Global Trends in Private Sector Savings Surpluses

I am preparing my quarterly review of what's happening to the fundamental relationships and flows that underpin investment cycles around the world. This is my attempt to track changes in returns on capital and labour, coupled with an effort to reconcile changes in economy-wide cashflows which can be expected to result from them. With that completed (hopefully), the review moves on to 'matters arising' – which is, perhaps, the main point of the exercise. If successful, I end up either confirming or moderating the basket of prejudices I inherited from previous efforts.

Those 'matters arising' inevitably change the emphasis I place on aspects of this analysis, with the main questions now shifting away from factors of production and on to monetary velocity (ie, the impact of zombie banking systems) and public-sector debt (ie, the impact the looming 'fiscal cliffs' may have on current savings/investment choices).

No matter where you start to pull at the threads, at some point you end up looking at movements in private sector savings surpluses/deficits. This fundamental cashflow-indicator is, after all, sensitive directly to changes in fiscal policy, but also indirectly to return on capital, and to financial confidence. (And plenty more.)

What's also true is that they are going to play a central role in the options available for tackling the fiscal cliffs which most developed economies will be approaching in the coming years. This is because in the normal course of events (ie, when central banks are not 'quantitatively easing') the world's private sector savings surpluses are precisely what end up buying government bonds. But since their fluctuations also generate economic volatility, the feedback relationships between growth, savings surpluses and fiscal solvency will only become more important over time. Does anyone really claim to understand them? I think over the next couple of years Japan will be the crucial testing-ground.

In the meantime, all major economies are running private sector savings surpluses. They need to be, given the world's population of zombie-banks are in no state to fashion an artificially positive cashflow for the non-financial private sector by lending faster than their deposits rise. But the trend of these surpluses is different around the world. 

US – The Unexpected Rise of PSSS

In the US, the PSSS is unexpectedly rising above 5% of GDP, sapping domestic demand and probably reflecting a lack of confidence (fiscal cliff, just now, probably). As the savings surplus has risen, so domestic demand has disappointed in the first half of the year. But this may represent more of an opportunity than a threat in the short-term. After all, the normal determinants of ROC (and thus ultimately cashflow) look positive – asset turns are rising, returns to labour are rising, terms of trade are rising, and bond yields remain sharply below those implied by 'fair value'. Stabilization, or reversion back to the declining trend would allow a re-acceleration of domestic demand from the levels seen in 1Q12.

Eurozone – Quiet, Too Quiet

If the unexpected rise in the 1H US PSSS provides firepower for an early acceleration of domestic demand, the opposite is true in the Eurozone. One would expect that current recession and impending financial catastrophe would have resulted in the private sector restraining both consumption and investment, and thus pushing the PSSS up despite the fall in ROC and terms of trade. In fact, the ratio has remained stable over the past nine months at around 4% of GDP. The threat, of course, is that further shocks will push this ratio higher, triggering a more intense period of debt-deflation/recession. Outside the Eurozone, this danger is even more pronounced in the UK, where the surplus has fallen sharply throughout 1H12, to just 2.5% of GDP (on a 12m basis).   

Test Case - Japan

Japan's situation is without doubt the most interesting, because it is here that we're likely to learn first how the PSSS interacts with growth, ageing demographics, and the fiscal cliff. Since the bursting of Japan's bubble in 1990, Japan's private sector has generated a savings surplus averaging 8.7% of GDP. But as the population has aged, this surplus has been in gradual inexorable decline. The emergencies of the last three years (global financial crisis, earthquake/tsunami) has disguised this, but the trend is now re-emerging. 

In the 12m to June, Japan's PSSS fell to 3.3% of GDP. Absent spectacular gains in profitability, the demographics are likely to continue to erode this surplus. Already, this surplus is no longer enough to buy the JGBs the Japanese government needs to sell: in the year to June, the PSSS totalled Y15.72tr, whilst the stock of outstanding JGBs rose by sold Y27.76tr JGBs. The immediate impact on JGB yields has been nullified by Bank of Japan's quantitative easing program. But the lesson is not lost on Japan's fiscal planners: Japan's fiscal cliff is looming.    

The key problem here is that at this point, a surge in the PSSS is likely to be achieved only by renewed domestic demand recession – which in turn is likely to put further pressure on Japan's fiscal and public debt position.

So far, the world has largely ignored how these problems are once again concatenating in Japan. After all, we all know Japan runs a large savings surplus, so the problems are domestic.

Trouble is – that historic truth is rather rapidly reversing.  

China - PSSS As Policy Footnote

Finally China: last because, for now anyway, least interesting. China's PSSS is flat at around 3.5% of GDP, but probably rising at the margin, contributing to the slowdown in domestic demand during 2Q and later. The double-digit surpluses of the early 2000s were an expression of the financial repression (lack of savers' choices, undervaluation of the currency) which went with China's exogenous growth model. That it is coming down now is an expression above all of the slow easing of financial repression as China attempts the extremely tricky traverse towards an endogenous growth model. Furthermore, in the short term, any shortfall in internal cashflows which accompanies this (as is indeed happening) can and will be offset by lowering the extraordinarily high reserve ratios imposed on China's banks (more financial repression). Unlike in the US, Europe or Japan, the PSSS for the time being can be seen as a footnote response to policy, not a central factor determining and circumscribing it.