The death of the "global savings glut" theory, or, RIP Mr. Greenspan

[20000miles]

There are some economists, such as Paul Krugman and Alan Greenspan, who have been trying to pin the blame for the recession on the "global savings glut".

Here is Krugman on the matter:

In the mid-1990s, he pointed out, the emerging economies of Asia had been major importers of capital, borrowing abroad to finance their development. But after the Asian financial crisis of 1997-98 (which seemed like a big deal at the time but looks trivial compared with what’s happening now), these countries began protecting themselves by amassing huge war chests of foreign assets, in effect exporting capital to the rest of the world.
The result was a world awash in cheap money, looking for somewhere to go.

and here is Greenspan's defence as to why he was "powerless" to do anything about interest rates, as long term interest rates were being driven by these "excessive" savings:

The Federal Reserve became acutely aware of the disconnect between monetary policy and mortgage rates when the latter failed to respond as expected to the Fed tightening in mid-2004. Moreover, the data show that home mortgage rates had become gradually decoupled from monetary policy even earlier — in the wake of the emergence, beginning around the turn of this century, of a well arbitraged global market for long-term debt instruments.
U.S. mortgage rates' linkage to short-term U.S. rates had been close for decades. Between 1971 and 2002, the fed-funds rate and the mortgage rate moved in lockstep. The correlation between them was a tight 0.85. Between 2002 and 2005, however, the correlation diminished to insignificance.

Now this is Greenspan at his best. Can you spot the fallacy here? Robert Murphy can:

Now this is extremely misleading. Judging from Greenspan's description, the reader would think that the federal-funds rate (which the Fed directly targets with its open-market operations) and the mortgage rate moved along in sync, when all of a sudden Greenspan tried to jack up short-term rates in 2004, and yet those pesky mortgage rates refused to move up. Hence, he did what he could to slow the housing bubble, but alas, it was precisely when he tried to help that the markets rendered him impotent...



So it's true, the red and blue lines in the chart above moved pretty much in lockstep up until 2002, as Greenspan claimed. But the disconnect occurred when Greenspan slashed short-term rates while mortgage rates held steady. Since the participants in the mortgage market wisely realized that rates wouldn't be held at 1% forever, they didn't foolishly drop their own yields down so far. Then in June 2004, when Greenspan began ratcheting the federal-funds rate back up, it is perfectly understandable that mortgage rates wouldn't rise with them.
To repeat, Greenspan's defense of his policies made it sound as if he tried to push up mortgage rates, but that they wouldn't budge.

Alan Greenspan: Liar Liar, pants on fire! But that's not all, the death blow comes from Susan Lee of forbes.com:

Here's Taylor's take. Short interest rates fell in 2001 in response to the dot-com bust. But--and here's the important moment--beginning in 2002, the Taylor rule indicated that Greenspan ought to have tightened. Indeed, from 2002 to 2005, rates ought to have climbed to a touch over 5% and then stayed there through 2006.
But the Fed kept to a loose monetary stance, and rates kept falling during the period 2002 through 2004. Rates didn't start back up until middle of 2004 and didn't reach 5% until 2006.

The result? The Greenspan Loose policy went on to fuel a boom, while the Taylor Tight would have avoided one. As Taylor says, all the Fed needed to do was follow "... the kind of policy that had worked well during the period of economic stability called the Great Moderation, which began in the early 1980s."
The connection between Greenspan Loose and the housing boom is also clear. Housing starts took a sharp spike up in 2003 and then continued to climb through 2006. If the Fed had followed Taylor Tight, however, housing starts would have peaked at a much lower level at the end of 2003, and drifted down through 2006.

Taylor also takes on Greenspan's excuse that he was helpless in the face of a global saving glut. Cutting off the feet of Greenspan's excuse, Taylor says there wasn't a glut, there was a shortage. Figures from the International Monetary Fund show global saving rates, as a share of world GDP, were low during 2002 to 2004--way lower than rates in the 1970s and 1980s. In fact, the global saving rate fell at the end of 1990s, hitting bottom about 2003.




I really wish Greenspan would stop blaming the crafty Chinese for a crisis that so clearly has its roots in appalling US interest rate policy.

[Hazlitt]

Excellent post 20000, if I had 500 posts I'd thank you for it.

[feargach]

Excellent post 20000, if I had 500 posts I'd thank you for it.

I'm glad somebody got something out of it.

Would anyone mind summarising it?

Is it the point that the combined savings of the Chinese, Japanese, French and Germans are globally insignificant to the economy? Not to mind the Thais etc.

Last I heard, those savings equalled for a particularly large slice of global product. Seems important to me, but I'm not able to see how that post debunks it.

[20000miles]

I think this Taylor (a non-Austrian economist) summarises it:

Taylor also takes on Greenspan's excuse that he was helpless in the face of a global saving glut. Cutting off the feet of Greenspan's excuse, Taylor says there wasn't a glut, there was a shortage. Figures from the International Monetary Fund show global saving rates, as a share of world GDP, were low during 2002 to 2004--way lower than rates in the 1970s and 1980s. In fact, the global saving rate fell at the end of 1990s, hitting bottom about 2003.

[Hazlitt]

Is it the point that the combined savings of the Chinese, Japanese, French and Germans are globally insignificant to the economy? Not to mind the Thais etc.

Have you done one of your "controlled-experiments" to test and prove this? If not then shouldn't you not go off and do it and then come back to us?

[20000miles]

Mish takes Bernanke and Greenspan apart on "global savings glut" as well:

Mish's Global Economic Trend Analysis: Global Savings Glut Exposed
Mish's Global Economic Trend Analysis: Bernanke Blames Saving Glut For Housing Bubble

"That brief overview makes only one thing clear: Bernanke has no idea what he is talking about. There is no savings glut. Monetary printing in China to swap Renmimbi for US dollars (so that China could keep its currency artificially low) does not constitute a "savings glut". Nor does enormous carry trades in Japan. I have talked about the myth of the savings glut many times. Inquiring minds may wish to consider [COLOR=#002268]Global Savings Glut Exposed[/COLOR] from September 2007 and [COLOR=#002268]Global Savings Glut Revisited[/COLOR] from December 2006.

This nonsense is what happens when an academic meets the real world. That Bernanke cannot distinguish between monetary printing and savings is quite telling."

[Hazlitt]

I'm glad somebody got something out of it.

Bobert and Defeated Romanticist in the last 8 minutes seem to have got something out of it also feargach. . . [Edit] And Cael

[feargach]

Have you done one of your "controlled-experiments" to test and prove this? If not then shouldn't you not go off and do it and then come back to us?

God grand Hazlitt the courage to test the things that can be experimentally tested, patience to accept the things that cannot be, and wisdom to know the difference.

[west'sawake]

There are some economists, such as Paul Krugman and Alan Greenspan, have been trying to pin the blame on the "global savings glut".

Here is Krugman on the matter:

In the mid-1990s, he pointed out, the emerging economies of Asia had been major importers of capital, borrowing abroad to finance their development. But after the Asian financial crisis of 1997-98 (which seemed like a big deal at the time but looks trivial compared with what’s happening now), these countries began protecting themselves by amassing huge war chests of foreign assets, in effect exporting capital to the rest of the world.
The result was a world awash in cheap money, looking for somewhere to go.

and here is Greenspan's defence as to why he was "powerless" to do anything about interest rates, as long term interest rates were being driven by these "excessive" savings:

The Federal Reserve became acutely aware of the disconnect between monetary policy and mortgage rates when the latter failed to respond as expected to the Fed tightening in mid-2004. Moreover, the data show that home mortgage rates had become gradually decoupled from monetary policy even earlier — in the wake of the emergence, beginning around the turn of this century, of a well arbitraged global market for long-term debt instruments.
U.S. mortgage rates' linkage to short-term U.S. rates had been close for decades. Between 1971 and 2002, the fed-funds rate and the mortgage rate moved in lockstep. The correlation between them was a tight 0.85. Between 2002 and 2005, however, the correlation diminished to insignificance.

Now this is Greenspan at his best. Can you spot the fallacy here? Robert Murphy can:

Now this is extremely misleading. Judging from Greenspan's description, the reader would think that the federal-funds rate (which the Fed directly targets with its open-market operations) and the mortgage rate moved along in sync, when all of a sudden Greenspan tried to jack up short-term rates in 2004, and yet those pesky mortgage rates refused to move up. Hence, he did what he could to slow the housing bubble, but alas, it was precisely when he tried to help that the markets rendered him impotent...



So it's true, the red and blue lines in the chart above moved pretty much in lockstep up until 2002, as Greenspan claimed. But the disconnect occurred when Greenspan slashed short-term rates while mortgage rates held steady. Since the participants in the mortgage market wisely realized that rates wouldn't be held at 1% forever, they didn't foolishly drop their own yields down so far. Then in June 2004, when Greenspan began ratcheting the federal-funds rate back up, it is perfectly understandable that mortgage rates wouldn't rise with them.
To repeat, Greenspan's defense of his policies made it sound as if he tried to push up mortgage rates, but that they wouldn't budge.

Alan Greenspan: Liar Liar, pants on fire! But that's not all, the death blow comes from Susan Lee of forbes.com:

Here's Taylor's take. Short interest rates fell in 2001 in response to the dot-com bust. But--and here's the important moment--beginning in 2002, the Taylor rule indicated that Greenspan ought to have tightened. Indeed, from 2002 to 2005, rates ought to have climbed to a touch over 5% and then stayed there through 2006.
But the Fed kept to a loose monetary stance, and rates kept falling during the period 2002 through 2004. Rates didn't start back up until middle of 2004 and didn't reach 5% until 2006.

The result? The Greenspan Loose policy went on to fuel a boom, while the Taylor Tight would have avoided one. As Taylor says, all the Fed needed to do was follow "... the kind of policy that had worked well during the period of economic stability called the Great Moderation, which began in the early 1980s."
The connection between Greenspan Loose and the housing boom is also clear. Housing starts took a sharp spike up in 2003 and then continued to climb through 2006. If the Fed had followed Taylor Tight, however, housing starts would have peaked at a much lower level at the end of 2003, and drifted down through 2006.

Taylor also takes on Greenspan's excuse that he was helpless in the face of a global saving glut. Cutting off the feet of Greenspan's excuse, Taylor says there wasn't a glut, there was a shortage. Figures from the International Monetary Fund show global saving rates, as a share of world GDP, were low during 2002 to 2004--way lower than rates in the 1970s and 1980s. In fact, the global saving rate fell at the end of 1990s, hitting bottom about 2003.




I really wish Greenspan would stop blaming the crafty Chinese for a crisis that so clearly has its roots in appalling US interest rate policy.

Once again, I thank you for posts like this, but I wonder if the Chinese are really that 'crafty'! Methinks they might be in a panic at the moment re the dollar. Are they not making noises about the need for some kind of global currency unit, a safer refuge perhaps where they can dump their dollars quickly?

Spot on though re Greenspan, all of our troubles have had their roots in his tenure at the Federal reserve and of course the madness of the Euro. (The Euro initially shouldhave been confined to France/Germany/Benelux.

I think we need to ressurrect Friedman, increasing the money supply globally without the normal build in stabilisers, (floating exchange rates), has been a disaster,first we had the Chinese, fixing their currency while they had huge trade surpulses; on top of that a contrived currency in a divergent economic zone (the euro), and now quantitative easing with real negative interest rates, all has been and will be a recipe for diaster.

An authentic equilbirum in the World economy may be forced on us by the ending of contrivances that could not forever buck the market or hide the truth that there was no real wealth creation to match the quantum leap in dud money (derivatives, over valued dollar in realation to the domestic U.S economy,etc, the proverbial chickens have come home to roost and are not going to leave the coop for a decade or so.

[Hazlitt]

God grand Hazlitt the courage to test the things that can be experimentally tested, patience to accept the things that cannot be, and wisdom to know the difference.

How about you give us all an example of your legendary analytical skills and give us all a critique on the original post ?