For this week’s blog entry I want to go a little abstract in order to suggest how different countries that participate in the global imbalances are going to adjust. The debate over the root causes of global imbalances is as fierce and as confused as ever. The confusion isn’t helped by the vast army of moralizers who like to contrast the hard work and thriftiness of households in high-savings countries with the laziness and binge-buying behavior of households in high-consuming countries. The world cannot possibly rebalance, they argue, until the later become more like the former.
Ok, I admit there are good reasons to recommend this argument. There are few things in the world as satisfying as being able to deride the moral weaknesses of our neighbors, especially if we are lucky enough to have the very high savings rates that come automatically with very high income levels.
There are nonetheless some obvious flaws in the argument. First of all, if the high-consumers become as virtuous as the low-consumers, that just means that global demand will decline, and with it, global unemployment will rise. In that case global savings won’t go up. They will go down, since rising unemployment causes income to decline faster than consumption.
Second, lazy spendthrift Americans are actually more productive and work longer hours than people in almost any other rich country, including the harder-working and higher-savings counties in Europe. Still, the argument does anyway fit in with a lot of cultural stereotypes about Spaniards and Greeks, with their wild lifestyles, long siestas, and dissolute charm, or about Germans and Dutch, whose tasteless food, boring sex lives, and grim movies leave them no choice but to work away at office and factory.
But is this really why people in some countries love to save and people in other countries love to consume? No, it isn’t. Aside from the satisfaction it brings, this moralistic argument is almost meaningless. Individual preferences may cause some of us to save more of our income than others, but we have to be very careful about generalizing. When entire counties have abnormally high or low savings rates, individual preferences are never the reason. Abnormally high or low savings rates are almost always caused by trade, industrial or tax policies at home and abroad that distort the relationship between consumption and production.
It might help to explain why this is the case if we call all the high-savings countries “Germany” and all the high-consuming countries “Spain”. Giving them these names may seem a little provocative, and will probably generate some hate mail, but I guess less so than calling them “China” and “the US”.
It turns out that domestic policies by the German government can explain both high German savings and low Spanish savings. For example assume that Germany has an undervalued currency, low wages relative to productivity, high explicit or hidden consumption or income taxes (repressed interest rates, for example, or environmental degradation), and high quality infrastructure subsidized by these taxes.
Notice how these work. Undervalued currencies and low wages relative to productivity have the effect of reducing the real value of household income and subsidizing manufacturers and employers. Consumption and income taxes also reduce household income in real terms, and by using them to subsidize infrastructure they reduce production costs.
These aren’t necessarily bad things – they can generate real growth especially when there is excess labor and poor infrastructure, but they can also become too much of a good thing. The main point is that under these conditions it is very likely that German GDP growth will exceed the growth in household income.
Why? Because all of these things tend to siphon off household income (or raise the price of consumption, which is the equivalent of a reduction in household income) and use the proceeds to subsidize production. In that case production growth is goosed while household income growth is constrained.
Savings must rise
If the German financial sector is also repressed, with constraints on consumer credit, consumption growth will largely be determined by the growth in household income. German consumption, in other words, will rise in line with German household income, which will be less than the growth in German GDP. Remember that national savings is equal to national production of goods and services less national consumption, and as production rises faster than consumption, by definition the savings rate must rise.
As German GDP growth exceeds consumption growth, in other words, the German savings rate will rise automatically, and this will have absolutely nothing to do with whether or not Germans are ethnically or culturally programmed to save money, work hard, and lead boring lives. What’s more, since the trade surplus is the excess of domestic savings over domestic investment, Germany will run a large trade surplus.
By the way, for the many who are skeptical about the relationship between currency value and savings rate, it has to be of at least some interest that countries whose currencies are sharply undervalued tend to have very high savings rates, and those with overvalued currencies tend to have low savings rates. This isn’t a coincidence. The relative value of the currency can have a direct impact on the differential between household income growth and GDP growth, and if it does, by definition it must affect the level of savings.
What about Spain? Obviously if Spain has the opposite conditions, it is likely to have a low savings rate. But it turns out that Spain’s low savings rate might itself also be a consequence of German policies. After all, if Spaniards are as virtuous as Germans, and also produce more than they consume or invest domestically, then the world has a serious problem in the balance of trade. Both countries cannot possibly run trade surpluses.
To put it another way, if both Germans and Spaniards reduce their consumption and increase their savings, the global savings rate will rise. This is fine if the global investment rate rises, but with consumers cutting back on consumption there is no reason for producers to increase investment, so global investment is actually likely to decline.
But savings must equal investment, by definition, so the world is left with two options. It can fund an increase investment, even if it is wasteful and unnecessary, and simply put the day of reckoning off into the future, or it can force global savings to decline. How can it do that? Simple. Fire lots of workers, force up unemployment, and eventually savings and investment will once again balance, albeit at very low levels consistent with much higher unemployment.
Germany’s “virtue”, in other words, is simply the other side of the coin of Spain’s “vice”. One cannot exist without the other, and if they are both forced by German policies, it is hard to speak of virtuous high-savings households and vicious high-consuming households.
And savings must decline
But how are Spanish savings affected by Germany? The most obvious way is through the currency. If Germany’s currency is undervalued, then by definition Spain’s must be overvalued. It doesn’t matter if they share a currency, or if one is pegged to the other. What matters is relative prices and productivity at the exchange rate.
In that case there is an implicit tariff on imports into Germany, which is used to subsidize German manufacturers. This is matched by a tax on Spanish manufacturers, which is used to subsidize Spanish imports. Not surprisingly under these conditions Germans will tend to save and under-consume relative to production and Spaniards to borrow and over-consume. Both are necessary to keep the economy in balance.
But there is more. Since German policies force domestic savings to exceed domestic investment, there are only four ways Spain can respond to German anti-consumption policies. First, it can force up the investment rate. Since German policies are likely to erode the profitability of Spanish manufacturing, private investment is unlikely to rise, but public investment can, funded by German capital exports. This means a rise in government debt. If Spain starts the game with very poor infrastructure, this is a viable policy choice, although it doesn’t really solve the imbalances. It merely pushes off the solution into the future, at which time Germany will be forced to stop being virtuous.
Second, Spain can allow consumption to soar, which means a declining Spanish savings rate. This is usually caused by rising consumer financing funded, again, by German capital exports. If Spain has no control over its interest rates because of manipulation by Germany, this outcome is almost guaranteed.
Third, Spain can allow unemployment to rise as German manufacturing replaces Spanish manufacturing. Rising unemployment of course causes the savings rate to fall as income falls faster than consumption. This allows low Spanish savings to balance high German savings at the expense, of course, of rising Spanish unemployment, which will remain high until wages have declined sufficiently to allow Spain to compete.
And fourth, Spain can devalue its currency against Germany’s currency or impose trade barriers. In either of the two latter cases Germany must adjust with either a rise in domestic unemployment or with an increase in investment.
Notice that these are automatic consequences of policies that constrained the growth of German consumption. The savings rates of the two countries turn out to have nothing to do with siestas and fine dining or with engineers and protestant work ethics. They have to do with policies in Germany.
The opposite can occur too. If Spain puts into place policies that force low savings onto Spaniards, Germany will be forced into high savings. It is pretty rare for this to occur, however, because most policymakers want to increase employment growth in their economies, not reduce it.
Planes and savings
Let me make another example of how policies affect savings rates – this time perhaps more controversial. Let’s say that Germany, the maker of Airbus, decides to provide such large subsidies to the company that Airbus is able to cut the price of planes in half, and Spain (the maker of Boeings, of course) does not retaliate. This subsidy will probably come from taxes on the household sector. The increase in taxes will reduce European household income (relative to the growth in production, that is – if Germany has high unemployment consumption might actually rise), and with it European consumption, but the Airbus subsidies will almost certainly cause a net rise in European production as the world dumps Boeings and buys Airbuses.
How does this impact German savings? If German production goes up and consumption goes down, savings, which is the difference between the two, must go up by definition. And savings went up not because Germans suddenly decided to become even more German, work harder, and save more. It went up automatically.
And what happens in the Spain? Clearly Boeing goes out of business, so Spanish production drops. On the other hand the fact that planes are so cheap means that Spaniards probably travel more, and so consumption might even rise, or at least drop more slowly than production (again, it depends on the level of unemployment). In that case the Spanish savings rate, of course, must automatically drop. This doesn’t require any increase in the viciousness or laziness of Spaniards. It is an automatic consequence of German subsidy of Airbus.
Trade and industrial polices, in other words, can force savings rate to change regardless of cultural or individual preferences. For this reason the solutions to the global imbalances will not come from exhortations that Spaniards become as virtuous as Germans. Virtue has nothing to do with it. The world requires a combination of policies that force domestic GDP growth to outpace household income growth in Spain and the reverse in Germany. It is just as important that Germany eliminates its anti-consumption policies as it is that Spain restructures its economy and lower wages.
If only Spain adjusts, the consequence must be a rise Spanish debt or a rise in global unemployment. In the latter case, and especially if Spain is unwilling or unable to borrow more, Spain will be forced to consider one of two alternatives. It can intervene in trade, and so force most of the rising unemployment onto Germany. Or it can refuse to intervene, in which case most of the increase in unemployment will take place in Spain. It would be exceedingly virtuous of Spain to choose the latter path.
The world needs less moralizing and more focus on why savings rates vary among countries. Perhaps if the moralizers can go back to discussing teenage promiscuity or President Obama’s birth certificate, policymakers can concentrate on resolving trade imbalances in a useful way. Will this happen? Probably not. My guess is that we will try to resolve the global imbalances by intervening in trade. This is clearly a suboptimal solution from an economic point of view, but it allows moralizing to continue full throttle, and this clearly has substantial value.
This is an abbreviated version of the newsletter that went out last week. Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at chinfinpettis@yahoo.com, stating your affiliation, please. Investors who are clients of Shenyin Wanguo Securities will already receive the newsletter. Investors who are not clients but who want to buy a subscription should write to me. also at that address.
“First of all, if the high-consumers become as virtuous as the low-consumers, that just means that global demand will decline, and with it, global unemployment.”
You mean global employment, correct?
The question now is, given the great infrastructure (e.g. ICE trains) in Germany and wasted infrastructure (e.g. Villas) in Spain (and the corresponding german banking “asset”), how do we, not only normalize future policy changes (e.g. reducing german subsidies), **and** address the debt issues? It sounds like debt write-off is the corollary to policy normalization (so-called retroactive normalization)?
Thanks, Philomath. I changed it.
Prof. Pettis,
Very nice summary in that regard. Let’s say the Spain intervenes through tariff. In the short term, will this reduce or increase the unemployment in Spain?
Bravo, Michael. Indeed, the issue of who should do the adjusting to BoP imbalances, the debtors or the creditors, is still with us. To a student of the great economics debates of the 1930s through the 197s, not much seems new.
Your piece is a wonderful lead in to the follow-up blog: what happens if the Spanish currency – call it pesos – is, for historical reasons, the world’s reserve currency
Suppose in your example that Spain was a fiat currency issuer (like Japan or the UK). What if their policy response was to increase net federal government spending to make up for the aggregate demand shortfall. They aren’t going to run out of currency (which is impossible for a currency issuer) and they have excess capacity available to purchase in their domestic market. Obviously excessive spending would at some point turn inflationary, but it seems like there’s a big demand hole in the Spanish economy in the model you sketch out above.
Combined with a Germany that’s voluntarily forgoing consumption so that the Spanish can enjoy cheap airplanes this seems like a great deal for the Spanish.
Best blog ever.
Mr Pettis
Two Questions
1. In general to high savings countries tend to have lower or higher interest rates over say a 30 year period vs low saving countries?
2. What is a more desirable situation for economic growth, to go from low to high savings or high to low savings?
Thank you enjoy your “theoretical scenarios” and predictions
http://www.cnbc.com/id/43403189
Pettis Reference here.
What can I said? I simply love your blog. I do recall that during my college years, I have an economics professor who preach like the moralizers you have described in this post. Every lecture, he almost never fail to highlight the “virtues” of East Asian model of thrift and hardwork vis-a-vis the decadent consumption of the US. These moralizers love using culture to explain everything without realizing that they are two sides of the same coin. I was appalled that an academic like him can be so lacking in his thoughts.
Well put as usual Michael.
This is the reason that ideologically free-market countries end up with chronic current account deficits. We assume the whole world is like us, and if government just gets out of way then savings and investment will find their own sustainable level. But of course the world is not like us, and we end up borrowing to absorb other countries’ excess production. I think it’s partly because so many senior policymakers have been through a Chicago-style grad school environment.
Hi Professor
One of the most important things a country can do is to look after its children.
A country that borrows from its children so that it can consume more today is greedy and selfish and should be condemned by the rest of the world.
America should be ashamed.
Thank you
Well said michael. There is a chinese saying that when there is a yin, there is a yang, where there are light, there got to be a shadow somewhere. The world will be a perfect place if there is no currency in the world that is pegged. Unfortunately we as human beings have our own self-destruction tendencies and we are soon looking at our own demise.
If the savers continue their moral high ground, those consumers should start consume less and see who ends up eating dust. As there is a saying, “what goes around, come around”. And those who peg currencies will start to wish they have not done so.
Environmental degradation is something I would like to hear more about. It seems that Germans in the moral outlook are seen as “environmental pigs” because of heavy fixed asset investment in infrastructure and the production industry. The environmenal price paid is not only “surpressed consumption” it is also increased scarcity of local resources. And this is where there might be a natural rebalancing of the economies. Germany builds infrastructure, production industry and real estate. This leads to diminishing arable land. Many other countries in the EU do the same and thus the price of foods go up, because agricultural productivity does not increase at the same rate as industrial productivity. Now Spain has been consuming and only producing environmental friendly products for a long time and the country has large quantaties of arable land. It can increase its agricultural production very fast. If the net price of foods in the near future for the first time in history exceeds the net price of industry products, then the German economy will rebalance as they consume more and more foods (unavoidable as the world/German urbanization and per cap wealth grows).
My point being that if agricultural products start out pricing (by a lot) industrial products then there will be a rebalance. Food and water are going to be priced differently over the next 30 years.
A good article Prof.Pettis. I would have expected a better analysis on why the policy is what it is, and not just how policy affects savings and investments; the latter of which, while being a better argument than that of on moral standards, is nonetheless less contentious and comparably less thought-provoking.
The Germany-Spain contrast presented here contained an unspelled assumption: both governements are accountable and rational hence can potentially act in a rational and effective way, if they realise the true consequences of their policies thus agree to change. Under these assumptions scholar’s observations like this can be very valuable as they can feed into action. My fear is that the real world “German” government, with no voters to answer to and no check and balances to limit their power (or rather, the elites’ power), the assumption inherent might not be valid.
In short, even if they realise the root of the problem as you rightly pointed out, it’s still inconceivable the power holders would take the recommended remedy, e.g simple things like redistrubting the wealth accumulated to improve consumption. Jamil Anderlini, FT Beijing Bureau Chief observed, “Attempts by the State-owned Assets Supervision and Administration Commission to collect the quite minimal dividend payments introduced in that year have often been thwarted by the big state enterprises themselves and suggestions that these dividends be increased have met with stiff opposition from powerful interest groups within the Chinese leadership” (http://blogs.ft.com/the-a-list/2011/06/14/the-myth-of-chinas-unbalanced-growth/?ftcamp=rss). As long as the interest groups have no incentive to stop serving their own interest and their own interests only, I don’t have much hope that the situation analysed here will improve however clear the problem exemplifies itself.
I know you are only a financial professor hence the remarks might not be fair. I fear, though, that the apparent economic problems we have now lie not in the markets, but in the politics.
Well done Michael.
Your posts are very educative. These years we have witnessed how the european comission looked like a exclusively german comission and when one of his members was travelling to, let`s say Spain, started lecturing about the benefits of austerity or saving. Similarly, the same guy, when going back to Germany should had been lecturing about the benefits of spending, but I don’t believe this has occured. It seems to me that Germany is increasingly subsydising isavings and forcing unemployment elsewhere. Why nobody is lecturing Germany while everyone is lecturing Spain?
“First of all, if the high-consumers become as virtuous as the low-consumers, that just means that global demand will decline, and with it, global unemployment will rise.”
This sounds like that old Keynesian chestnut, the paradox of thrift. But is this really necessarily the case? Is it not possible to imagine a combination of corrective policies in low savings, low investment countries that encourage higher savings AND facilitate higher investment (say, in decaying infrastructure or new industries), leaving aggregate demand the same or even higher than before?
Mr Pettis
What is you best read on the protests in southern China?
http://www.cnbc.com/id/43419991
Thanks
A very useful tool that has worked for the last 30 years for me is if any analysis of macro or sovereign markets has any moral qualities , easily caught by key words such as “spendthrift”, “thrifty”, “hard working” and so on, is almost always wrong. However such is the nature of our “AUM build” capital markets that for 80% of the time such moralising dominates the market as we keep the throttle full on in a Minskian “ponzi” economy. You are spot on but you have been spot on for the last decade – but are only right for a quarter or so amongst that time span. The last laugh of course is yours as those infrequent corrections are multitudes larger than the Conrad “Heart of Darkness” “pilgrims” markets.
I can see the Chinese carrying on for no one can dispute that the most poor in China now are thousands of times better off than they were from the pre-Mao days. But I cannot understand the Greeks and Spaniards and Portugeuse and Irish accepting the deal you most correctly outline. It seems the entire leadership of those countries have “sold out” to the siren of chic Habermasian mandarin power and chic conferences. Now here is when most dismiss me: the tribal forces of the elite intelligentsia in Europe that keeps Europe going is the saem forces that keeps “global warming” always with us – both are more “movements” and have religiousity as the underpining with secret decoder ring like rituals to gain entry into the leadership and then become mutually supporting of the leadership gang. This tribal “movement” like way of organizing poitical power is post-democrati, elitist, very cynical as to what the common man acting as an electorate can achieve and relativist. It dominates Europe, swaths of the USA (mostly liberals but the Concord crowd are right there), the UN , NGOs and all other collections of the new international elite PHD laden intellectual – all people without a country and rootless and at heart “pirates”. In the end this becomes more an analysis of a strange and very effective “putsch” that this crowd have implemented acorss so many fronts but all with the same methodology. I think it is obvious Chian is not sharing this as they are still very mch trying to keep folks alive and get them fed. But your macro identities hold for both sets.
A flippant and ugly comment (but I suspect true): Germany with its sidekick France – just as France was its sidekick and active participant/partner in WW II – has acomplished more in the last decade for Germany than 98 army divisions were able to achieve from 1939 to 1944. This is a great irony as one of the main tenets of the gang I mention above is that Europe at its core is supposidly to maintain peace and contain Germany. Hah!
(It also means that if Germany had any smarts at all it would immediately bail out Greece and all the peripheras so as to maintain their vassalage (and markets) – but I imagine Germany has no idea how venal it is at the core of its Euro policy. It seems Merkel really believes all her indulgent moral high ground cant. But if Germany doesnt make “the street” and common man happy – sooner or later they are gonna see the lesson of Iceland.)
Well,
What is the people of Germany (or CHINA) decides they are fed-up with repressed consumption and fed up with savings. In other words I agree with the argument that the savings rate is a function of policies which repress consumption and forced savings, i.e. to have sweet real rates for SOEs. But what happens if the government of Germany does not stay in power because . Then what happens with trade balance for Germany
I don’t mind Germany – my country – being chosen as the high-savings model, and Spain as the high-consuming model in your post, Professor. I just doubt that it will lead to a truly different debate. If more Europeans read your blog, you would get much of the same as what you get when choosing America and China instead.
These years we have witnessed how the european comission looked like a exclusively german comission and when one of his members was travelling to, let`s say Spain, started lecturing about the benefits of austerity or saving
I believe that I can understand your anger, Ignacio. You know why? Because just a decade ago, we were lectured in the same way. That said, I do believe that the reforms of the German welfare state made sense, and savings make sense, too, given that Germany (just as China) is an aging, or greying, nation.
Many Germans felt or still feel that they are being screwed by the limitations put to their purchasing power by political decisions. Personally, I feel that we are made to pay twice – first with our reduced opportunities for consumption (which would have been much more fun than saving), and now with the European financial crisis. But that is an issue between us (Germans) and our political class.
Leo Liao pointed into that direction with his comment. I think it is important to make such a point, even on a mainly financial blog.
In your case, too, you (the Spanish) need to deal with your own political class. It may be convenient to blame Germany – but that makes as little sense as accusations that go the other way round.
I hope that the “European project” can succeed. But that will require better political decisions – and citizens who look at their own countries’ potential to improve, before blaming citizens elsewhere, across the borders.
JT, yes, when the value of debt exceeds the value of assets, the debt must be written off. The main question is whether it happens quickly or slowly. Doing so quickly is more efficient but also more disruptive.
Mobi, intervening in trade should increase employment in the short term, although depending on the circumstances and on how it is done, it could hurt employment in the short term. Let’s say, for example, that the Spanish government imposes a very high consumption tax and uses the proceeds to build out infrastructure. This would almost certainly cause employment to rise.
Michael’s Prof, a very interesting question, but of course one with absolutely no bearing on the real world, right? Among other things it suggests that Germany could continue forcing the adjustment onto Spain up until the point where Spanish credit becomes worthless.
KD, if it’s such a great deal for Spain why would Germany do it? More generally, why do countries fight to be on the generous side of the trade and resist so forcefully attempts to give them the benefit of this largesse?
RS, I think we have to systemically about these issues. The optimal amount of savings in the system as a whole is, by definition, equal to the optimal amount of investment. The problem is that for countries within a system, investment and savings don’t have to match. They only match across the system as a whole.
Adrian, yes, “culture” is one of those great explanations for all the things we aren’t smart enough to explain.
Tea, don’t confuse households and countries. Countries borrow mainly from themselves.
Liao, yes, and if no one consumes, there is no point saving.
Andrew, I am not sure what are the implications of calling it an old Keynesian chestnut. Does that mean it is wrong? I am, not sure just the fact that someone said this before is enough to suggest that therefore it can no longer be true.
Thanks, Justrecently. It is really hard to discuss these issues without infuriating one side or the other, but in fact it is easy to find mistaken policies across the board and they all need to be adjusted. To me the resolution of this crisis is really the test of European unification. If Europeans (Germans and Spaniards, in my example) see this crisis as “our” screw-up, which we need to fix, Europe survives. If however it is seen as “your” screw-up, which you need to fix, then I would argue that there’s no chance.
How would increasing income/wealth inequality play into this? Labor’s share of income is dropping hard in the US, while corporate profits have risen. Ultimately, the US households will decrease their consumption power, even though a small percentage of the population increases their share.
http://economistsview.typepad.com/.a/6a00d83451b33869e2014e892e4c48970d-popup
How does this fit into your analysis?
The implicit assumption here is that a country’s economic policies are entirely detached from that country’s culture; that policy is policy and culture is culture and never the two shall meet.
Such a seemingly unwarranted assumption, unwarranted because it contradicts the most basic notion intrinsic to representative governments (a functioning govt reflects its peoples’ will, however imperfectly) calls into question the entire blog post.
Are the individuals, so quickly discounted as inconsequential in this piece, mindless drones subject to the impact of policies they can never hope to comprehend? No, some of those people, products of their unique culture, in fact wrote those policies.
-pete
Pete, that is most certainly not the assumption, explicit or implicit, and I even say that in the entry. It seems to me you are inventing a position in order to advance an argument that otherwise hasn’t much merit. The point is that while culture matters, its importance tends to be overstated to cover all the things we don’t otherwise understand or want to understand. Savings rates are partially affected by cultural factors, but extreme distortions in savings rate are almost never caused by cultural factors alone.
Michael, thanks for the response. I doubt I’m clever enough to invent positions but am certainly taking one in relation to the thought-provoking piece. My position may or not have merit but is taken in support of the fact that “[t]rade and industrial polices” don’t spring forth from a vacuum, instead (in the developed world) they’re most often a product of governments that represent people in unique national cultures. Whether the impact of this fact is “almost meaningless” is certainly up for debate. Thanks again.
-pete
If you define everything that men and women do as a product of culture, then you are right, Pete, and I am sure Pettis and every single person in the world would agree in that case that culture “matters”. But don’t you think Pettis’s argument is the teensiest bit subtler than that? He is arguing that the same set of policies applied in two countries with very different cultures would affect the savings rate in both countries in the same way. You may disagree, but either way Pettis’s claim is not the same thing as saying that nothing that men and women do have any impact on men and women. I think as a general rule whenever you think people are making that claim you should assume that you have misunderstood that argument.
I really value your blog and read it regularly. But with a caveat: like almost all modern economists you configure the world into monetary relationships and disregard culture, education et al into a black box.
Unfortunately the real world is very different. Spain might devalue its currency as much as it likes; it simply has nothing to the world to sell.
Conversely Germany (or Japan where the Plaza accord of the Eighties had no long term effect on the trade balance) can consistently hike their currencies (as Germany did with the mark appreciationg from 4 to the Dollar in 1973 to 1,5 to the Dollar in 1979 and will still run a surplus (in this case with the States).
Case in point is a factory complex making low voltage circuit breakers near Mannheim in South West Germany, which I helped to evaluate for a bank loan. It was formerly called Stotz then became a unit of ABB. (Won´t be more specific for obvious reasons)
The product is not high tech but these 2000 employees churn out a good part of circuit breakers in the world and forced from the market factories in the US and in GB and companies like GE. The workers at ABB are all unionized, get huge salaries, five weeks paid vacations a year and can´t be fired without a very, very good reason.
Now people who are for unions say that is the reason for the success and other people might say it is, because workers are represented in the workers council of the factory. But the real reason why they manage to dominate the market for such a low technology product that could – theoretically – be produced everywhere (they just try in Shanghai up to now in vain) is very simple if you look closer.
It is their production line called Goliath and that was preceded by David. These are in house developments costings upwards of a hundred Million Euro. These are hugely complex machines requiring the harmonisation of workers and engineers skilled in anything from cutting metal to a thousands milimeter to an advanced knowledge of chemistry and take years to build. (Three years in the case of Goliath) These production lines take huge up front investments but once they are in place they deliver a quality product with unbeatably low productions costs. No matter how low the wages anywhere else as wages are anyhow only a small fraction of production costs as soon as something like Goliath is up and running.
And these are not machines like a car that anybody can drive. Only the people who built them can operate them as it just turns out in Shangahi where they shipped David.
First that something like that is possible has something to do with German business culture. In the US after a take over by private equity they would have never renewed the line but squeezed profits from it until it fell apart. That would have been the end of the factory and it happened in a good many cases which are well know to their German competitors. But that is only one and not even the main point ragarding culture.
Goliath and all the other in house developments in German factories are the result of a combination of fabulous in house training of the shop floor people; strong emphasis of tradition (old teaching the young) and the non existence of barriers between engineers and the people implimenting their designs.
These are not simply reproducable around the world. ABB is a multinational with branches all over the world and they would love to relocate and get rid of the pesky German wages and workers rights. But they tried and didn´t succed.
In GB you can´t built something like that because there´s no vocational training that´s good enough. Also there´s the problem of the cultural barrier between engineers and workers. (In Mannheim they all talk the same dialect). In the US (as BMW has discovered in his plant in Savannah Georgia) only college graduates have the required reading and mathematics skills to do, what shop floor workers in a German factory are expected to do. But these people are difficult to motivate to get their hands dirty.
In Spain there are similar problems.
These are cultural problems and in China at the moment the greatest problem is, that shop floor workers are afraid to think for themselves. But without it you can´t operate a machine like David.
About China I believe they will learn and eventually become a strong competitor. But only if there is a cultural and probably concurrently also a political shift. Right now the hierarchies are too rigid and there´s no chance for workers to think for themselves. I am confident about China because the Japanese managed this as well. And their culture is ultmimately derived from China.
I don´t really see a way out of the crisis along the line that Michael Pettis has sketched. I see no way out in fact. Regarding the situation now in Europe there´s only one solution: for Germany to pay up and shut up. For indeed the advantages of Germany are not due to harder work (they work less hours that Spanish workers) but simply the product of a unique set of historical and cultural circumstances. Best would be for Germany simply to pay the Spanish to buy their products. And the Chinese (which do have the advantage of extremely low wages) to pay the US to buy theirs. Which both did until now in a way. But that will not happen I am afraid so there´s only one solution: default.
How come?
Prof Pettis,
Thanks for the response. That’s a great question and at the heart of the issue of how to respond to the current crisis. By the way, I wanted to say that I really enjoy your blog and I’ve learned a tremendous amount from your postings. So thank you for all the extremely high level free content you’ve posted!
I think a big part of the reason that countries fight to be, or stay, on the positive side of international trade balances is that they approach their currency with a gold standard mentality- they want to make sure that they don’t run out of currency. (It’s the same mentality that has the IMF, for example, putting the US and Japan in the same sentence as Greece or Ireland) Modern fiat currency doesn’t work that way, the winner of the terms of trade is the country that gets the most stuff in exchange for fiat currency. To continue your example, if Spain won a war with Germany and as a reparation the Germans had to sell planes at a buy on get one free rate to the Spanish that would quickly seem pretty onerous. In this example the Germans think they’re getting away with something by giving exactly that deal to the Spanish in exchange for Germans accumulating Spanish financial assets (as they must do if they want to run a surplus with Spain). The only thing they can do with that currency is buy Spanish assets – financial or otherwise. If the Spanish government finances German accumulation of Spanish assets AND finances enough aggregate demand in Spain to sustain full Spanish employment, then the result is a bunch of Spaniards cheaply flying around the world while the Germans happily (?) stare at their computer screens and watch the amount of Spanish currency they’ve accumulated roll upwards. It’s not like Spain can run out of their own fiat currency.
Of course this could start to unravel for the Spanish at some point if the Germans get tired of subsidizing Spanish airplane demand or satisfy their demand for Spanish currency, but the planes will still be in Spain and all Germany could do at that point to run down their Spanish currency reserves is to start buying Spanish assets which Spanish citizens would have to voluntarily sell them. If the Spanish government mismanages this process then there could be inflation, but as long as the Germans are happy to trade airplanes for foreign fiat currency, then why wouldn’t the Spanish government want to accommodate them.
Maybe I’m missing an important point here, but without a gold standard (or gold-standard-like Euro) this seems like the logical conclusion for a floating exchange rate, fiat currency economy.
KD,
“all Germany could do at that point to run down their Spanish currency reserves is to start buying Spanish assets which Spanish citizens would have to voluntarily sell them.”
Do you think the Spaniards would be happy if their assets are largely owned by the Germans? It’s no fun to be on the receiving end of colonization.
Ken
Thanks for your insightful ground level view of German competitiveness, which explains part of the picture. However, I do believe that some of the factors Prof. Pettis mentions are also at work. One such factor is tax structure. If a product is exported from Germany to the US the VAT is rebated, effectively reducing the selling price into the US market. If a similar product is exported from the US to Germany the US does not rebate taxes embedded in the selling price but Germany adds the full VAT to the import price of the US product. This can significantly increase profit margin or reduce selling price of German made versus US made products.
I think that the “probem” with Germany, China, Japan and other persistent surplus is not thier effiecient manufacturing. IMO the main problem is that they are succefull at exporting and then refuse to spend the money they bring in. If they took the point of view that “we must find ways to spend our export earnings or our customers are going to have to stop buying from us,” I think we might make some headway in reducing the imbalances that are heading the world economy towards a likely disaster.
Hi Stegen
If it was the matter of the tax code or something like that the US or GB or any other of the persistent deficit countries (the problem goes back to the sixties) would have long ago done somthing about it.
The US is an exception as they ultimately don´t care. They have the reserve currency. But countries like GB or Spain do. GB has devalued consistently since the Sixities and her trade balance only gets worse. The trade balance of GB is today that of an underdeveloped country and were it not for the oil and the city the country would be in for a free fall. Spain managed to holds her own but then entered the Euro and now can´t devalue anymore.
For fairness sake Germany should just transfer the money to the South I maintain. Both would be better off.
As to China and the other Asian countries they never fell for the the nonsense of the service economy being able to substitute for a manufacturing base. They know very well that ultimately imports of raw materials have to be paid for with other goods and not with paper. As soon as the Dollar stops being the reserve currency the Dollar will drop into an abyss. There are no or almost no manufactured goods that the rest of the world wants to buy from the US.
As for services (read Wall Street) I don´t need to go on.
That is what you get if you plow all your investment into ultimately non productive areas (armament industry). But the US is a special case.
As to the supposed most productive workers in the US that Prof Pettis mentioned that is clearly based on an overvalued Dollar. Nobody in his right mind locates a factory in the US. The big multinationals from Germany and Japan do it only because they are forced to. They don´t want the heat in congress.
The capital outlays are staggering and in the final analysis wages are only a small part of the production costs.
You locate them there where you have an educated work force with an industrial tradition. Both is less and less the case in the US in Britain and in a few other countries.
G. Stegen,
You said:
“If they took the point of view that “we must find ways to spend our export earnings or our customers are going to have to stop buying from us,” I think we might make some headway in reducing the imbalances that are heading the world economy towards a likely disaster.”
Great point! Instead, they save for the purpose of accumulating. They lend and then they complain that they don’t trust anyone who would borrow from them. It’s a Marxian perspective: Groucho Marx!
Ken, the idea that Spain simply has nothing to see is not true at all. Spain produces a large variety of low-end and some high-end manufacturing products. It has the world’s best olive oil and some of the world’s best wine, food and agricultural products. It also has a huge tourism industry. Remember that the current account is simply the obverse of the capital account. If Spanish savings are less that investment, it will import capital and run a current account deficit, but if it engages in policies that sufficiently force up its savings rate (i.e. force down its consumption rate), it will run a current account surplus.
As for your claim that “The trade balance of GB is today that of an underdeveloped country and were it not for the oil and the city the country would be in for a free fall,” this also does not make sense. You cannot say that if it weren’t for financial services and oil income the UK’s trade deficit would be larger. It would not, and by saying it you make the same mistake as the many others who don’t see that the balance of trade must balance by definition. This, by the way, was similar to criticisms of British policy in the late 1920s, but once the UK devalued sterling and imposed trade barriers the current account deficit fell sharply and the British economy started growing much more quickly. Oil and financial services income push up the value of sterling and affect the relationship between British savings and investment, and that determines the UK’s trade balance. It is all very well to accuse economists of thinking too much about economics and not enough about culture, but completely to ignore the accounting identities cannot possibly be a better way of thinking about economic issues.
Ken2, yes, I think that is exactly it. The problem with mercantilist policies is that there is no attempt to recycle demand so that other countries enjoy the benefit of domestic demand. The main only goal is to use foreign demand to generate domestic employment and to accumulate claims on foreigner. That makes it a little strange when they complain about the eroding value of those claims. Basic arithmetic tells you that when some countries put into place policies that make them forever a net absorber of foreign demand, either foreigners must have an infinite pool of assets to sell, the mercantilist policies must be reversed, or the value of foreign claims must be eroded. The former cannot happen. The Germanys of the world refuse to allow the second to happen. So the third is the only possible outcome.
Thanks for the detailed reply. First a word about Spain:
You are right with with all your points. The main problem is the Euro which did´t let Spain devalue like it used to. I agree with the concept of accounting identities but purely monetary aggregrates are only part of the story. They don´t cause reality they merely mirror it. Money is not a means in itself but represents an underlying reality. Although one might forget that when looking at todays financial markets.
Case in point GB and how you misread me. I didn´t make any claim about GB having a larger trade deficit without oil and the city. I made a claim about a free fall. All countries but the US must earn whatever they import by selling something in return. And be it her beaches (like in the case of Spain) or services by the City. A close look at the current account balance of GB would tell you immediately that if she would have to import her oil and wouldn´t have the city to export services, her imports would have to shrink by half or more. Unless somebody lends the cash to keep buying. (That is what indirectly happened in Spain to an extent that wouldn´t have been possible before. But people kept pumping money in because the Euro gave the illusion of stability)
Your point about GB and the Twenties doesn´t count. Then GB had a capitve market in the colonies from where she could shut out the rest of the world (i.e. Germany). No need for competitiveness. The colonies had to give up what they had if they wanted (only British) manfactured goods.
It was part of the post war deal brokered by the Americans that Germany (and then Japan, then Taiwan, then Korea) were given equal access to the flesh pots. Today GB doesn´t have the option of battering the hatches anymore. There´s only the city and the hope that the oil won´t run out before she has something else to sell to the world. If not there will indeed be a free fall. Half the food has to be imported, the vast majority of manufactured goods etc.
Spain by the way has some industrial regions that GB can only dream of: Catalonia and the Basque country for instance.
Finally a word about the trade surplus countries: it doesn´t make any sense to follow the lead of the US and GB and introduce the kind of crazy living-beyond-your means that has caracterised these two countries for too long. (Again that doesn´t hold for Spain – no easy consumer credit – no credit cards in the mail etc. – purely over speculation in real estate which has its root in cheap money by the ECB). Sure that was aided and abetted by China which recycled her currency earning instead of letting the Yuan appreciate.
But the case of Germany (and Japan) is different. Germany already 20 years doesn´t make her own monetary policy and it is unfortunately wrong to think the government would have such a strong input into the every day behaviour of consumers that it could make them buy let´s say Spanish goods or vacation at the Costa Brava. Not to mention buying British goods except maybe Scottish whisky. Anyhow a savings rate of ten perrcent like in Germany is by no means excessive.
You can make the point about China with a savings and investment rate of 50%. But then on the other hand China is catching up and the people always had to bleed in industrialising countries. That is not to say that your analysis (for which I thank you very, very, very much) isn´t right in the case of China.
I really don´t know a way out of the problem Germany-Spain except to say that Germany should pay up or forget about part of her debt in her own interest. And let´s for god´s sake bleed the banks.
I goddamn love this blog, and the following discussion.
I find the resemblance between the piigs countries or whatever you want to call them and germany in the ’20 striking. Basically Germany was in the position Spain etc are in now – dependent on the flow of foreign capital and running large current account deficits. The Germans conveniently seem to have forgotten that part – always reminding us about the hyperinflation of the early ’20 but never the deflation of the early thirties.
I can recommend reading Eichengreens European economy between the wars.
Prof Pettis
Yes, it seems this debate never goes away does it?
True, government policies can and does influence consumption, but to say that it “forces” consumption in certain directions is a bit much. There is always a choice, albeit between the devil and the deep blue sea, but there is choice.
For example:
Pettis: On the other hand the fact that planes are so cheap means that Spaniards probably travel more, and so consumption might even rise, or at least drop more slowly than production (again, it depends on the level of unemployment). In that case the Spanish savings rate, of course, must automatically drop. This doesn’t require any increase in the viciousness or laziness of Spaniards. It is an automatic consequence of German subsidy of Airbus.
To make things a little less abrasive, let’s go with the most “inventive” nomers S and G, S could well decide not to channel consumption towards travel but to reroute that towards re-education or a form of expenditure that will allow for the growth of new industries. This is not moralizing but the awareness of alternatives and the existence of choice.
The currency adjustment issue is moot since within the euro zone, that probably translates to bonds and bond rates? Here again, there are other factors at work, expectation that default or downgrades of ratings are on the horizon causes speculation to be amplified and that accelerates the spreads.
Pettis:it has to be of at least some interest that countries whose currencies are sharply undervalued tend to have very high savings rates, and those with overvalued currencies tend to have low savings rates. This isn’t a coincidence. The relative value of the currency can have a direct impact on the differential between household income growth and GDP growth, and if it does, by definition it must affect the level of savings.
Yes, it can have impact but does not rule out other factors, productivity and wage levels/costs do still impact household income growth and GDP, as does the expectation of future expenditure on social security/pension schemes. In a sense, the last will play a crucial role in Europe’s future because it is starting to look like the “retirement pastures” in Orwell’s Animal Farm, that were promised but could never be realised.
Consumption, looked through an economist’s eyes may have a statistical and mathematical inevitability, but it also has a social aspect and that social aspect is tied up with choice. That is also the aspect that prompts the moralizing that is part of the “populist approach” so popular with politicians these days.
Ken wrote ‘If it was the matter of the tax code or something like that the US or GB or any other of the persistent deficit countries (the problem goes back to the sixties) would have long ago done somthing about it. The US is an exception as they ultimately don´t care.”
I do not understand this statement at all. There are many millions of unemployed workers in the US that care. Obama may well lose a second term because of it, so I think he perhaps cares, along with a lot of other incumbants that may be voted out largely because of the unemployment rate.
Lets assume that the US were to impose tax equalization adjustments, e.g. add a compensating fee on imports equal to the amout of VAT rebates, and give a rebate on exports roughly equal to the taxes embedded in their selling prices. Assuming a German VAT of 19% the price of German goods sold in the US market would suddently rise by about 19% while the price of US goods sold in Europe would suddently drop by about 19 %. I suspect that this just might have some effect on the relative competitiveness of US versus German manufacturing and hence the trade balance. Of course the Europeans might howl “protectionism.” To which the US could reply: if that is the case then why don’t you stop doing it.
Meanwhile: Kenneth Rogoff: “. . .loans from emerging economies are keeping the debt-challenged U.S. economy on life support.”
Paul Krugman: ” . . .inflows of capital from other nations simply add to the already excessive supply of U.S. savings relative to investment demand.” (from Krugman’s recent speech at a Keynes conference in U.K.)
Ken, I don’t think I am talking at all about monetary aggregates. I am talking about the balance of payments. By the way you should read Tim Booth’s “British Protectionism and the International Economy”. It is not at all clear that British colonies in the 1920s and 1930s were much good in the UK’s trade balance. As for crazy, living-beyond-your-means policies in the US and the UK, I think that completely mischaracterizes the issue. Trade policies force over- and under-consumption, and it is impossible to have one side without the other. You are assuming that the distortions emanate automatically from the deficit countries, but there is no reason at all to assume that. If you want to go back to British colonial times, remember that Hobson (and Lenin and Hobsbawm and many others) argued that surplus countries forced deficits onto their colonies in the 19th century by forcibly exporting capital to them. Since the surplus countries today are doing the same thing – forcibly exporting capital to the only countries whose minimal capital restrictions make them unable to resist capital imports – why should we assume that the causality has reversed?
Rookie, Eichengreen is always worth reading.
Judy, yes, it is the same old argument, but the idea that policies don’t affect savings rates and that extremely distorted savings ratios can culturally persist for years is to me incomprehensible.
Dan, in fact everyone should read the Krugman article. You can find it at:
http://www.voxeu.org/index.php?q=node/6668
I can’t believe it! It seems that all world thinks that spain is in the 19th century. People are all day sleeping “siesta” and rides donkeys. Come on!
I like to see numbers.
Spain is a low savings rate because….etc
Germany is…..etc
GDP USD 2010
Germany: 3,315,643
Spain: 1,409,946
Dan, Dean Baker does a better job at debunking Rogoff….
This is the implication of his statement in a NYT column that:
“loans from emerging economies are keeping the debt-challenged United States economy on life support.”
Is that so? Suppose that emerging economies announced tomorrow that there will be no more loans to the United States. There would be two responses. First, interest rates in the U.S. would rise. Second, the dollar would plummet, especially against the currencies of countries like China, which have been buying U.S. bonds (e.g. lending money) as part of a deliberate policy to keep down the value of their currency against the dollar. Will these events sink the U.S. economy?
First, it’s not clear how high U.S. interest rates will go, since U.S. Treasury bonds remain one of the few safe assets for investors around the world. However, if rates did start to rise precipitously then the Fed could engage in a QE3 and buy huge amounts of debt.
Could this lead to inflation? It is unlikely given the massive amount of excess capacity and huge numbers of unemployed workers in the U.S. economy. However, even if it did lead to an uptick in inflation, this would be a good thing since it would help relieve the debt burden of homeowners and help to spur growth. This argument was made not long ago by an economist named Ken Rogoff.
What about the falling dollar part of the story? Actually, this is what both the Obama and Bush administrations supposedly have been requesting/demanding from China. A lower dollar is essential for getting the trade deficit down. Everything else is chicken feed. There is nothing in any economist’s bag of tricks that will have as much impact on the trade deficit as a 20 percent decline in the value of the dollar.
This should be a headline item in every newspaper every day, since the trade deficit is tied directly to the budget deficit. If the U.S. has a trade deficit, then it must have negative national saving. (It’s an accounting identity.) This means either negative private savings (e.g. the zero household savings rate of the housing bubble years) or large government budget deficits.
This means that if deficit whiners understood economics, they would all be demanding a lower-valued dollar. In short, the emerging economies have no weapons against the U.S. They would do us and the world a great favor if they stopped lending us money.
Interesting view of 20th century debt, Greece/Germany, and the role of forgiving debt. “Should” temper the sturm und drang over Greek debt. Reminds us how quickly the roles can be reversed.
http://www.spiegel.de/international/germany/0,1518,769703,00.html
Excellent post Professor Pettis! Extremely informative.
There seems to be another class of country that responds to foreign mercantilism “virtuously” through stagnation. I’m thinking of the Dutch Republic in the 1700′s which experienced essentially the following:
A decimated industrial sector (largely as a result of foreign mercantilism)
Combined with capital exports (in the case of the Dutch Republic, to England and later to France) as well as stagnation, rising income inequality and mass unemployment.
The Dutch Republic was a net exporter but still experienced long term stagnation in a context of increasingly effective English, French, Danish, Swedish, Prussian and (eventually) Russian mercantilism.
Hi Michael
I am not saying at all that the deficits are emanationg solely from the deficit countries. It takes two to tango. So indeed China delibaretely keeps its currency devalued by I quote “forcibly exporting capital to the only countries whose minimal capital restrictions make them unable to resist capital imports “. Unfortunately Germany and Japan are part of the very same system, have no capital restrictions whatsoever and have been running surpluses as long as anybody can remember. That is where cultural factors come in.
(Germany not for a few years after reunification and Japan after Fukushima).
Even if Germany would suddenly half her savings rate there is no guarantee she would buy Spanish goods. Or for that matter US goods. It is anyhow to late.
The US doesn´t even have a tool machine industry anymore. If they wanted to reindustrialize they would first have to buy tool machines from Japan and Germany (or even Italy) just as China is now doing. There´s no easy fix for trade balance problems as soon as industry is gone.
You imply that somehow Germany with the right policies could effect a rebalancing. I don´t see how.
As to GB: again you didn´t get my point. What kept her industry chucking along until after the World War II were her captive markets. Ever since the colonies are gone her industry has gone into decline and her trade balance worsens relentlessly. There is no going back to protectionism. The island would simply starve without trade and there are no more colonies that one could force to take British goods by denying them an alternative.
That won´t happen to the US as the US can indeed batten the hatches and still have more than enough to eat. But if the Dollar stops being the piece of paper everybody recognizes as the valid means of world wide exchange I don´t see what the States could offer the world beyond bombers which are made in such miniscule amounts that the process might better be described as pre industrial assembly.
Suddenly the US would have to go from consuming 20% of the worlds oil to much less. That would arguably be a very good thing for over weight citizens but it will cause a lot of short term pain.
I don´t believe this day can´t be that far away. The reasons the Saudis are still selling oil for Dollars is because they can turn around and buy with it the things they want from other countries. That is why there tends to be an inverse relationship between the exchange rate of the Dollar and the price of oil.
My final thoughts: the world or at least Europe and especially Germany and her Northern neighbours plus Japan Taiwan and Korea has profited enormously from the US world system. But the world has gotten to large for Atlas to carry. We are heading for bad troubles and no adjustment of the monetary screws can change that.
Prof Pettis
I think most do agree with policies having some effect on savings rates, just not that policies “dictate” (or in some way makes it inevitable, causation, as usual can be a real pain) savings or consumption. The social nuances associated with ideas of savings and consumption are precisely that which lend such topics the populist slant politicians love to exploit. Such is the imperfect world we live in ~shrug~ of course, that gesture itself is loaded with cultural stereotypes
Mr. Pettis,
One could argue about the lack of social safety net in China as a significant determinate of high household savings. You would also need to consider a lack of consumer credit availability, the one child policy or rising home prices causing people to save more for down payments. But the only real research I have seen that tries to account for these variables shows that China, along with other Asian countries, have a higher preference for liquidity versus the West. The decline of real rates into negative territory in China has done nothing to counter a rapid increase in the percent of income households are saving.
I’m more familiar with Asia than Europe so correct me if I am wrong, but hasn’t Germany maintained a consistently higher household savings rate for quite some time despite changes in tax policy which had been meant to encourage increases in domestic consumption? I remember several years ago the CFO of BMW joked that they might as well raise the VAT tax back up in Germany because the previous reduction had no effect on raising consumption.
So my question to you is have you considered that maybe the relationship could be the reverse? A culture of high savings (or maybe better phrased as a persistently higher liquidity preference) can offer an attractive environment which gives a government a to-good-to-turn-down opportunity to pursue certain tax and trade policies.
A couple of examples. Brazil for instance has an abysmally low household savings rate (5-7% I believe) despite having some of the highest real rates in the world. Also Japan Post continues to be one of largest holders of household savings in the world despite having offered negative real rates for some time.
What about differences in productivity (labor and capital) between countries, and differences in rates of productivity growth? It seems to me this explains much of the wealth differences and changes in relative wealth over time.
In your Plane example, the Germans would by definition be working harder (and producing more), and clearly not happy about their taxes funding ever more exports. The Spanish would be working less hard (and producing less), but happy about it until their borrowing got cut off. Sounds familiar, doesn’t it?
BTW if anyone thinks Germans are boring they haven’t spent enough time in Bavaria.
I don’t buy that over the say 20 years from 1988 to 2008 that US citizens changed their cultural behavioral balance of consumption vs savings. f there is a behavioral aspect to consumption, I would argue that it is principally attributable to the wealth effect of the real estate bubble. People thought they were richer than they were. I would also assert that such a phenomenon is not limited only to western countries. Here in China, there are many of the same personal drives (greed) that western people have. In fact, I observe examples of outlandish behavior, simplistic thinking, gambler’s mentality all the time. ALL THE TIME.
Policies matter.
Great stuff as usual.
I think it is interesting what has happened in the last week, Greece problems, Bernanke admiting US is crappy, and oil problems too. A crazy week, I am guessing there is a bigger move coming on the market.
Been following this guy for a while, his trading advice is killer and is very accurate…. latest video – http://www.youtube.com/watch?v=xKP90DrpfzQ
Prof. Pettis,
thanks for this thought provoking blog. In one of your replies you mention the accounting identities, which force certain outcomes when books are being balanced. But books are balanced ex-post, and some of the respondents here take a more ex-ante view, in which individual preferences do influence the path
of outcomes like savings and consumption.
You write for instance: “If the German financial sector is also repressed, with constraints on consumer credit, consumption growth will largely be determined by the growth in household income.” At the very least I would have added to the caveat “all other things being equal”. And all other things are not equal. There are cultural attitudes to credit, and for a given level of credit availability there will be different uptake. In Germany (the real country), credit cards are used mainly as cash substitutes, with balances paid in full each month. In US, credit card loans are maxed out and repaid over many years. These attitudes would have their contribution to consumption and savings levels independently of any policy. Could policy change the incentives, so that “Germans” are more inclined to consumption? There are examples (like rebates for clunkers), but so far these just pulled consumption from one year to another, no increase overall.
In another instance you write: “If Germany’s currency is undervalued, then by definition Spain’s must be overvalued. … What matters is relative prices and productivity at the exchange rate.” This is an obvious ex-post truth, but the path of relative prices is hardly only a matter of policy in the corresponding countries. For any given policy, variation in attitudes of economic actors will lead to different outcomes. In Germany use of profits for R&D expenditures of private companies has been constantly high under a wide range of write-off regulations, hence the high productivity / low unit labor cost. In Russia, oil profits have been recycled in mansions in Southern France, leaving Russian oil producers with inadequate technology, and low productivity. (not that it matters, with oil at 100 USD).
I could go on and on. Thus is the danger of accounting identities – they allow for showing that surplus in G = deficit in S, but not why G and S are in the position where they are today. To put all burden on policy it is too easy an answer – and even if it were true, culture and attitudes would affect how a given policy works. Think about government income in Greece – they’re not lacking a tax policy, they just can’t collect taxes.
What I get out of this–as a layperson–is that Germany blaming Spain for what transpired is roughly like the drug dealer blaming the addict? Would that apply to the big US banks relationship to their subprime borrowers as well? Thanks
mpettis: “KD, if it’s such a great deal for Spain why would Germany do it? More generally, why do countries fight to be on the generous side of the trade and resist so forcefully attempts to give them the benefit of this largesse?”
Obviously it’s not exactly beneficial for the average worker to have his consumption (income) repressed to facilitate export surpluses.
It is more a question of who benefits and who can influence policy.
If a part of the population that has significant political power can realize a gain for themselves at the expense of everyone else by depressing overall consumption, they might put in place such policies. It’s not just finance that lobbies for policies favorable to their sector.
In any case, if your debt is held externally, there’s not that much of a difference between devaluing your currency and defaulting on your debts.
Personally, I appreciate that the euro means that the “default” has to be more highly visible than the previously employed route of serial devaluations have been.
The very fact that this is politically more difficult to solve might eventually push the surplus countries populations to realize that they aren’t benefiting from such policies after all.
The main problem I see is that the general economic literacy is insufficient for the public at large to realize this. The people with a vested interest in continuing these policies certainly aren’t going to tell them.
Hi Christian
I quote you: “Obviously it’s not exactly beneficial for the average worker to have his consumption (income) repressed to facilitate export surpluses.”
If you mean Germany I believe you don´t know what you are talking about. Germany is one of the last countries in the industrialised world with strong unions. Also all the big corporations have workers councils with rights that are unheard in the rest of the world.
So if there was a fall in real income (which pales besides the fall in the US and GB since the Eighties) then it certainly wasn´t caused by some nefarious elites which wanted to push German exports. Anyhow ceterum censeo I don´t see how higher German income would necessarily correct the trade balance with Spain. I suspect it would rather effect the trade balance with countries that offer something that German consumers want. I.e. China or Japan or Korea. I also for the life of me can´t imagine what would be gained by lowering the by no means sky high savings rate in Germany.
@Deppendorf
Agreeing with you on the dangers of identities. By drawing on the linear nature of such equations and assuming that causation is therefore simplistically constructed could give credence to “political interpretations” which may be debatable. By allowing ourselves to be trapped by these equations could blind us to factors /elements not captured in these formulas.
where did michael go??
its been two weeks….