The Hindu Business Line : If all nations are developed, who will save and lend to US?

What Mr Greenspan conveniently side-steps is that while savers in developing countries are ‘forced’ to save for their rainy day, the consumers in US are forcibly ‘taxed’ to pay for their social security, which just substitutes coercive tax for compulsive savings! Yet he sees savings as ‘forced’ and a sign of under-development, points out S. GURUMURTHY.

Bankers live on people’s thrift. Central bankers, as regulators and guardians of banks, work to bring people’s savings into banks for two good reasons. One, thrift restrains consumption and savings moderate prices, which is a critical function of a central bank.

Two, savings into the banking system besides placing the cash in bank’s till also ensures that money, a mischievous destabiliser unless kept in check, is placed under its control and discipline.

But here is a central bank, the US Federal Reserve System, and a central banker, Mr Alan Greenspan, who headed US Fed for 28 years, with a difference. Actually a lot of it. Both, and certainly the latter, seem to dislike money in the bank’s till, and would like to see it diverted to stock markets instead.

For diverse reasons, some historic, the US Fed exerts deep influence, not just on the US but over the entire global financial system. First, the US, from being the world’s biggest creditor, is now the world’s largest debtor. Despite being a prime borrower, the US still remains as influential now as the biggest lender decades ago.

Two, consequently, even small hints from the US Fed can impact beyond the country’s boundaries. Just one example. The then US Fed Chairman, Mr Alan Greenspan’s terse remarks of ‘irrational exuberance’ and ‘unduly escalating stock prices’ in the context of Japan, made Japanese stocks fall by 3.2 per cent on just one day in 2006!

Third, unlike other central banks, it is not fully under the US government. It is a private bank, fully owned and partly controlled by huge financial tsars. Even when the US Fed was formed, it was seen as an extension of Wall Street. Result, it is not the US government, but Wall Street which influences the world through the Fed. This is a subject in itself.

Addiction to markets

Traditional banks as the fulcrum of the financial system, as in most regions of the world and particularly the eastern part of it, has been going out of fashion in the US from the late 1970s, a process that seems almost complete now.

A small volume of statistical data is adequate to demonstrate the extent to which the US financial system has become addicted to, and actually dependent on, stock markets.

One, during 1978-1995, the share of banks in US financial assets halved to 32 per cent and simultaneously, the share of Wall Street stocks more than doubled to 42 per cent.

Two, the share of banks in Retirement Funds (with $16 trillion corpus) declined from 42 per cent in 1990 to a mere 7 per cent — yes, just 7 per cent — in 2006. Their investment in stocks through mutual funds and brokers increased from 52 per cent to 85 per cent in the same period.

More, US banks have turned households into borrowers instead of savers. How did the US Fed, particularly, Mr Greenspan, manage this paradigm shift in US financial system? Mr Greenspan himself provides the answer in his recent book The Age of Turbulence.

In his book, Mr Greenspan theorises that the propensity of the people to save is — believe it — a sign of underdevelopment! He says that in developing countries — read, not fully developed ones — ‘people are forced to save for a rainy day and retirement.’

He contrasts hist with how developed countries, through vast financial networks, enable a ‘significant fraction of the consumers to spend beyond their current incomes.’ Here, Mr Greenspan’s thinking comes very close to the philosophy of Charuvaka in ancient India who, thousands of years ago, advised householders to borrow and spend, and live happily.

What Mr Greenspan conveniently side-steps here is that while savers in developing countries are ‘forced’ to save for their rainy day, the consumers in US are forcibly ‘taxed’ to pay for their social security — read for their rainy day — which just substitutes coercive tax for compulsive savings! Yet he sees savings as ‘forced’ and as a sign of under-development.

Development and savings

Also, Mr Greenspan’s theory that development makes people save less is not borne out by any society other than the Anglo-Saxon societies, namely the US, the UK and Australia, where alone savings are negative. Again, his assumption that credit instruments of developed countries help consumers to spend more than their income has not worked in, say, developed Japan, or in Singapore and Hong Kong with high incomes and also high savings.

Not development, but something else, makes people save less or spend more. The clue lies in understanding what makes the developed Japanese keep saving after the government had mandated ‘nil’ return on their deposits? Two reasons. One, the family; and, two, the state has not taken over the family.

Mr Greenspan again seems wide off the mark when he says that global liquidity, not the US Fed rates, drove down long-term interest rates in the recent past. How global liquidity, which is essentially current account surpluses — that is, forex reserves — of different countries and is short-term in character, would drive down long-term interest rates is not clear.

On the contrary, forex holdings of different countries are more sensitive to short-term than long-term interest rates.

Again, statistics show that US Fed interest rates have not, as Mr Greenspan claims, moved with global liquidity flow but actually against it. The global forex reserves declared in specific currencies increased from $1.5 trillion in (Q1) 2001 to $3.65 trillion in (Q2) 2007 — showing a glut of liquidity with an increase of 142 per cent in six years, and over 15 per cent on a YoY basis.

$ in global forex

If Fed interest rates were in alignment with the flow, they must have fallen with rise in liquidity. On the contrary, the Fed first cut, but, then hiked the interest rate over this period. The US Fed interest rate, which was 6 per cent as 2001 opened, was cut sharply to 1.25 per cent in 2002 and 1 per cent in 2003. With this cut, the share of dollars in global forex reserves, which was 72 per cent in 2001, came down to 67 per cent.

This fall was even as global liquidity was increasing by over 15 per cent a year. This fall forced the Fed to hike the interest rate step by step to 3.25 per cent in (Q1) 2005. But that too failed to arrest the decline of the share of US dollars in global forex holdings, which came down further to 65.4 per cent, forcing US Fed to move up the rate to 4.25 per cent in (Q4) 2005. This hike saw the share of US dollar move up, for a while, to 70.5 per cent, but only to come down again to 66.4 per cent in (Q1) 2006 and still less to 64.1 per cent in (Q4) 2006 despite further Fed rate hike to 5.25 per cent.

Against the flow

It meant that US Fed rates were, and even now are, moving against the flow and not with it. Decline in long-term interest rate has nothing to do with high short-term liquidity. It has to do with the fact that the intended investment, as Mr Greenspan says, was less than the intended savings, resulting in the continuing short-term glut in global liquidity.

More. Mr Greenspan, an eternal optimist, seems convinced that because the ‘risk-adjusted’ interest of all other countries will fall short of the returns the US will provide, the rest of the world will save and keep its money invested in US dollars and this will finance US consumption and current account deficits.

But here he seems to forget the case of Japan, whose official interest rate has been ‘nil’ from 2001 to 2005 and now 0.5 per cent, when the risk-adjusted US Fed rate had increased from 1 per cent to 5.5 per cent, proving that Japanese capital very largely remained home-bound and did not fly out of Japan.

Completely ignoring such obvious trends, Mr Greenspan goes on to say that savings, on the one hand, and spending and investment will balance at the global level. So, Mr Greenspan implies, the US need not worry and can keep spending without saving.

All this now leads to one final question, which brings out the contradiction in Greenspan’s theory. Mr Greenspan, if, as you say, the underdeveloped, who save and lend to the US, will stop saving once they develop, who will save and finance the US consumption and current account deficits?

(The author is a corporate advisor. His e-mail is guru@gurumurthy.net)

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