Delve into the core. Imagine that the global economy is an onion, and keep peeling, until we reach the core. What do we find? Maybe there are forces at play which are buried so deep below the surface that we barely notice them. But nonetheless they shape the world, create booms, and charge recessions. Without these underlying forces there would have been no banking crisis in 2008, no boom over the previous decade and half. One of these vital underlying forces – perhaps the one that sits at the very core – is set to change and the implications are profound.
So what do you think caused all the woes of 2007 and beyond? Was it bad bankers, poor regulation, or perhaps it was governments infused with hubris who thought they knew better than the markets? Here is another explanation: the global movements of money.
You could dig even deeper and ask: what caused these global movements? There is more than one explanation: new technology creating a surplus of capital, lack of trickle down as a smaller chunk of economic growth found its way into wage packets, demographic changes creating a rise in global savings, the rise of the BRICs –particularly China and its policy towards the yuan. The list goes on.
Whatever the causes, in the build-up to the credit crisis one fact often gets overlooked – there was a massive surplus of savings. It’s not intuitive. How can a crisis of credit be caused by savings? Well, actually it does make sense when you think about it.
A savings glut led to lower interest rates set by the markets. These days Alan Greenspan does not have the creditability that was once his, but that does not mean he was wrong about everything. And he warned about the savings glut. He tried to tell us, although, as is the way with central bankers, he couched his warnings in words of too much subtlety. But when towards the end of his tenure at the Fed, long term interest rates set by the market fell below short-term rates largely determined by central bankers, it should have been clear something was up.
The savings glut led to low interest rates, which encouraged borrowing. What we forget is that during the boom years when credit exploded, not everyone ran up debts. The problem really was one of uneven distribution. And that is why we got a credit boom, rocketing house prices, and then bust.
But during the era of the so called credit crunch, paradoxically the savings glut did not go away. Instead it found its way into government bonds. The credit crunch was not a crisis of too little credit; it was a crisis of where the credit went. In 2006 the total value of global debt and equity outstanding was $185 trillion. In 2010 it was $219 trillion (Source: McKinsey).
Now consider a new report from McKinsey – Financial globalization: Retreat or reset?
The report’s authors stated: “Global financial assets—or the value of equity-market capitalization, corporate and government bonds, and loans—have grown by just 1.9 per cent annually since the crisis, down from average annual growth of 7.9 per cent from 1990 to 2007. This slowdown is not confined to deleveraging advanced economies; surprisingly, it also extends to emerging markets.”
The report continued: “Cross-border capital flows have collapsed, falling from $11.8 trillion in 2007 to an estimated $4.6 trillion in 2012. Western Europe accounts for some 70 per cent of this drop, as the continent’s financial integration has gone into reverse. Eurozone banks have reduced cross-border lending and other claims by $3.7 trillion since 2007, and central banks now account for more than 50 per cent of capital flows within the region.”
However, McKinsey added: “Even beyond Europe, global banking is in flux. Cross-border lending has fallen from $5.6 trillion in 2007 to an estimated $1.7 trillion in 2012.” In fact, says McKinsey, even the financial markets of the emerging world have stalled since 2008.
Look beyond the McKinsey figures, however.
In Japan, the household savings rate has crashed. The most likely explanation for this is demographic. As baby boomers go from approaching retirement to retired, they draw down on savings. The savings pool starts to diminish. As China tries to do the things experts say it needs to do, such as allow the yuan to trade freely and get internal demand to rise, less money will flow from China into international money markets.
In short, the savings glut is slowly being eroded. What does that mean? If it is a symptom of more money trickling down into wages, this may be a good thing. But a side-effect may be sharp rises in interest rates later this decade. And those rates may rise, whether it is in our best interests or not.
But the McKinsey Report also contained a little gem of information, that may provide an even a more important explanation of what has been going on. Read the next piece to find out more.
© Investment & Business News 2013