Sunday, July 10, 2005

Excess savings in the world?

Businessweek has on its cover this article on "World is awash in savings glut". What I cant figure out is this - how can there be a net savings glut in the world. If I sell someone something for $50, then my balance increases by $50, and the other person balances decreases by $50. So net savings in the world is 0. Maybe what they are saying is that the world has net positive savings vis-a-vis US. (They do say it at places in article, but still the feeling that one gets is that net savings in world is +ve) I dont know how economists calculate global savings, maybe I should figure it out.

If there is a net savings surplus globally, I strongly suspect that there can be only two reasons:

a) Asset inflation: Do savings include asset price increases? If the price of my home has jumped from $100 to $150, and that $50 unrealized gain is included in savings, then the problem is one of asset inflation. So I need to figure out whether these unrealized gains are included in calculating the savings.

b) Money multiplier effect: We all know the money multiplier effect the banks create. Similarly, there is a money multiplier effect when I borrow from my banks for house loans and credit card company. Are the global savings netted for debt? If not, then the problem is not of high savings, but one of low interest rates.

Now asset inflation can also be linked to low interest rates. Due to removal of ineffeciencies in the world financial markets, cost of money might have gone down globally. Question is: how much?

What exactly is the 2 line conclusion of the 10 page article of businessweek. That Americans are consuming a lot of imports, while the rest of world is not consuming American products. Instead it is investing in America. That is keeping interest rates down in the US. And because the world is not consuming, the interest rates in other countries have been held low by central banks.

I guess the best situation for the world is if Americans reign in their consumption, while the rest of world increases its consumption.

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