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Elliott Morss | August 27, 2014

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The G-20 Meetings: Bernanke on Capital Flows

by Elliott R. Morss, Ph.D.

Introduction

At the recent G-20 meetings in Paris, Fed Chairman Ben Bernanke gave a talk that summarized research he has done on international capital flows over the last 20 years. His points are interesting and important. Capital flows are as important in determining the value of the dollar as the US trade deficit. Below, I summarize his points and provide data on a number of the key issues. On a related note, I show why the US savings rate has appeared to have been so low in recent years.

Capital Flows

Bernanke said that in the late 1920s and early 1930s, the U.S. dollar and French franc were undervalued. That resulted in current account surpluses (large capital inflows) for both countries. If markets were working properly, these inflows should have caused both currencies to strengthen, thereby making imports cheaper and exports less competitive. And this, plus growing domestic aggregate demand resulting from the capital inflows, should have narrowed their international trade surpluses. But that did not happen. Both countries neutralized the effects of the capital inflows by reducing the money supply so their currencies remained undervalued. Bernanke concludes that the actions of France and the US helped to destabilize the global economic situation and bring on the Great Depression.

Bernanke then pointed out that the United States has recently been the recipient of the largest capital inflows ever. But unlike earlier times, this has been accompanied by massive current account deficits. Why are things different? He argued that the capital inflows are in part the result of what he calls the “global saving glut”.1 The very high savings rates of certain emerging market countries meant they had large surpluses to invest. And emerging market investors were attracted to what they viewed as the safest and most liquid assets: US debt and equities. So the resulting large capital inflows helped to offset the US trade deficits and kept the dollar from losing more value.

Back to the “global savings glut”. Table 1 provides data on savings rates for the G-20 countries.

Table 1. – G-20 Gross Savings Rates

  1998-
Country 2008 ave.
China 45%
Saudi Arabia 36%
South Korea 32%
Russia 30%
India 30%
Japan 27%
Canada 22%
Mexico 22%
Germany 22%
Indonesia 21%
France 20%
Italy 20%
Australia 20%
Argentina 20%
Turkey 18%
Brazil 16%
United States 15%
South Africa 15%
United Kingdom 15%

Source: World Bank Database

China’s saving rate is quite exceptional, but the oil countries along with India and South Korea also have extremely high savings rates. And yes, the US has had a low savings rate. But there are reasons for the low US rate.

Why the US Savings Rate Was Low

There is a unique feature the composition of US income that explains why its savings rate has been so low. There is no country in the world that earns such a large fraction of its income via capital gains. Remember that the savings rate is roughly (I – C)/I, where C is consumption and I is income. And what is most important, capital gains income is not included in I when the savings rate is calculated. Now look at Table 2. The first savings rate (line 5) is calculated in the traditional manner without including capital gains. But note how important capital gains income (and losses) has been as a component of total income: between 2003 and 2006, it averaged 31% of total income. Americans got used to it and got in the habit of spending more because of it. And note that when capital gains are included as income, the US savings rate is much higher.

Table 2. – US Net* Savings Rate, With and Without Capital Gains

Item 2003 2004 2005 2006 2007 2008
Consumption 7,704 8,196 8,694 9,207 9,710 10,106
Disposable Personal Income 8,163 8,681 9,062 9,641 10,170 10,664
Net Savings 459 485 368 434 460 558
Net Savings Rate 6% 6% 4% 5% 5% 5%
Capital Gains Total 6,925 3,039 3,006 3,381 420 -8,923
  – Real Estate 1,130 1,547 1,756 768 -106 -933
  – Equities 5,795 1,492 1,250 2,614 526 -7,991
Income, including Capital Gains 15,088 11,720 12,068 13,022 10,590 1,741
Net Savings Rate, incl. Cap. Gains 49% 30% 28% 29% 8% -480%

Sources: Bureau of Economic Analysis, Federal Housing Authority, and Federal Reserve Flow of Funds

* Net savings data are used in this table whereas gross savings was used in Table 1.

But both the real estate and equity markets go up and down. And look at how dramatically income, including capital gains, was affected in 2008 when both the real estate and stock markets collapsed. Income, including capital gains, fell from $10.6 trillion in 2007 to only $1.7 trillion in 2008. That led to a massive reduction in US consumption and the consequent global recession.

Capital Flows

Table 3 shows what has happened to the US current account (the net trade in goods and services plus income) and capital account over time.

Table 3. – US Current and Capital Accounts (bil. US$)

Item 1973 1982 1990 2006 2007 2008 2009
Current Account 14 11 -52 -711 -603 -547 -253
Capital Account -4 -33 58 779 632 611 165

Source: US Bureau of Economic Analysis

From a surplus of $14 billion in 1973, the current account went to a deficit of $711 billion in 2006. The global recession reduced it for a while, but it is growing again. But note how the capital account has compensated for these deficits: from a deficit of $33 billion in 1982 to a surplus of $779 in 2006. Part of this was fed by Bernanke’s savings glut and the world’s preferences for US securities. But there is more to it than that.

Table 4 gives a breakdown of the US Current Account. Note the large foreign government purchases of US government securities. This reflects the purchases by China and Japan to prop up the dollar relative to their currencies so as to keep their imports competitive. And note the growing propensity of US investors to buy foreign stocks and bonds.  

Table 4. – US Capital Account (bil. US$)

Type of Investment 2000 2007 2008 2009
         
Capital Account 377 632 611 165
         
U.S. Foreign Investments -561 -1,485 -16 -147
         
  US Government -1 -22 -534 489
         
  US Private -559 -1,463 519 -636
    Direct investment (current cost) -159 -414 -351 -269
    Foreign securities -128 -367 198 -208
      Stocks -107 -148 39 -63
      Bonds -21 -219 159 -145
    Other US Private Claims -272 -682 672 -159
         
Foreign Investments in U.S. 937 2,116 627 311
         
  Foreign Governments 43 481 551 450
    U.S. Treasury securities -5 98 549 561
    Other U.S. government securities 41 171 43 -120
    Other Net Claims 7 211 -41 9
      0 0
  Foreign Private 894 1,635 77 -139
    Direct investment (current cost) 321 271 328 135
    U.S. Treasury securities -70 67 161 23
    Other US Securities 359 614 6 6
      Stocks 192 231 58 136
      Bonds 166 384 -51 -131
    Other 284 683 -419 -302
         
Derivatives (net) n.a. 6 -33 51

Source: US Bureau of Economic Analysis

Looking Ahead – Investment Implications

But consider possible changes in the Current Account. In Table 5, data on the first three quarters for the last four years are presented.

Table 5. – Capital Account, First Three Quarters (bil. US$)

  2007 2008 2009 2010
Type of Investment I-III I-III I-III I-III
         
Capital Flows, Net 833 1,120 313 418
         
U.S. Foreign Investments -1,253 6 -132 -767
         
  US Government 0 -266 442 6
         
  US Private -1,253 272 -574 -773
    Direct investment (current cost) -267 -247 -186 -259
    Foreign securities -343 99 -163 -111
    Other US Private Claims -643 420 -225 -403
         
Foreign Investments in U.S. 2,085 1,114 445 1,185
         
  Foreign Governments 657 1,169 576 454
    U.S. Treasury securities 37 334 437 306
    Other U.S. government securities 355 634 242 197
    Other Net Claims 265 201 -104 -48
         
  Foreign Private 1,428 -55 -131 731
    Direct investment (current cost) 223 228 93 140
    U.S. Treasury securities 46 96 8 269
    Other US Securities 484 -119 -20 109
    Other 675 -261 -212 212
         
Derivatives (net) 20 -15 30 26

Source: US Bureau of Economic Analysis

Questions that need to be considered:

  • Will private US investors increase their holding of foreign securities?
  • Will foreign governments to continue to prop up the dollar by purchasing large amounts of US government securities?
  • Will foreign private investors continue to purchase large amounts of US government and private securities?

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