By James H. Nolt
Former Fed Chairs Alan Greenspan, Ben Bernanke, and other prominent economic pundits have been characterizing the current world economic situation as a savings glut. In other words, too much saving and not enough spending. It is more accurate to say it is a capital glut. A capital glut occurs when the stock of investable capital is large in relation to the pool of attractive new productive investments.
It is a commonplace of neoclassical economics that all output is either saved or consumed by households that receive it. This is in keeping with the economists’ habit of dividing the world into households, firms, and government. The idea is that the saving of households is recycled by “financial intermediaries,” banks, and other financial institutions, to firms that borrow to invest in productive capital equipment. If everything is in equilibrium, as economists typically assume, then the interest rate adjusts until the amount that people want to save exactly matches the amount that businesses want to invest productively. Therefore, that portion of GDP that is not consumed by households is deposited in savings accounts and immediately lent to buy productive equipment, i.e., the investment portion of GDP.
Thus, a savings glut would be a disequilibrium condition because it means people are saving more than firms are willing to spend on investment goods. The textbook solution would be for interest rates to fall so that people are willing to save less and, at the lower interest rate, investors are willing to borrow more, restoring equilibrium through the magic of free markets. Incidentally, if the problem today is a savings glut, why is current Fed chair Janet Yellen talking about raising interest rates? The logic of economists is twisted.
This entire textbook fable is nonsense. Our global “savings glut” is one of myriad instances of markets unable to find equilibrium, not least because free markets do not allocate credit. Credit allocation is a private power. There is no mechanism to guarantee that private decisions to extend or refuse credit will ever be in equilibrium with investor desires to purchase new means of production. Such equilibrium as does momentarily occur during the stormy ups and downs of the business cycle is because of episodes of temporary balance between contending bears and bulls.
New capital is created not just because of how much people choose to save, but because creditors decide to issue credit in any numerous possible forms. Even when new capital is created, it might be used to invest productively, buying new productive equipment, as economists assume “investment” could be used to purchase existing assets, including real estate, stocks, bonds, etc. If lots of new capital is created without being invested in means of production, then this expanded demand for assets creates a bubble in asset prices, which collapses as soon as credit tightens.
From my account so far, it might seems as if credit and capital are unconstrained by the real economy. In a tactical sense, that is true. Credit can be created and new capital conjured into existence without immediate limit. The eventual constraint is that if that capital is to accrue income for its owner, it must be invested in some asset, real or financial, that produces income. The total share of society’s resources is scarce. If capital is claiming them, someone else is deprived.
Another way to think of this is to imagine the real growth rate of the economy is 2 percent per year, yet on average, capital is increasing its share faster than this. This is only possible if someone else’s share (that of labor, for example, or pensioners) is falling. I cannot grow my share of the total output faster than the average growth rate of the economy unless someone else’s share is falling.
Indeed, this is the real origin of the “savings glut,” or, as I say, capital glut. Capital is accumulating faster than the real rate of growth of the economy, faster than the growth of total output, largely because of the worldwide increase in economic inequality since the 1970s, as recently and quite famously documented by Thomas Piketty. Although wealthy capitalists do not “save” in quite the way the textbooks describe, they do tend to invest more of their wealth in assets rather than in newly produced commodities. Therefore, expending credit for capitalists without any commensurate increase in incomes of most other people leads to sluggish real investment and recurring boom and bust cycles in the value of various assets that become fashionable and then crash.
This is a worldwide narrative, not just confined to the U.S. In fact, it applies very well to “socialist” China as well. For decades, China has had the world’s highest savings rate, yet conversely, the world’s lowest consumption rate. This high savings rate leads to the formation of a vast pool of capital seeking investment. Part of that pool flows to the U.S. to help fund the growing U.S. national debt. Other portions flow abroad elsewhere, recently including the Chinese government effort to direct a portion of its investable surplus to other Asian countries through the vehicle of the newly created Asian Industrial Investment Bank.
However, most of China’s massive savings have funded its rapid industrial and commercial development. Such development consists of one of the highest building rates in the world and an admirable public transportation infrastructure including many new subway systems and the world’s largest high-speed rail network.
Yet China’s high-pace development is now in jeopardy and to some extent, it is a victim of its own success. For decades, China has emphasized export- and investment-led development. This strategy is now failing. The export portion is failing because China could grow its exports much faster than the rate of the growth of the world economy only when it was a relatively small exporter. The bigger it grew, the harder it was to grow at the expense of the market share of other exporters. Now as the world’s biggest exporter, China’s export growth is much more constrained by the overall rate of growth of the world economy, which is sluggish.
The investment portion of China’s rapid growth expanded its industrial and real estate capacity faster than its own lagging consumption demand can sustain. This shows up particularly in real estate prices, which have been driven to very high levels not so much by people seeking homes to live in, but by investors with no other output for their surplus capital. This is an instance of capital glut.
I have Chinese friends who sold their apartment in downtown Nanjing and moved to a lakefront apartment in Chicago, finding real estate prices in rich America to be a bargain compared to China! But with real estate prices so high, every Chinese city today is full of forests of newly-built high-rise apartment buildings that are dark at night because Chinese consumers cannot afford apartments at the sky-high prices to which speculators have driven them.
China’s capital glut also shows up in excess industrial capacity and in the tendency of its financial markets to boom quickly in a rush of bullish optimism as asset prices are rapidly driven to extreme levels by the inflow of massive quantities of under-employed capital seeking higher returns. They crash repeatedly as the levels to which prices are driven by this glut of capital become unrealistically and unsustainably high. Those lucky enough to sell at the peak make a fortune, but many others are trapped in falling markets and lose big.
Tune in next week as I will look more at how and why China’s tumultuous boom and bust cycle impacts the wider world.
James H. Nolt is a senior fellow at World Policy Institute and an adjunct associate professor at New York University.
[Photo courtesy of The Speaker News]
Please note that there will be no new blogs for the next two weeks. We hope you will join us again on Sept. 3 for the next installment of “Polarizing Political Economy.”