As I mentioned over at AB I agree that the effect of exchange rates on savings is small - but to the extent that the e.r. affects real income it of course affects savings as well. In the long run we need a general depreciation of the US real exchange rate in order to provoke a switch from a housing-centered economy to one where we produce more traded goods.
But we need to get our spending-income back closer to balance. One note re: your graph - It isnt just private savings that is the problem (though seeing it go negative is a remarkable thing and a bad omen for the future) It is also the public sector - This is important because private savings habits are typically a much slower moving variable - If/when a crunch comes it is usually the govt. that responds fastest. That's why it would be so much less painful to start now and do it slowly rather than have it forced on us all at once.
Just a quick clarification. In general I think that there is little relationship between savings and interest rates. My argument as to why there is a link at present is that low interest rates have fostered and sustained the housing bubble, which in turn has spurred consumption through the wealth effect. Typically housing prices have not been very sensitive to interest rates. I believe that they are now (because we have an unsustainable bubble).
btw, how would higher savings lower the dollar? Do we think that if people saved more, interest rates would go even lower, and then people would stop holding dollar assets? that seems unlikely to me. The Fed might lower short-term rates some, but it seems unlikely that long-term rates would drop much below their current level.
Dean: you raise an interesting and pretty fundamental question: what caused the housing bubble? Was it low short-term interest rates, low long-term interest rates, both, or some other factor altogether? I could tell several different (and perhaps contradictory) stories, but I don't know which is the right one.
My thinking is that the main channel of higher savings reducing the value of the dollar would be by reducing economic growth (maybe we're talking about very sluggish growth, but more likely a recession), which in turn would reduce the return on investments in the US. I don't just have interest rates in mind for this story, btw (though I can easily see them going down somewhat), but also returns on equity and direct investment in the US, as profits fall. So I guess that in a sense, yes, I see a higher savings rate in the US causing returns on investments in the US to fall, which would thus cause demand for dollar assets to fall.
Now I feel like I've accomplished something - getting Dean Baker and Kash in a debate on this issue. It should be fun watching Kash and Menzie Chinn discuss!
The graph is misleading - what affects the savings rate is the _real_ rate of interest, not the nominal rate. And of course there are exogenous shocks, precautionary saving, etc. which may shift the overall supply of savings, but interest rate does affect the actual quantity supplied.
Here is a contrarian thought. Higher savings, if they led to a narrowing of our current account deficit, would mean we were emitting less paper for the central banks of the world to swallow every day and hence less downward pressure on the dollar. At the moment our aggregate dissaving means that the central banks of the world have to take on board $2 billion a day (more or less) and HOLD it in order for the flow S and D to equilibrate at the exchange rate of the moment. Take away either the foreign central bank demand or our supply (through saving more) and there you have it! A stronger dollar.
Note that you could in theory get to higher savings either by spending less or by producing more. The former is more likely a feature of a "hard" landing while the latter is what everyone wishes for in a "soft" landing.
Oops - I should never try to think about exchange rates this late at night. Take away the foreign central bank demand and the dollar tanks. Take away our supply through more savings and it gets stronger.
Bottom line of late night exchange rate pronouncements: "Everything I say is true or the reciprocal of it is true."
interesting discussion- thanks
Kash,
your story on the exchange rate is reasonable, but the slow-growth/recession part rarely gets mentioned when folks say that the key to correcting the current account inbalance is to get the fundamentals right, by which is meant raising public and private savings.
I think it is important to put the implications of policies on the table. It would be nice if we get the folks we say we have to get the fundamentals right that they are advocating at the least a period of slow growth, if not actual recession. This may be unavoidable (I think we get there because of a collpasing housing bubble), but the public should know that this isn't just a question of making a few tweaks (even large ones) to the federal budget.
Dean - while I think you are correct about the possibility of slowing aggregate demand, in my own William Poole (his QJE 1970 article) - my hope is for the 1993 deal where Clinton agreed to fiscal restraint and Alan Greenspan agreed to easy money. So the maestro story went until Kash pointed out that 1994 episode where the Federal Reserve tightened up on monetary policy. Why? I have no clue. And what is Chairman Ben up to with those higher interest rates? I give up.
It is practically a truism that if you are spending more than you earn (which we are by a large margine) then starting to live within your means almost inevitably implies spending less (i.e. a recession). That is what happens to 3rd world countries when they exhaust their creditors' forebearance and it is what will happen to the US if we dont take steps to engineer a happier outcome.
Picking up on Steve Kyle's point, one cannot save if one is not earning enough to cover the basics.
The official statistics show real American median family income to have remained steady for 30 years. Officially, this is only achieved by spouses entering the work force. I think there are flaws in hedonic adjustment that, if corrected, would show real median income falling. If so, there's no mystery to falling savings rates.
The world faces some serious business in the next years. Remediating a host of environmental problems is one. Letting Asian living standards rise without devastating the earth is another. And preventing American living standards from falling is a third.
I would suggest that the long-term effect of a falling dollar would be for inflation to cause American nominal local currency wages to rise, and for debt to be erased at the expense of creditors. The net effect would be to inhibit purchasing and promote saving.
One hates to recommend inflation as a means to solving problems, but sometimes economic systems get sufficiently screwed up that it's the only way.
What you really need to look at is the savings-investment gap that first emerged in the 1980s and the spread between us and foreign interest rates.
When Reagan first created the structural deficit in the early 1980s many worried about crowding out.
But what you had was a sharp increase in the spread between US and foreign interest rates that attracted foreign capital and drove up the dollar so that the current account deficit would expand to match the foreign capital inflow.
this was the first stage of a structural adjusment where crowding out worked through the dollar to crowd out the sectors exposed to foreign competition.
So this created a structural change in the world economy driven by the domestic savings-investment gap in the US and a like surplus in Japan driving up the spread between us and foreign rates. Once the new structural flows were established they did not need the high rate spreads and strong dollar to sustain the new equilibrium and in the late 1980s the rate spreads and dollar weakened but the capital inflow and trade deficit were sustained.
But in the 1990s the savings -investment gap expanded again and it was accompanied by another widening of the rate spread between the US and foreign rates and a strengthening of the dollar. In the 1980s the savings-investment gap was driven by falling personal savings and a rising federal deficit. In the 1990s it was driven by falling personal savings and stronger business investment as the federal deficit contracted. In the late 1990s boom the inflow of foreign capital and the federal surplus provide the savings to finance almost half the capital spending boom.But at the margin this time the source of foreign capital shifted from Japan to China.
In the recession we saw the savings-investment gap narrow because of the
plunge in capital spending and falling imports narrow the current account. This was accompanied by a narrowing of the inernational interest rate spread
and a weakening dollar.
But over the last couple of years as capital spending resumed and the savings-investment gap widened we have seen the international interest rate spreads widening again -- but this time they are not causing the dollar to strengthen.
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