Originally published at Project-Syndicate | April 4th, 2022
Regardless of whether America’s persistent current-account deficits really can be explained primarily by the accumulation of excess savings abroad, recent developments now promise to render this popular theory obsolete. If so, the turmoil we have seen in bond markets so far this year could be just a prelude.
LONDON – In 2005, Ben Bernanke, then a governor of the US Federal Reserve Board, introduced the idea of a global savings glut to explain why the United States ran persistent current-account deficits. Departing from much of the academic thinking of the 1980s and 1990s, he argued that excess savings outside the US made interest rates – particularly long-term rates – lower than they otherwise would be.
Bernanke was developing an idea that then-Fed Chair Alan Greenspan had also flirted with. The US current-account deficits persisted because US Treasury bonds appealed to savers around the world who were eager to hold supposedly safe assets. In the past, there had been an assumption that these persistent deficits would at some point jeopardize the stability of the dollar and force US interest rates higher as protection against inflation and domestic financial instability.
Bernanke’s thesis became quite fashionable in international monetary circles at the time. And it gained even wider currency after the 2008 financial crisis, when inflation was persistently low and US current-account deficits continued. From the late 2000s, many companies changed their saving behavior and started building war chests, lending further momentum to the idea.
Even though I tend to accept the wisdom of much sharper academic minds than my own, I never really bought into Bernanke’s thesis. I was skeptical for two reasons.
First, a country’s balance of payments is an accounting identity comprising the current account and the capital account. The current account is determined by the domestic saving-investment balance. A country that saves more than it invests will have excess savings and a current-account surplus, and vice versa, just as a country that imports more than it exports (at least on a current-account basis) will have a trade deficit. But it does not follow that the capital account (reflecting the flow of money into and out of the country) necessarily dictates what happens to the current account.
Second, given that the popularity of the savings-glut thesis coincided with a period of persistently low inflation, it could be that the general decline in bond yields was primarily due to that factor.
Beyond these issues, I have never quite understood why advocates of the savings-glut idea were not challenged more when China started reducing its own massive current-account surpluses. If pushed, they probably would have said that the change was offset by bigger surpluses elsewhere, such as in the post-crisis eurozone and on the books of companies that had been hoarding cash for fear of a rerun of 2008.
But now, two new developments are presenting the savings-glut thesis with yet another test. First, we appear to have entered an era of higher inflation, which may or may not prove persistent. For central banks, the only way to ensure that it is temporary is to tighten their monetary policies and pursue normal levels of positive real interest rates, rather than clinging to old theories to justify their persistent low levels. It is to be hoped that everyone will also remember their Economics 101, which holds that there should be a close association between the trend rate of economic growth and real interest rates.
The second big development is the new regime of Western sanctions against Russia, including freezing a large share of the Russian central bank’s Western foreign-exchange reserves (the lion’s share of its financial war chest). This masterstroke may lead other excess reserve holders to stop accumulating so much foreign exchange, which would put a decisive end to Bernanke’s global savings glut.
That would not be such a bad thing. Even if the savings-glut thesis is true, why do all these countries need persistent massive current-account surpluses? We should welcome a world where the value of other countries’ currencies can rise more, thereby boosting residents’ real domestic incomes. Greater purchasing power would allow them to acquire more foreign goods. Their leaders might even consider pursuing policies to reduce their domestic savings rate and increase domestic consumption and investment. And that, in turn, might even contribute indirectly to an increase in domestic US savings.
I have shared these ideas with several international monetary experts, and most politely dismiss my thinking. They argue that most other countries with large foreign-exchange holdings have no need to fear Western policy responses, or that they lack the political structures needed to manage a smooth domestic economic regime shift. Others have suggested that America’s use of sanctions might lead to further diversification away from the dollar. But it is not clear what other highly liquid currencies one could hold with confidence. In the absence of alternatives, more countries may start to wonder why they should hold so many reserves in the first place.
If so, and especially if the inflation trend of the past 30 years is reversed, the turmoil we have seen in bond markets so far this year could be just a prelude.
Jim O’Neill: Former chairman of Goldman Sachs Asset Management and a former UK treasury minister, is a member of the Pan-European Commission on Health and Sustainable Development.