Beware The End Of Savings Glut

The late 1990s were an aberration, we're told. Money flowed into emerging markets and then abruptly flowed out, a disruption that, at the time, seemed a big crisis.

The 2000s, we're told, were an aberration. First the tech-stock bubble burst. Then emerging-market governments, seared by the late 1990s, built huge war chests of U.S. dollars in what Federal Reserve Chairman Ben Bernanke dubbed 'the global saving glut.' Along with easy money and short-sighted regulation in developed countries, that capital fueled a borrowing binge and housing bubbles in the U.S. and elsewhere.

The last few years, we're told, were an aberration. The end of the credit and housing booms ended in a once-in-a-century bust. Governments rushed to the rescue, and central bankers pushed short-term interest rates very low. Investors rushed to the safety of U.S. Treasurys, helping keep long-term interest rates down even as the U.S. borrowed heavily and, now, the Fed is keeping them from rising.

What next? What will happen when the U.S. economy recovers, as it surely will some day? One likely outcome: a reversal of the global saving glut and an end to the abundance of cheap capital.

Looking beyond the next few years, McKinsey Globe Institute, the think-tank arm of the consultancy, foresees a surge in investment by emerging markets, particularly China and India, at the same time as those countries begin to save less. Business, banks, consumers, investors and governments 'all will have to adapt to a world in which capital is more costly and less plentiful, and where over half the world's saving and investment occurs in emerging markets,' McKinsey says in a new report, 'Farewell to Cheap Capital.'

As a whole, the world economy can invest only as much as it saves. A farmer in the old days divided his crop between corn that he'd eat or sell (consume) and corn that he set aside (save) to plant next year (invest). The same goes for the output of the global economy. Turning history on its head, much of the increased saving over 25 years has come from China and other poorer countries and flowed to richer countries, particularly the U.S.

Thrifty Chinese workers and peasants put money in the bank. The banks lent to the government which lent to the U.S. Treasury and mortgage giants Fannie Mae and Freddie Mac. And it ended up financing cheap mortgages in the U.S. before the crash and the big Obama fiscal stimulus after the crash. Government, companies and households in China accounted for a remarkable $1 in every $4 of global saving in 2008.


Copyright (c) 2010 Dow Jones & Company, Inc.McKinsey says all this is bound to wane in the next several years, as China and India pick up the pace of investment. 'China,' it says, 'plans to build new subway systems, highways and high-speed trains in its top 170 cities.'

170! To keep pace with urban population growth, China needs to add one New York City's worth of residential and commercial space every two years; India, one Chicago's worth every year. With so many Asian factories producing close to capacity, predicts Hong Kong-based HSBC economist Frederic Neumann, a surge in business capital spending is likely. Based on the consensus forecasts for global growth, McKinsey projects global investment -- which amounted to a bit more than 22% of world output before the financial crisis -- could reach nearly 25% by the end of this decade, a level not seen since the early 1970s.

But China, and particularly its consumers, are likely to save less, if history and the Chinese five-year plan are any guide. The still-thrifty Japanese are likely to save less, too, as a growing number of retirees tap their savings -- though the dearth of promising investments in a country with a shrinking population means Japan will keep exporting savings to others.

So where will the saving come from? If all goes well, much of it will come from the U.S. Americans, chastened by the past few years, probably will save more. The federal government probably will shrink its deficit (which economists, who like making up words, call 'dissaving') even while spending more on health care and pensions. If U.S. and U.K. households continue as they are today, global saving rates would rise one percentage point and partially offset the fall in Chinese savings as its consumers spend more of their incomes, McKinsey says.

But only partially. The global saving glut could easily become global savings dearth. And that would mean substantially higher interest rates.

If long-term rates, adjusted for inflation, returned to the 40-year average, McKinsey estimates, they would be 1.5 percentage points higher, a big jump from the current 3% or so yield on 10-year Treasurys. And rates could go up more if emerging markets try to step up infrastructure and other investments faster than U.S. and other rich countries increase their overall saving, which could be an unwelcome brake on global growth.