Savings Glut

The notion of a worldwide "savings glut" is being hotly debated by various pundits in the press and on the internet. And rightly so: It's rather obvious that the current downturn is a problem of "not enough demand", which is the same thing as "too many savings".

The question is: What can be done about it? Anglo-saxon commentators like to argue that "high-saving/surplus" countries (by which they mainly mean China, and to a lesser extent Germany) somehow need to save less to counterbalance the rising savings rates in the US and Britain (as well as the sharp drop in investment demand just about everywhere in the world).

I am wondering if the "savings glut" is maybe a structural problem of the world economy. Not so much something caused by certain "surplus countries" (though China does have a ridiculously high savings rate, which exacerbates the overall problem), but caused by the worldwide demographic shift, and the way the world deals with it:

All developed countries are aging rapidly (and China is not far behind either). Securing sufficient income in old age is a big topic. It used to be the case that most countries had more or less generous pay-as-you-go pension schemes. But these weren't popular among economists: No capital stock being built, just a giant ponzi scheme, where the young generation pays for the old generation, and if there isn't a big enough young generation, then too bad for the elderly. So the right thing to do was to move towards funded pension schemes. Either via organized public pension schemes (Singapore's CPF), or via private retirement savings (usually tax-advantaged, i.e. 401k in the US, superannuation funds in Australia, Riester in Germany). And people started accumulating funds. And more funds. And still more funds.

Singapore's case is the most extreme one: The whole pension scheme is funded, there is no pay-as-you-go element whatsoever. Not coincidentally, Singapore also keeps running one of the biggest current account surplusses worldwide when measured as a percentage of GDP. China doesn't come close. Of course, it's inevitable: Singapore has a gargantuan savings rate, and can't possibly invest all of it at home. So the foreign assets grow and grow. (Though Singapore made the mistake of investing most of it in overseas equities, with a focus of financial services, so they lost a large chunk of their national savings in 2008. Tough luck!)

Anyway, a small country like Singapore can get away with it. The world as a whole cannot. It doesn't need that much capital - at least not anymore, now that the US is finally doing some net saving of its own, and China has also entered its inevitable real-estate-binge hangover.

So what can be done?

- What is anyway already being done at the moment: High budget deficits to put the savings to use. If private savings are recycled into public spending, net savings go down accordingly.

- Alternatively, pay-as-you-go pension schemes could make a come-back. If people have sufficient pension entitlements from such a scheme (and actually believe that they will really get that money when they are old), there is less of a need to save. What this would imply is a higher tax-burden for the young generation, as they would need to finance payments to the old generation (which coincidentally would decrease net income of the tax-payer generation, and therefore automatically crowd out savings). In terms of economic effects, it's the same thing as government debt really, because government debt also needs to be serviced by tax-payers. But apart from short-term crisis management, it's more appropriate and targetted to do the intergenerational transfer via an explicit pension scheme, as opposed to government debt being poured into pork barrel spending.

In any case, real interest-rates need to be low to discourage saving and stimulate investment. The market would normally take care of that, except that in a liquidity trap, the market can't. So somebody needs to make sure there is sufficient inflation, i.e. the usual 2-3 % target. But it's kind of silly to argue (as some people do) that the low real interest rates in the US and China have caused overinvestment and bubbles of all sorts: If there are excess savings, the time value of money is low or even negative in real terms. Money is cheap if lots of people offer it (i.e. want to save) and not enough people want it (i.e. want to invest). That's the way a functioning market works - it balances supply and demand.