Friday, April 3, 2009

iCapital Lays An Egg

iCapital in an article in the Star today talks about the 'perception' that current global imbalances have to be unwound is wrong:

"One of the most often cited global imbalance is the high saving, low consuming Asians and the high spending, low saving Americans...According to this school of thought, the global economy is heading for a serious and protracted contraction because Americans need to save more while Asians are not spending enough...So if Americans save more, where will the global demand come from? If there is insufficient global demand, how can the export addicts of Asia expand?...So, the way to solve the current end-of-the-world contraction is for the global savings/spending imbalance to be rectified. Unfortunately, this would take years. Now you get the drift of why they think the world economy will be down and out for many years to come?...i Capital really does not buy into this argument. When this is all over, when we are over the Lehman panic, for the record, Capital Dynamics, i Capital, and its boss would want to be known as non-bear...Is there any cast-in-stone law that says the global savings/spending imbalance needs to be rectified now? Is there any rule that says Americans must save more now?"


"First, the less than one billion people in the Western economies plus Japan have enjoyed much higher standards of living for a very long time, while the five billion-plus people in the rest of the world have either been in poverty or struggling for a very long time...This global imbalance should have been corrected a long time ago but it has instead persisted for a very long time despite all the aid given by the wealthy developed economies...Second, the imbalance in the perception of the developing countries by the rest of the world and the perception of the developed world by the rest of the world has existed for a very extended period too...This global imbalance in the perception of the developing countries by the rest of the world and the perception of the developed world by the rest of the world needs to be rectified but will it ever be? So do not be surprised if the global imbalance of high saving, low consuming Asians and high spending, low saving Americans persists for a while longer."

What are these guys smoking? I don't have a problem with their conclusion: capital markets are I think forming a bottom and anybody with the capital and patience to invest should find some great medium term bargains right now. But the basis for their view on the other hand is built on a house of cards. There is a real serious global imbalance, which is also right now being unwound.

Comparing the global consumption-savings imbalance to cultural perceptions is disingenuous at best; there aren't any market forces acting on those, but there are on global trade and capital flows. The US savings rate is rising, not because it was underestimated in the first place, but because Americans are actually beginning to save.

The meme iCapital is disputing is high saving, low consuming Asians; low saving, high consuming Americans - how much of this true? Going back to the national accounts identity:

Y = C + I + G + NX

where Y is income
C is consumption
I is investment
G is government deficit
and NX is net exports
In addition I = S (savings)

For a given level of income and government spending, excessive consumption and investment turns up as a negative value for the NX term, and vice versa. In short, a trade deficit indicates excess consumption and investment (or for that matter, excess government spending). The opposite is true for a trade surplus - savings in excess of consumption.

To get a finer understanding of this, it must be understood that I = savings, does not necessarily imply investment must equal domestic savings - international savings can be involved as well. Second, savings covers not just individuals, but also corporate and government savings. Third, international trade and capital flows are zero-sum; the existence of a trade deficit implies a surplus somewhere else, same with capital flows.

With that background, what's the record on the US trade deficit? (1992-2008)

And as a ratio to GDP (1992-2008):

I dare anyone to say there isn't a problem here, but that it is also beginning to reverse. Here are the countries/regions that have the largest trade surplus against the US as of January 2009:

China - 46.9%
Other Pacific Rim countries 17.4%
Canada & Mexico - 11.8%
OPEC - 9.2%
EU - 7.9%

That's pretty clear. It's actually even easier to see than that, because the US actually compiles statistics on personal income, expenditure and savings. Here's personal savings as a ratio to personal income (1947-2008):

So on that score, I think there is no question that over-consumption in the US is true and that the savings rate has been declining over time, and moreover this over-consumption was financed by savings elsewhere including Asia and the Middle East.

The real question isn't whether there will be a redressing of global imbalances, but rather to what extent and in what form it will take. A country can usually sustain an imbalance of the current account, if it is supported by fundamentals like demographics. An older population base, with a significant ratio of retirees, would generally be dissaving, thus inducing an excess of imports over exports (by that argument, Japan ought to be running a deficit - another imbalance waiting to be fixed).

But the US is not in this position. While it’s true that imbalances can and do persist over time, this crisis is likely to cause a structural change in the US relationship with the rest of the world. The shock to the consumer psyche isn't going to disappear even with the flood of liquidity in the banking system, or the massive stimulus package that's already being rolled out. An increase in the US savings rate should be taken as a given. Will it return to the level of the 1970s? Perhaps not - but a complete redressing of global imbalances doesn't require that.

The easiest way to address the US trade and capital flow imbalances is through a change in relative prices i.e. a fall in the USD or equivalently an appreciation of the currencies of trading partners. The harder, more painful way is through balance sheet adjustments i.e. deleveraging.

I think both are happening or will happen in the case of the USD, especially with the pressure on the exchange rate from monetary expansion and government borrowing. And this will cause a retreat in US imports and Asian exports. And neither is this necessarily bearish for capital markets.

Technical Note:
All trade, personal income and GDP data from the Bureau of Economic Analysis


  1. all this while most of the spending in US was done in a bubble.

  2. Hi HishamH,

    I think the iCapital’s article is disputing the following as a whole (not individually):

    1. “high saving Asian, low saving Americans” imbalance;
    2. imbalance needs to be rectified but take years;
    3. therefore: economy down for years to come

    I guess the iCapital economist also agrees that there is imbalance, just that they don’t agree that “global savings/spending imbalance need to be rectified for economy to be out from the recession”.

    I wonder: what are the “necessary conditions” to go out from global recession ?
    I guess the iCapital economist doesn’t think rectification of imbalance is one of those conditions.

    I like this sentence of yours:
    “The real question isn't whether there will be a redressing of global imbalances, but rather to what extent and in what form it will take.”

    “change in relative prices”
    US has been doing these many times, changing rules (“cheating”) to change relative prices; sometimes through unilateral decision, sometimes through global “cooperation”, for e.g:
    1933 executive order 6102 (confiscation of gold)
    1971 Nixon shock
    1985 Plaza Accord

    In what form do you think it will happen this time ?

  3. You raise a good point. One other nuance you might consider is that they are not considering economic recovery per se, but just capital markets.

    To be honest, what set me off on this was their comparison to American mental perception of developing countries, of which they spent about half the article talking about. That's hardly an appropriate comparison.

    As far as the rebalancing mechanism, it's a matter of political economy (which subject I never took at university :( ):

    1. To what extent will US creditors accept a loss on their holdings? This can happen in two ways - inflation (which reduces the future real of debt), as well as a depreciation of the USD. China has already responded by moving to the short end of the Treasury curve.

    2. To what extent will the US population (and Congress) accept higher interest and tax rates? The former is necessary to keep a lid on inflation, while the latter is necessary to repay the non-inflated away portion of the national debt.

    3. At what point do consumers and businesses decide that they have saved enough and start spending again?

    4. Crucially for countries like Malaysia - how do we respond to the loss of external demand emanating from the US? Expansion in China can only cover so much of the gap.

    That's a lot of questions with very uncertain answers.

    BTW, I'm increasingly leaning towards the view that inflation will not be a major issue going forward, but rather high interest rates. Slower global growth on the other hand is probably a given.

  4. Haha, the “mental perception” part I read it as a totally different part, though loosely connected through the word “imbalance”. The author may want to bring out the point of “unfairness” in the perception.
    I think developed countries have been through the similar path of “uncivilised” behaviours shown by the developing countries now.

    I like Milton Friedman's "motto" : "there is no such thing as free lunch".
    Inflation maybe the necessary evil to solve the crisis. But, my worry is that inflation escalating into hyperinflation ? can it be controlled ? It may breed leaders like Hitler and wars may erupt.

    There is a belief that “it is easier to handle inflation than deflation”. Wonder whether it’s true. (?)

    If Depression looms, the risk is riot/unrest etc. Seems like economy should be like “Goldilock” – conditions that are just nice.

    Sidetrack a bit, wonder how newspaper like Star gets their articles on economy issues.
    I think your blog articles can be possible candidates (for e.g Dali’s blog).
    If iCapital’s articles can, so do yours. However, may need your employer’s approval.

  5. I'm fairly confident that hyperinflation can be controlled - I don't think the Fed or ECB are run by idiots like in Zimbabwe. The way quantitative easing is being conducted right now means an orderly reduction in central bank balance sheets is possible. The biggest change I think has been the decision to pay interest on bank reserve balances at both central banks, which means much finer control over credit creation than before.

    The main channel for money supply growth turning into general inflation is through the banking system (see my post on fractional reserve banking to see how the mechanism works).

    High credit creation->higher investment, which under full employment leads to bidding up of wages. Higher wages leads to higher goods and services demand, and since in the short term supply is inelastic, leads to a continuous rise in the general price level.

    However, the price of central bank balance sheet unwinding would be much higher average interest rates - which necessarily leads to slower growth, through higher cost of investment.

    Yes, inflation is much easier to handle than deflation. The psychology of both are self-reinforcing, but inflation-fighting isn't capped by the zero nominal interest rate boundary.

    Publication - it's been discussed internally, but management isn't keen.

  6. Thx for your insights.

    OIC. Manangement isn't keen. Probably your management target customers are HNWI, rather than masses.

    Probably put some ads on your blog.
    Have been getting lots of insights from your blog. Recommended some friends (forum friends included) to this blog. Hope to generate some traffic..

  7. LOL, ironically, it's quite the opposite - we go out of our way NOT to target HNWI. You can probably tell where I'm working from that.