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.
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.
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