October 16, 2006 –
U.S. Federal Reserve Chairman Ben Bernanke recently stated that the enormous U.S. trade deficit that the U.S. has incurred over the years is nothing to worry about because it merely reflects global savings patterns. He states that emerging economies have a huge glut of savings and thus the U.S. necessarily must have a great debt to balance out the rest of the world’s savings. The logic is, of course, that as the emerging market’s enormous savings glut unwinds, then the U.S. deficit will be reduced significantly. This explanation has a number of gaping holes in it wide enough to drive a Mack truck through.
To begin with, although it may seem like emerging economies like Brazil, China, Russia and India rose overnight, it took decades for these economies to gain the stability and purchasing power parity to final command the world’s attention. During all these years when savings were growing incrementally, why was the United States deficit burgeoning out of control? Furthermore, there are many contributing factors to the enormous U.S. debt such as the war in Iraq and increased military spending, deficit financing, corporate welfare, etc. that have nothing to do with the savings glut of emerging economies. To blame America’s debt solely on the savings glut of emerging economies is delusional. The roots of the problem extend well below Bernanke’s surface level explanation.
Furthermore, an analysis of the U.S. trade deficit through the singular lens of an American perspective without accounting for cultural differences is miscalculating at best and deeply flawed at worst. Asian culture has always been a savings culture. For decades, somewhat due to histories of economic and political instability, Asians have always saved far more than we ever spent every year – even most Asians that have since immigrated to different countries continue this tradition of saving and living under, and not above, our means.
For example, India and China possess two of the largest aggregate private savings base in the world due to cultural traditions with roots hundreds if not thousands of years old, and neither Ben Bernanke nor anyone else will be able to change this savings culture just because America needs it to change. Other people have argued that once financial systems and platforms become more sophisticated that the savings glut in Asia will shrink, and that the only thing keeping it so high right now is the lack of access to sophisticated financial products and services.
However, even this will be a gradual change and not one that by any means will happen as fast as the U.S. would like. I’ve worked in the investment industry a long time, and if there is one truth, it is that people will be very cautious about new financial products no matter their cultural backgrounds. So a sudden increase in sophisticated financial investment vehicles will certainly not translate into a directly proportional increase in investing. For those investors that already have offshore accounts and have already been engaged in sophisticated investment vehicles, they may opt to quickly jump into newly introduced domestic opportunities. However, where the general populace is concerned, even those with considerable wealth, unfamiliarity with new sophisticated investment vehicles will require a longer timeline for adoption.
Furthermore, Bernanke’s analysis excludes other cultural preferences. The lack of investment opportunities in India hasn’t prevented private individuals from collecting the largest private stash of gold in the world. People invest their money where they say fit according to their history. No one living in India can forget the cycle of enormous run-ups and crashes that their stock markets have endured. It is not likely either that many Indians are going to forget the crash of the Indian stock market earlier this year that destroyed such considerable amounts of wealth that armed personnel were called upon to guard waterways and prevent financially-devastated men from committing suicide.
In addition, many emerging countries have witnessed the collapse of financial systems when colonial powers have withdrawn, and thus have become conditioned to store away their money in assets that have intrinsic value such as gold rather than invest them and risk losing everything. Remember when I mentioned that I believed that investing in fine art was a wise decision in the SmartKnoweldgeU Newsletter #011, and then in a subsequent newsletter, specifically mentioned Sothebys (NYSE: BID) as my stock pick for benefiting from this trend? Since then, in less than five months, BID has increased by about 35%. And in India, the fine art market is soaring right now.
Turning our focus to China, if we consider that China saves a ridiculous 50% of its GDP, one may conclude that indeed such a high savings rate is unsustainable. However, it we look at China’s savings rate by household, this savings rate of 50% falls of drastically to only 16% of GDP. So where is the rest of this savings coming from?
The answer is the government and corporate China.
The only problem with this equation is that many governments such as China (and Russia for that matter) that have an enormous savings glut also have strained relations with the United States. Consequently, these countries are much more likely to turn to world partners other than U.S. when conducting business. For example, in a previous post, I mentioned that China has been investing billions of dollars into Africa as well as Venezuela. Russia, too has been investing considerable money in Venezuela. And much to America’s chagrin, China is on the brink of replacing the U.S. as Japan’s largest trading partner. All this does not bode well for the American economy, nor does it particularly provide any support to Bernanke’s prediction that the U.S. economy will massively benefit from the unwinding of emerging economies’ savings glut.
Even when countries like China have shown an interest in spending some of their enormous savings glut in purchasing American assets, at times, the U.S. Congress, under the declaration of national security, has stepped in to block such investments (as in the case with China’s bid to buy American oil company Unocal). Such significant events are not likely to be forgotten when such countries decide where they will spend their savings glut in the future.
So while the global economy may very well benefit from the unwinding of the savings glut of emerging markets, it is much too presumptuous for U.S. Federal Reserve Chairman Ben Bernanke to assume that emerging economies will come to the rescue of the U.S. economy in the future.
[tags]U.S. Federal Reserve, Ben Berananke, politics and stocks, China, wealth literacy[/tags]
