The savings glut and its impact on asset price inflation explained
The savings glut is probably THE one critical factor to explain the magnitude of global fund flows, exposing economies worldwide to inflation and uncontrolled risk
The sequence - from cumulative savings to bank intermediation feeding into asset price inflation - is undisputable
However, political convenience, all too often, misdirects economic and financial priorities, depriving monetary policy from fiscal (budgetary) backbone and putting fragile interactions at risk
How does this savings glut originate?
What is the role of the international banking system?
How can the impact of this ‘savings glut’ be measured?
What is being done to mitigate the risks to the financial system?
Is a financial institution, such as the U.S. Federal Reserve, in control?
Cutting through the day-to-day financial news, the answers matter
Where do the savings come from?
Agreement amongst economists is universal – the savings originate with the positive balance of trade numbers, originated by mercantilist countries, such as China and Germany, which rely on massive exports to boost their ultra-competitive economies
The Trump Administration is right in targeting American trade deficits, only not for the reasons propounded by the U.S. president
- No one has actually been ‘taken advantage of’ in America by importing cheap Chinese consumables or advanced German machinery....
- The concern is real : by skewing trade relations, and the corresponding financial flows, fundamental tensions have been building-up with unpredictable consequences
By remaining out of balance for decades, the deficits are mirrored in their exporting counterparties, all over the world, by cash entries, all of which is not reinvested by the direct beneficiaries
This is where the banking system comes in
The international banking system
The international banking system fulfills its function of intermediation
Simply stated, the ‘savings’ do not stay ‘saved’ for long
The banking system reallocates the savings and, by way of the multiplier effect of bank loans, a tsunami of cash has been landing on available assets, across the world
The multiplier effect of loans within a fractional reserve system is familiar – cash deposits enter in a continuous cycle of deposits and loans, as new loans in turn generate new deposits
Measuring the impact of this ‘glut’ in savings
Measuring the impact of this ‘deposits and loans’ cycle initiated by the savings glut is straightforward
Looking for reliable and liquid investments, U.S. assets – bonds and shares – and global real estate have been on the receiving end of this investment windfall
The magnitude of this merry-go-around is hard to fathom, considering a single ratio comparison to make the point
The U.S. economy represents approx. 25% of global GDP but… its stock markets hog 70% of the world exchange listed market cap, delivering growth and profitability
Preference for U.S. Treasuries is another self-fulfilling reality – the more confident foreign investors are, the deeper and the more liquid the bond market and the lower the cost for the indebted U.S. government
Something unquestionably has to give...some day ....
What to do about it?
To mitigate the risks to the financial system, regulators have to be convinced of the risks and to show willingness to address the issues at their root-cause
Uncomfortably, the link from cause (the savings glut) to effect (ever increasing asset prices) raises very unwelcome questions
Rising share prices earn applause as proof of well-functioning economies – bringing the ‘cash hose’ to a trickle not so much
And Treasurys supplied to eager investors are not to be sniffed at by a U.S. budget, only to happy to run ever-increasing deficits at reasonable cost
The ultimate beneficiaries – asset owners and deficit-toting governments – probably are short-sighed but obviously reluctant to step down just yet…
And the banking system, beneficiaries on both sides of the trades, surely add weight to this ‘front of resistance’
Are the financial institutions in control?
Financial institutions, such as the U.S. Federal Reserve, first amongst its peers, are assumed to exercise control over the vast domain of international finance
In fact, the U.S. Fed is entangled in impossible choices – between too little (impacting rates at the short maturity end of the yield curve) in case of major disruption and too much (with quantitative easing, supporting prices of assets acquired with ‘central bank virtual cash’) when the markets normalize
In retrospect, the Fed has been criticized on both accounts, doing too little in the face of looming crises and doing too much for too long when massive market interventions are not warranted by calmer tides
It remains true that the most precious tool of U.S. Federal Reserve is credibility, precisely because the monetary and extra-monetary instruments at its disposal cannot be fine-tuned on their own, coming out as too blunt or too weak
Credibility, conveyed astutely to the markets, signals confidence that modest rate shifts will actually convince and move markets as intended – and provides assurance that more radical interference in the markets is nothing but very temporary
What is left unsaid is that the dollar as reserve currency has mutated worldwide with extra-territorial deposits and loans and global ex-U.S. trades – a massive, multi trillion dollar-driven economy, not precisely under the purview of the U.S. monetary authorities but still relying on access to dollar liquidities in times of crisis
…an even broader mandate for the American monetary authorities, requiring credibility in their own right as well as cooperation between the world’s dominant Central Banks
… undoubtedly challenging times ahead, to be discussed in 'the Euro-Dollar and the stable coin'