A country that saves more than it invests will have excess savings and a current account surplus, and conversely, just as a country that imports more than it exports (at least in current account) will have a trade deficit. But it does not follow that the capital account (reflecting the flow of money into and out of the country) necessarily dictates what happens to the current account.
Second, given that the popularity of the excess savings thesis coincided with a period of persistently low inflation, it could be that the general decline in bond yields is mainly due to this factor.
Beyond these issues, I never quite understood why proponents of the savings glut idea weren’t more challenged when China began to shrink its own current account surpluses. Had they been pushed, they would likely have said the change was being offset by larger surpluses elsewhere, such as in the post-crisis eurozone and on the books of companies that had been hoarding cash for fear of a 2008 recovery. .
But now, two new developments present the savings glut thesis with yet another test. First, we appear to have entered an era of higher inflation, which may or may not prove persistent. For central banks, the only way to ensure it is temporary is to tighten their monetary policies and pursue normal levels of positive real interest rates, rather than clinging to old theories to justify their persistent low levels.
Hopefully, everyone will also remember their Economics 101 course, which said there should be a close association between the trend rate of economic growth and real interest rates.
The second major development is the new regime of Western sanctions against Russia, including the freezing of a large part of the Russian central bank’s Western foreign exchange reserves (the lion’s share of its financial war chest). This stroke of genius could lead other holders of excess reserves to stop accumulating so much currency, putting a decisive end to Bernanke’s global savings glut.
It wouldn’t be such a bad thing. Even if the excess savings thesis is true, why do all these countries need massive and persistent current account surpluses? We should welcome a world where the value of other countries’ currencies can rise further, thereby increasing the real domestic incomes of residents.
Greater purchasing power would allow them to acquire more foreign goods. Their leaders might even consider pursuing policies aimed at reducing their domestic savings rate and increasing domestic consumption and investment. And that, in turn, might even contribute indirectly to an increase in US domestic savings.
I have shared these ideas with several international monetary experts and very politely reject my thought.
They argue that most other countries with large currency holdings need not fear Western policy responses, or lack the political structures necessary to manage a smooth domestic economic regime change.
Others have suggested that America’s use of sanctions could lead to greater diversification against the dollar. But it’s unclear what other highly liquid currencies one could confidently hold. Without alternatives, more countries may begin to wonder why they should hold so many reserves in the first place.
If so, and especially if the inflation trend of the past 30 years reverses, the turmoil we’ve seen in bond markets so far this year could be just a prelude.
Jim O’Neill is a former Chairman of Goldman Sachs Asset Management and a former UK Treasury Secretary.