<blockquote>"
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:
<blockquote>“...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.”</blockquote>
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.
...
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" (emphasis added)</blockquote>
Revisiting the Global Savings Glut ThesisBy Doug Noland
March 27, 2009
Source“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