Revenge of the savings glut

Paul Krugman (following on from Brad Setser earlier this year) revisits Federal Reserve Chairman Ben Bernake's 2005 speech, The Global Saving Glut and the U.S. Current Account Deficit, in light of current economic circumstances. ECON1082 International Monetary Economics students will be covering this material next week. In a nutshell, Bernake's thesis is that the principal causes of the U.S current account deficit is located outside of the country's borders, with the rest of the world, particularly the Asian region and oil exporters, consuming too little and saving too much. Krugman and Setser argue that without this savings surplus, rising US interest rates would have constrained the US housing bubble.

Revenge of the Glut, by Paul Krugman. How did this global debt crisis happen? Why is it so widespread? The answer, I’d suggest, can be found in a speech Ben Bernanke, the Federal Reserve chairman, gave four years ago. At the time, Mr. Bernanke was trying to be reassuring. But what he said then nonetheless foreshadowed the bust to come.

The speech, titled “The Global Saving Glut and the U.S. Current Account Deficit,” offered a novel explanation for the rapid rise of the U.S. trade deficit in the early 21st century. The causes, argued Mr. Bernanke, lay not in America but in Asia.

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.

Most of that money went to the United States — hence our giant trade deficit, because a trade deficit is the flip side of capital inflows. But as Mr. Bernanke correctly pointed out, money surged into other nations as well. In particular, a number of smaller European economies experienced capital inflowsthat, while much smaller in dollar terms than the flows into the United States, were much larger compared with the size of their economies.....

For a while, the inrush of capital created the illusion of wealth in these countries, just as it did for American homeowners: asset prices were rising, currencies were strong, and everything looked fine. But bubbles always burst sooner or later, and yesterday’s miracle economies have become today’s basket cases, nations whose assets have evaporated but whose debts remain all too real. And these debts are an especially heavy burden because most of the loans were denominated in other countries’ currencies.

Nor is the damage confined to the original borrowers. In America, the housing bubble mainly took place along the coasts, but when the bubble burst, demand for manufactured goods, especially cars, collapsed — and that has taken a terrible toll on the industrial heartland. Similarly, Europe’s bubbles were mainly around the continent’s periphery, yet industrial production in Germany — which never had a financial bubble but is Europe’s manufacturing core — is falling rapidly, thanks to a plunge in exports.

If you want to know where the global crisis came from, then, think of it this way: we’re looking at the revenge of the glut.