Demography and the financial crisis

The Financial Times’ chief economics commentator, Martin Wolf, has put forward a convincing explanation for the ultimate cause of the current financial crisis. To briefly summarise, some countries, such as China, Germany and Japan – ‘the savers’ – produce more than they consume. This excess production is exported to ‘the spenders’ (dominated by the USA, but also other countries such as the UK and Spain). The resultant excess savings are exported by the savers to the spenders to fund the consumption, which has resulted in asset bubbles and huge debts amongst the spenders.

 

I am broadly in agreement with this explanation. However, Wolf goes further, suggesting that the savers need to reduce their ‘chronically high’ savings rates so that they no longer run large current account surpluses. The recent research completed under the IEA Empowerment Through Savings programme provides an alternative view.

 

Germany and Japan are both characterised by old and ageing populations. China has a young but rapidly ageing population (see my previous blog post). It therefore seems highly appropriate for these countries to have high savings rates.

 

It is true that the UK and USA, for example, have younger populations than Germany and Japan. However, they still have ageing populations. Yet gross national savings rates in both countries are approximately 13% of GDP (compared with 27% and 25% in Japan and Germany respectively (IMF data)). The demographics therefore suggest that it is the USA and UK that have the serious problem – chronically low savings rates.

 
What might happen if the spenders’ savings were in line with their demographic situation? They would have a lower propensity to borrow and spend, so would have a lower demand for the savers’ capital. The savers would still export capital to the spenders, due to the age differential between the populations, but in far smaller quantities. Saving countries would therefore export more capital to younger countries, in regions such as South Asia, the Middle East and South America. Local investments would also be relatively more attractive, as would increased consumption.

 

Faced with the ‘credit crunch’, the mantra of most economists and politicians has been to encourage consumers and companies to borrow and spend. And if they stop spending, governments are acting as spenders of last resort.

 

This is akin to giving a heroin addict more heroin to stop the pain of withdrawal – it might stop the immediate pain but as a treatment it’s totally self defeating. The real problem is that certain economies, notably the UK and USA, are structured in such a way that they are heavily reliant on ever increasing borrowing backed by over-inflated asset values – when this stops, growth and employment collapse. It is this that has to change.

“The resultant excess savings are exported by the savers to the spenders to fund the consumption, which has resulted in asset bubbles and huge debts amongst the spenders.”Had the savings been predominantly used by US/UK to invest in industry and make and manufacture things that could then be exported there would be no real problem. Instead its been frittered away on consumer borrowing. In addition, this analysis completely misses the culpabiity of fractional reserve borrowing which has grossly inflated the money supply over the last few years causing massive malinvestment. Hence the current crisis.We certainly should not be blaming China, Japan & Germany for our predicament.

There is a sense in which we can possibly blame Chinese monetary policy and their socialised banking system to some extent. But, abstracting from this, there is no reason why the phenomenon should cause any sort of a bubble. People from other countries are prepared to lend to us at low interest rates. Unless you have monetary expansion as well that simply transfers purchasing power from one group of people to another (and acts to raise the exchange rate – the reversal of this process at least partly explaining its fall).

One of the basic rules of Vanilla Bank Lending is that the money lent should be invested and not wasted, leaving the debtor financially stronger and therefore better positioned to repay the debt. It is easy to blame the debtor but how do you get your money back? The lending is in the debtor currency in this case and should therefore be used for asset purchases from the debtor countries which would therefore be investments from which wealth can be exported from the debtors, restoring the balance. How can this be encouraged at a policy level?

The domestic saving rate is parameter which divides between savings and investment: the less are savings, the more is investment and vice versa.
Investment means allocation of the funds to economic development; with more investment under low savings rate.
Developed states such as UK and US have to continually develop – not to loose competetiveness of their economies: e.g. by inventing new technologies and obtainning new competitive positions.
Chinese win by incredibly low cost of labor, while in most of cases they copy what was technogically invented in developed states. R.Reugan administration used this scenario by inviting foreign funds to come to state and re-equipping the US economy.

This could not be done by G.W.Bush administration which instead of further moving towards economic devlopment, started to spend on war taking roughly 3 blns annually. So the crisis which started in the US had this fundamental reason, having US economy to become stagnated and ill since it was pushed to very end and was not anymore to carry on with this significant warfare expenditures, multiplied by real estate problems. But generally the low investment is a way to economic development. To restore that trend in the US has to decrease military expenditures which seems to tale place after 16 months as President B.Obama promised.

Please read “But generally the low savings rate is a way to economic development” (instead of investment)

“The resultant excess savings are exported by the savers to the spenders to fund the consumption, which has resulted in asset bubbles and huge debts amongst the spenders.”Had the savings been predominantly used by US/UK to invest in industry and make and manufacture things that could then be exported there would be no real problem. Instead its been frittered away on consumer borrowing. In addition, this analysis completely misses the culpabiity of fractional reserve borrowing which has grossly inflated the money supply over the last few years causing massive malinvestment. Hence the current crisis.We certainly should not be blaming China, Japan & Germany for our predicament.

There is a sense in which we can possibly blame Chinese monetary policy and their socialised banking system to some extent. But, abstracting from this, there is no reason why the phenomenon should cause any sort of a bubble. People from other countries are prepared to lend to us at low interest rates. Unless you have monetary expansion as well that simply transfers purchasing power from one group of people to another (and acts to raise the exchange rate – the reversal of this process at least partly explaining its fall).

One of the basic rules of Vanilla Bank Lending is that the money lent should be invested and not wasted, leaving the debtor financially stronger and therefore better positioned to repay the debt. It is easy to blame the debtor but how do you get your money back? The lending is in the debtor currency in this case and should therefore be used for asset purchases from the debtor countries which would therefore be investments from which wealth can be exported from the debtors, restoring the balance. How can this be encouraged at a policy level?

The domestic saving rate is parameter which divides between savings and investment: the less are savings, the more is investment and vice versa.
Investment means allocation of the funds to economic development; with more investment under low savings rate.
Developed states such as UK and US have to continually develop – not to loose competetiveness of their economies: e.g. by inventing new technologies and obtainning new competitive positions.
Chinese win by incredibly low cost of labor, while in most of cases they copy what was technogically invented in developed states. R.Reugan administration used this scenario by inviting foreign funds to come to state and re-equipping the US economy.

This could not be done by G.W.Bush administration which instead of further moving towards economic devlopment, started to spend on war taking roughly 3 blns annually. So the crisis which started in the US had this fundamental reason, having US economy to become stagnated and ill since it was pushed to very end and was not anymore to carry on with this significant warfare expenditures, multiplied by real estate problems. But generally the low investment is a way to economic development. To restore that trend in the US has to decrease military expenditures which seems to tale place after 16 months as President B.Obama promised.

Please read “But generally the low savings rate is a way to economic development” (instead of investment)

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