields added 2 bps to 0.85%. Five year T-note yields jumped 12 bps to 1.72%. Ten-year yields rose 12 bps to 2.76%. The long-bond saw yields decline 4 bps to 3.67%. The implied yield on 3-month December '09 Eurodollars dropped 8 bps to 1.305%. Benchmark Fannie MBS yields were unchanged at 3.94%. The spread between benchmark MBS and 10-year T-notes narrowed 12 to 118 bps. Agency 10-yr debt spreads widened 4 to 84 bps. The 2-year dollar swap spread declined 8.75 to 55 bps; the 10-year dollar swap spread declined 13 to 18.75 bps, and the 30-year swap spread declined 3 to negative 31 bps. Corporate bond spreads were narrower. An index of investment grade bond spreads narrowed 14 to a one-month low 248 bps, and an index of junk spreads narrowed 12 to 1,233 bps. GE Capital Credit default swaps were little changed this week.

It was a another large week for corporate debt sales. Investment grade issuance included Citigroup $6.0bn, Wells Fargo $3.5bn, Time Warner $3.0bn, Verizon $2.75bn, Illinois Toolworks $1.5bn, US Bancorp $1.1bn, Berkshire Hathaway $750 million, Con Edison $750 million, Bank of New York $600 million, Atmos Energy $450 million, Staples $500 million, Cornell University $500 million, Metlife $400 million, Praxair $300 million, Emory University $250 million, Northwestern Corp $250 million, and Idaho Power $100 million.

Junk issuers included Newell Rubbermaid $300 million, Texas-New Mexico Power $265 million, Sunoco $250 million, and Kansas City Southern $200 million.

And, what do you know, a convert deal priced today: Amkor Tech $240 million.

International debt issues this week included Loyds Bank $6.25bn, International Bank of Reconstruction and Development $6.0bn, ANZ National $1.0bn, Peru $1.0bn, and Bacardi $500 million.

U.K. 10-year gilt yields surged 26 bps to 3.28%, and German bund yields jumped 11 bps to 3.08%. The German DAX equities index increased 3.3% (down 12.6%). Japanese 10-year "JGB" yields rose 7 bps to 1.32%. The Nikkei 225 surged 8.6% (down 2.6%). The emerging market rally continued. Brazil's benchmark dollar bond yields were little changed at 6.51%. Brazil's Bovespa equities index gained 4.3% (up 11.3% y-t-d). The Mexican Bolsa jumped 4.9% (down 9.2% y-t-d). Mexico's 10-year $ yields declined 3 bps to 6.19%. Russia's RTS equities index increased 3.5% (up 14.1%). India's Sensex equities index rallied 12.1% (up 4.2%). China's Shanghai Exchange gained another 4.1% (up 30.4%).

Freddie Mac 30-year fixed mortgage rates dropped 13 bps to a record low 4.85% (down 100bps y-o-y). Fifteen-year fixed rates declined 3 bps to 4.58% (down 76bps y-o-y). One-year ARMs fell 6 bps to 4.85% (down 39bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 5 bps this week to 6.42% (down 63bps y-o-y).

Federal Reserve Credit expanded $9.6bn last week to $2.051 TN. Fed Credit has dropped $196bn y-t-d, although it expanded $1.163 TN over the past 52 weeks. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt last week (ended 3/25) rose $4.5bn to $2.595 TN. "Custody holdings" have been expanding at a 13.5% rate y-t-d, and were up $410bn over the past year, or 18.8%.

Bank Credit sank $91.1bn to $9.714 TN (week of 3/18). Bank Credit was up $149bn year-over-year, or 1.6%. Bank Credit increased $322bn over the past 28 weeks. For the week, Securities Credit gained $4.9bn. Loans & Leases dropped $96bn to $7.040 TN (52-wk gain of $84bn, or 1.2%). C&I loans declined $15.4bn, with one-year growth of 3.8%. Real Estate loans dropped $52.4bn (up 3.5% y-o-y). Consumer loans fell $11.4bn, and Securities loans dipped $1.7bn. Other loans declined $15.1bn.

M2 (narrow) "money" supply surged $33.3bn to a record $8.376 TN (week of 3/16). Narrow "money" has now inflated at a 17.4% rate over the past 26 weeks and $773bn over the past year, or 10.2%. For the week, Currency added $1.4bn, while Demand & Checkable Deposits dropped $12.9bn. Savings Deposits surged $36.8bn (6-wk gain of $139bn), while Small Denominated Deposits slipped $1.2bn. Retail Money Funds gained $9.1bn.

Total Money Market Fund assets (from Invest Co Inst) declined $7.1bn to $3.856 TN. The 52-wk expansion was reduced to $351bn, or 10.0%. Money Funds have expanded at a 2.9% rate y-t-d.

Asset-Backed Securities (ABS) issuance slowed this week. Year-to-date total US ABS issuance of $17bn (tallied by JPMorgan's Christopher Flanagan) is a fraction of the $45bn for comparable 2008. There has been no home equity ABS issuance in months.

Total Commercial Paper outstanding jumped $14.8bn this past week to $1.491 TN. CP has declined $190bn y-t-d (49% annualized) and $342bn over the past year (18.6%). Asset-backed CP added $2.2bn last week to $702bn, with a 52-wk drop of $101bn (12.5%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $194bn y-o-y, or 3.0%, to $6.646 TN. Reserves have declined $300bn over the past 23 weeks.

Global Credit Market Dislocation Watch:

March 25 - Bloomberg (Li Yanping): "China's leaders may press at the Group of 20 summit for specific steps to protect its more than $1 trillion of dollar assets as U.S. fiscal policies risk sparking a 'currency war,' a senior Chinese researcher said. The dollar weakened after the Federal Reserve said March 18 it would buy as much as $300 billion of Treasuries and the U.S. this week outlined plans to buy as much as $1 trillion of illiquid bank assets. U.S. purchases of Treasuries are 'irresponsible' because they may weaken the dollar, Li Xiangyang, of the government- backed Chinese Academy of Social Sciences, told a forum... 'Chinese leaders are likely to articulate their concern to their U.S. counterparts strongly and ask for specific measures.'"

March 25 - MarketWatch (Chris Oliver): "China's calls for a new international reserve currency to replace the U.S. dollar are more than mere bluster and could likely lead the debate over the future of the global foreign-exchange system, analysts say. 'By proposing such a sweeping reform, China is demonstrating its growing influence in reshaping the global monetary system, and is now on offensive in the debate of who is responsible for the global imbalances,' Deutsche Bank's chief economist for Greater China Jun Ma said... The comments by People's Bank of China Gov. Zhou Xiaochuan are setting a framework for talks on how to resolve the huge trade imbalances between China and the U.S., analysts said. In the past, China has been blamed for its large trade surplus by officials in the U.S. and elsewhere, who see the yuan as undervalued. 'China has effectively set the agenda for the G20 leaders' summit,' wrote SocGen economists... referring to next week's meeting of finance chiefs from the Group of 20 leading economies in London."

March 27 - Bloomberg (Tony Czuczka): "Swedish Finance Minister Anders Borg said that the rise in government borrowing during the financial crisis poses a threat to economic stability and laid the blame at the door of the U.S. and U.K. Borrowing requirements are reaching levels that are putting economies "in jeopardy," Borg told an audience at the German Finance Ministry in Berlin today. He singled out the U.S. and U.K., which he said are shouldering 'humungous deficits.'"

March 24 - Bloomberg (Tony Czuczka): "President Barack Obama urged fellow Group of 20 leaders to provide a 'robust and sustained' fiscal stimulus, saying that 'much more' action is needed to fight the global recession. In an article published today in newspapers including Germany's Die Welt and the Paris-based International Herald Tribune, Obama also urged increased funding for international lenders and a 'common framework' of steps to restore the world economy's flow of credit."

March 23 - Bloomberg (Rebecca Christie and Robert Schmidt): "The Obama administration unveiled its plan to remove toxic assets from the books of the nation's banks, betting that it can revive the U.S. financial system without resorting to outright nationalization. The plan is aimed at financing as much as $1 trillion in purchases of illiquid real-estate assets, using $75 billion to $100 billion of the Treasury's remaining bank-rescue funds. The Public-Private Investment Program will also rely on Federal Reserve financing and Federal Deposit Insurance Corp. debt guarantees..."

March 25 - Wall Street Journal (Sudeep Reddy and Michael R. Crittenden): "The Treasury Department's program to deal with banks' troubled assets leaves as little as $82 billion in the $700 billion bailout fund approved last fall, putting the U.S. government's financial-rescue squad in a bind. The remaining cash will be needed to cover aid to troubled auto makers, potentially tens of billions of dollars to recapitalize major financial institutions, and any other unwelcome surprises. But a sharp backlash against bailouts means Congress is unlikely to mandate more funds anytime soon."

March 24 - Bloomberg (Ari Levy and Daniel Taub): "U.S. banks, battered by record losses from the worst housing slump since the Great Depression, now must weather increasing loan delinquencies from owners of skyscrapers and shopping malls. The country's 10 biggest banks have $327.6 billion in commercial mortgages, which face a wave of defaults as office vacancies grow and retailers and casinos go bankrupt."

March 26 - Bloomberg (Christopher Swann): "The World Bank completed its largest-ever bond issue, raising $6 billion to provide financing for developing countries suffering from the economic crisis."

March 25 - Wall Street Journal (Peter Lattman, Jenny Strasburg and Deborah Solomon): "Stocks surged world-wide after the White House formally unveiled its plan to clean banks' balance sheets, with an emphasis on luring private investors to buy up to $1 trillion in toxic assets that are choking the flow of credit. The Dow Jones Industrial Average soared 6.8%, or 497.48 points, to 7775.86, in its biggest gain since late October. Bank stocks rose sharply on hopes the plan will rid them of much of the soured debt and securities weighing on their balance sheets. Citigroup Inc. shares were up about 20% and Bank of America Corp. shares rose 26%."

March 25 - Bloomberg (Laura Cochrane): "Emerging-market borrowing costs are 'unrealistic' and will increase to near record highs this year as governments and companies seek to make $760 billion of debt repayments and global defaults rise, according to ING Groep NV. The extra yield investors demand to own emerging-market sovereign and quasi-sovereign bonds, which dropped to a four- month low of 6.69% today, may climb to above 10%, said David Spegel, global head of emerging-market strategy at ING..."

Currency Watch:

March 23 - MarketWatch (Polya Lesova): "Federal Reserve Board Chairman Ben Bernanke and Treasury Secretary Timothy Geithner flatly rejected on Tuesday a call from a senior Chinese official to drop the dollar as the world's key reserve currency. Zhou Xiaochuan, head of the People's Bank of China, proposed the creation a new international reserve currency in an essay published on the central bank's Web site... The proposal is the latest sign of tension between China and the U.S. over important global economic matters."

Another interesting week for the currencies. The dollar index rallied 1.5% this week to 85.11 (up 4.7% y-t-d). For the week on the upside, the South Korea won increased 4.75%, the New Zealand dollar 2.2%, and the Australian dollar 1.1%. On the downside, the Norwegian krone declined 3.8%, the Euro 2.1%, the Danish krone 2.1%, the Japanese yen 2.0%, the Swiss franc 1.4%, the Mexican peso 1.2%, and the British pound 1.0%.

Commodities Watch:

Gold dropped 3.0% this week to $924 (up 4.8% y-t-d), and silver fell 3.8% to $13.32 (up 18% y-t-d). May Crude was little changed at $52.26 (up 17 y-t-d). May Gasoline added 1.8% (up 40% y-t-d), while May Natural Gas sank 12.7% (down 33% y-t-d). May Copper added 1.9% (up 30% y-t-d). May Wheat dropped 7.8% (down 17% y-t-d), and May Corn declined 2.4% (down 5% y-t-d). The CRB index dropped 1.7% (down 3.2% y-t-d). The Goldman Sachs Commodities Index (GSCI) dipped 1.0% (up 5.6% y-t-d).

China Reflation Watch:

March 27 - Bloomberg (Li Yanping and Kevin Hamlin): "China is scolding the world before the Group of 20 meeting next week, telling the largest countries to spend more on stimulus and fix their financial supervision. Central bank Governor Zhou Xiaochuan yesterday lambasted governments that failed to emulate China's "decisive" action to spur economic growth. Earlier this week he suggested creating a new international reserve currency to rival the dollar."

March 24 - China Knowledge: "Daimler AG's Mercedes-Benz Friday said its monthly vehicle sales grew 21% year on year to hit 2,800 units on the Chinese mainland in February, 3.4% higher than the average growth rate of the overall sedan segment, the China Daily reported."

March 24 - Bloomberg (Jiang Jianguo): "China barred the nation's state-owned companies from taking part in speculative hedging, the Chinanews news service reported..."

March 27 - Bloomberg (Li Yanping and Nipa Piboontanasawat): "Chinese industrial companies' profits dropped for the first time on record as the global recession cut demand for exports from the world's third-largest economy. Net income sank 37.3% in the first two months of 2009 from a year earlier to 219.1 billion yuan ($32 billion)..."

Japan Watch:

March 25 - Bloomberg (Saburo Funabiki and Norihiko Kosaka): "Japan's companies are paying the least to borrow since 2006 after the central bank started buying commercial paper, signaling an end to the credit squeeze that helped push the world's second-biggest economy into recession."

March 23 - Bloomberg (Katsuyo Kuwako): "Japanese residential land prices fell to a 24-year low as job losses and wage cuts discouraged homebuyers, while tighter credit markets choked off funding for property developers."

March 24 - Bloomberg (Naoko Fujimura): "Japan's vehicle sales may fall to the lowest in 32 years as the country's deepening recession discourages customers from visiting showrooms. Industrywide sales... may fall 8% to 4.3 million vehicles... the Japan Automobile Manufacturers Association said..."

Asia Reflation Watch:

March 24 - Bloomberg (Seyoon Kim): "South Korea plans to spend a record 17.7 trillion won ($13 billion) on cash handouts, cheap loans, infrastructure and job training to revive an economy on the brink of its first recession in more than a decade. The stimulus will boost economic growth by 1.5 percentage points and help create 552,000 new jobs, the finance ministry said..."

Central Banker Watch:

March 26 - Bloomberg (Anchalee Worrachate): "Bank of England Governor Mervyn King says Gordon Brown should be 'cautious' on public spending while the official in charge of U.K. bond sales says the central bank is undermining demand for government debt. For the first time in almost seven years, the U.K. couldn't find enough buyers for one of its debt sales when it offered 1.75 billion pounds ($2.55 billion) of bonds... Robert Stheeman, head of the U.K.'s Debt Management Office, which runs the bond auctions, says it wasn't able to attract enough bids partly because of the Bank of England's efforts to lower yields through debt purchases."

Fiscal Watch:

March 25 - Associated Press (Randolph E. Schmid): "The post office will run out of money this year unless it gets help, Postmaster General John Potter told Congress... 'We are facing losses of historic proportion. Our situation is critical,' Potter told a House panel. The agency lost $2.8 billion last year and is looking at much larger losses this year. Reducing mail delivery from six days to five days a week could save $3.5 billion annually, Potter said."

GSE Watch:

March 27 - Washington Post (Zachary A. Goldfarb): "Half a year after the government seized Freddie Mac, confusion about its role is stoking tensions between the company and its regulator, including a dispute this month over how much the mortgage giant should reveal to private investors about its financial troubles. Federal officials who took over Freddie Mac stopped short of nationalizing the company, leaving it partly in private hands. This means Freddie still has to answer to investors and file financial disclosures. But when Freddie Mac's executives concluded a few weeks ago that they had to disclose that the government's management of the... company was undermining its profitability and would cost it tens of billions of dollars, the firm's regulator urged it not to do so, according to several sources... The clash grew so severe that they threatened to go to the Securities and Exchange Commission... The company's regulator backed down, the sources said"

March 25 - Bloomberg (Romaine Bostick): "Freddie Mac, the mortgage-finance company under federal control, said its portfolio of home-loan assets rose at an annualized rate of 35% last month. The holdings climbed by $23.1 billion in February to $822 billion as regulators leaned on the company to help modify or refinance more loans for struggling borrowers..."

MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

March 27 - Bloomberg (Dawn Kopecki): "Mortgage originations may double to $3.1 trillion this year as historically low interest rates and looser financing standards at Fannie Mae and Freddie Mac lure more borrowers, Bank of America Corp. analysts said."

Unbalanced Global Economy Watch:

March 24 - Wall Street Journal (John W. Miller): "The World Trade Organization issued the most pessimistic report on global trade in its 62-year history, forecasting a drop of 9% or more in 2009. Monday's prediction is worse than previous estimates by the WTO, the World Bank and independent economists..."

March 27 - Bloomberg (Jurjen van de Pol): "European industrial orders dropped the most on record in January as the global recession forced companies to cut production, reducing demand for equipment and machinery. Industrial orders in the euro area fell 34% from the year-earlier month, when they declined 24%..."

March 25 - Bloomberg (Simone Meier): "German business confidence fell to the lowest level in more than 26 years in March, adding to signs that the recession is deepening."

Bursting Bubble Economy Watch:

March 26 - Bloomberg (Bob Willis): "The number of people collecting U.S. jobless benefits rose to a record 5.56 million, indicating more Americans are spending longer periods out of work. Initial claims topped 600,000 for an eighth straight time."

March 27 - Bloomberg (Lee J. Miller): "Coupon clipping is back in vogue, increasingly driven by the Internet, as recession prompts consumers to turn in price-off tokens, according to retailers including McCormick & Co., the world's biggest spice seller, and Kroger Co., the largest U.S. supermarket chain. 'Redemptions in the U.S. are up 20% versus last year,' McCormick Chief Executive Officer Alan Wilson said."

California Watch:

March 25 - Los Angeles Times: "Ravenous investor demand allowed California today to boost the size of its infrastructure bond sale to $6.54 billion from a planned $4 billion, and to close out the deal a day early. The offering, the state's first sale of longer-term bonds since June, didn't come cheap for taxpayers: The longest-term bond, maturing in 2038, will pay investors an annualized tax-free yield of 6.1%. By contrast, California paid a yield of 5.3% on bonds of that maturity in the June sale. Still, the deal allowed Treasurer Bill Lockyer to make a dent in the state's backlog of voter-approved bonds to be sold..."

March 25 - California Association of Realtors: "Home sales increased 83% in February in California compared with the same period a year ago, while the median price of an existing home declined 40.8%. The median price... was $247,590, a 40.8% decrease... The February 2009 median price fell 2.3% compared with January's... C.A.R.'s Unsold Inventory Index... in February 2009 was 6.5 months, compared with 15.3 months for the same period a year ago."

March 25 - Wall Street Journal (By Peter Sanders): "As Don Bransford prepares for his spring planting season, he is debating which is worth more: the rice he grows on his 700-acre farm north of Sacramento, or the water he uses to cultivate it. After three years of drought in California, water is now a potential cash crop... Water -- or the lack of it -- has been costing the state dearly. According to Richard Howitt, a professor at the University of California, Davis, the drought and resulting water restrictions could cost as much as $1.4 billion in lost income and about 53,000 lost jobs, mostly in the agriculture sector."

New York Watch:

March 26 - Bloomberg (Henry Goldman): "New York City experienced a record month-to-month increase in its unemployment rate, climbing to 8.1% in February from 6.9% in January..."

Muni Watch:

March 27 - Bloomberg (Jeremy R. Cooke): "U.S. state and local borrowers sold about $12 billion of bonds in the biggest week for new issues since December 2006, as strong reception for California's record deal helped to cap yield increases in the broader market."

Speculator Watch:

March 24 - Bloomberg (Bei Hu): "The global hedge fund industry may shrink by 11% this year as funds liquidate and investor withdrawals persist, a Deutsche Bank AG survey said. Industry assets may fall to $1.33 trillion by December..."

March 23 - Financial Times (James Mackintosh): "Hedge fund investors believe the industry will see even bigger withdrawals this year than last, when record levels of cash were pulled from the sector. A survey of investors by Deutsche Bank found a third expect more than $200bn to be withdrawn, after a net $155bn was taken out last year, according to calculations by Chicago consultancy Hedge Fund Research."

March 27 - Bloomberg (Michael B. Marois): "The California Public Employees' Retirement System, the largest U.S. state public pension fund, said it wants to renegotiate the fees it pays hedge funds. Calpers, as the fund is known, said hedge fund payments should be based on long-term rather than short-term performance."

Revisiting the Global Savings Glut Thesis:

"The extraordinary risk-management discipline that developed out of the writings of the University of Chicago's Harry Markowitz in the 1950s produced insights that won several Nobel prizes in economics. It was widely embraced not only by academia but also by a large majority of financial professionals and global regulators. But in August 2007, the risk-management structure cracked. All the sophisticated mathematics and computer wizardry essentially rested on one central premise: that the enlightened self-interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring their firms' capital and risk positions." Alan Greenspan, March 27, 2009, Financial Times

Alan Greenspan remains the master of cleverly obfuscating key facets of some of the most critical analysis of our time. The fact of the matter is that "the sophisticated mathematics and computer wizardry" fundamental to contemopary derivatives and risk management essentially rested on one central premise: that the Federal Reserve (and, more generally speaking, global policymakers) was there to backstop marketplace liquidity in the event of market tumult. More specific to the mushrooming derivatives marketplace, participants came to believe that the Fed had essentially guaranteed liquid and continuous markets. And the Bigger the Credit Bubble inflated the greater the belief that it was Too Big for the Fed To ever let Fail. It was clearly in the "enlightened self-interest" of operators of "Wall Street finance" and throughout the system to fully exploit this market pervision. With unimaginable wealth there for the taking, along with the perception of a Federal Reserve "backstop," why would anyone have kidded themselves that there was incentive to ensure individual institutions "maintained a sufficient buffer against insolvency"? By the end of boom cycle, market incentives had been completely debauched.

The Greespan Fed pegged the cost of short-term finance (fixing an artificially low cost for speculative borrowings), while repeatedly intervening to avert financial crisis ("coins in the fusebox"). There is absolutely no way that total system Credit would have doubled this decade to almost $53 TN had the Activist Federal Reserve not so aggressively and repeatedly intervened in the markets. To be sure, the explosion of derivatives and attendant speculative leveraging was central to the historic dimensions of the Credit Bubble.

Mr. Greenspan today made it through yet another article without using the word "Credit." "Free-market capitalism has emerged from the battle of ideas as the most effective means to maximise material wellbeing, but it has also been periodically derailed by asset-price bubbles..." "Financial crises are defined by a sharp discontinuity of asset prices. But that requires that the crisis be largely unanticipated by market participants." "Once a bubble emerges out of an exceptionally positive economic environment, an inbred propensity of human nature fosters speculative fever that builds on itself..." He might cannily dodge the topic, but Mr. Greenspan recognizes all too well that Credit has and always will be central to the functioning - and misfunctions - of free-market Capitalistic systems.

With respect to the past, present and future analyses, I believe the spotlight should be taken off asset prices. Such focus is misplaced and greatly muddies key issues. Much superior is an analytical framework that examines the underlying Credit excesses that fuel asset inflation and myriad other distortions. Ensure us a stable Credit system and the risk of runaway asset booms and busts disappears. Today's financial crisis - and financial crises generally - are defined by a sharp discontinuity of the flow of Credit. Major fluctuations in asset markets - on the upside and downside - are typically driven by changes in the quantity and directional flow of Credit. Central bankers should focus on stable finance and resist the powerful tempation to monkey with asset prices and markets. As common sense as this is, today's flawed conventional thinkng leaves most oblivious and poised for Mistakes to Beget Greater Mistakes.

When it comes to flawed conventional thinking, few things get my blood pressure rising more than the "global savings glut" thesis. Two weeks ago from Alan Greenspan, via The Wall Street Journal:

"...The presumptive cause of the world-wide decline in long-term rates was the tectonic shift in the early 1990s by much of the developing world from heavy emphasis on central planning to increasingly dynamic, export-led market competition. The result was a surge in growth in China and a large number of other emerging market economies that led to an excess of global intended savings relative to intended capital investment. That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005. That decline in long-term interest rates across a wide spectrum of countries statistically explains, and is the most likely major cause of, real-estate capitalization rates that declined and converged across the globe, resulting in the global housing price bubble. By 2006, long-term interest rates and the home mortgage rates driven by them, for all developed and the main developing economies, had declined to single digits -- I believe for the first time ever. I would have thought that the weight of such evidence would lead to wide support for this as a global explanation of the current crisis."

It is difficult these days for me to accept that Greenspan, Bernanke and others are sticking to this misplaced view that a glut of global saving was predominantly responsible for the proliferation of U.S. and global Bubbles. The failure of our policymakers to understand and accept responsibility for the Bubble must not sit well internationally. Long-time readers might recall that I pilloried this analysis from day one. The issue was never some glut of "savings" but a historic glut of Credit and the resulting "global pool of speculative finance." In today's post-Bubble period, it should be indisputable that the acute financial and economic fragility exposed around the globe was the result of egregious lending, financial leveraging, and speculation. True savings would have worked to lessen fragility - instead of being the root cause of it.

Unfortunately, there is somewhat of a chicken and egg issue that bedevils the debate. Greenspan and Bernanke have posited that China and others saved too much. This dynamic is said to have stoked excess demand for U.S. financial assets, pushing U.S. and global interest rates to artifically low levels. This, they expound, was the root cause of asset Bubbles at home and abroad. I take a quite opposing view, believing it is unequivocal that U.S. Credit excess and resulting over-consumption, trade deficits, and massive current account deficits were the underlying source of so-called global "savings." Again, if it had been "savings" driving the process, underlying system dynamics wouldn't have been so highly unstable and the end result would not have been unprecedented systemic fragility. Instead, the seemingly endless liquidity - so distorting of markets and economies round the world - was in large part created through the process of unfettered speculative leveraging of securities and real estate.

As is so often the case, we can look directly to the Fed's Z.1 "flow of funds" report for Credit Bubble clarification. Total (non-financial and financial) system Credit expanded $1.735 TN in 2000. As one would expect from aggessive monetary easing, total Credit growth accelerated to $2.016 TN in 2001, then to $2.385 TN in 2002, $2.786 TN in 2003, $3.126 TN in 2004, $3.553 TN in 2005, $4.025 TN in 2006 and finally to $4.395 TN in 2007. Recall that the Greenspan Fed had cut rates to an unprecedented 1.0% by mid-2003 (in the face of double-digit mortgage Credit growth and the rapid expansion of securitizations, hedge funds, and derivatives), where they remained until mid-2004. Fed funds didn't rise above 2% until December of 2004. Mr. Greenspan refers to Fed "tightening" in 2004, but Credit and financial conditions remained incredibly loose until the 2007 erruption of the Credit crisis.

It is worth noting that our Current Account Deficit averaged about $120bn annually during the nineties. By 2003, it had surged more than four-fold to an unprecedented $523bn. Following the path of underlying Credit growth (and attendant home price inflation and consumption!), the Current Account Deficit inflated to $625bn in 2004, $729bn in 2005, $788bn in 2006, and $731bn in 2007. And examining the "Rest of World" (ROW) page from the Z.1 report, we see that ROW expanded U.S. financial asset holdings by $1.400 TN in 2004, $1.076 TN in 2005, $1.831 TN in 2006 and $1.686 TN in 2007. It is worth noting that ROW "net acquisition of financial assets" averaged $370bn during the nineties, or less than a quarter the level from the fateful years 2006 and 2007.

The Z.1 details, on the one hand, the unprecedented underlying U.S. Credit growth behind our massive Current Account Deficits. ROW data, in particular, diagnoses the flooding of dollar balances to the rest of the world - and the "recycling" of these flows back to dollar instruments. This unmatched flow of finance devalued our currency, and in the process inflated commodities, foreign debt, equity and assets markets, and global Credit systems more generally. In somewhat simplistic terms, ultra-loose monetary conditions fed U.S. Credit excess, excessive financial leveraging and speculating, asset inflation, over-consumption, and enormous Current Account Deficits. And this unrelenting flow of dollar balances to the world inflated the value of many things priced in devalued dollars, thus exacerbating both global Credit and speculative excess. The path from the U.S. Credit Bubble to the Global Credit Bubble is even more evident in hindsight.

Back in November of 2007 Mr. Greenspan made a particularly outrageous statement. "So long as the dollar weakness does not create inflation, which is a major concern around the globe for everyone who watches the exchange rate, then I think it's a market phenomenon, which aside from those who travel the world, has no real fundamental economic consequences."

Similar to more recent comments on the "global savings glut," I can imagine such remarks really rankle our largest creditor, the Chinese. As we know, the Chinese were the major accumulator of U.S. financial assets during the Bubble years. They are these days sitting on an unfathomable $2.0 TN of foreign currency reserves and are increasingly outspoken when it comes to their concerns for the safety of their dollar holdings. There is obvious reason for the Chinese to question the reasonableness of continuing to trade goods for ever greater quantities of U.S. financial claims.

Interestingly, Chinese policymakers are today comfortable making pointed comments. Policymakers around the world are likely in agreement on a key point but only the Chinese are willing to state it publicly: the chiefly dollar-based global monetary "system" is dysfunctional and unsustainable. Mr. Greenpan may have actually convinced himself that dollar weakness has little relevance outside of inflation. And the inflationists may somehow believe that a massive inflation of government finance provides the solution to today's "deflationary" backdrop. Yet to much of the rest of the world - especially our legions of creditors - this must appear too close to lunacy. How can the dollar remain a respected store of value? Expect increasingly vocal calls for global monetary reform.

"The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.' Zhou Xiaochuan, head of the People's Bank of China, March 23, 2009

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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