Did excessive savings in China and Japan cause the world-wide recession?

March 9, 9:58 PMEconomic Policy ExaminerJoseph Hight

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National People's Congress Chairman Wu Bangguo, center walks past Chinese Premier Wen Jiabao, left, and President Hu Jintao, right, National People's Congress in Beijing's Great Hall of the People, China, Monday, March 9, 2009. (AP Photo/Greg Baker)

This column comes from one of the many ideas I get from readers and colleagues. In a response to an academic paper on price swings I had sent to him, Economics and Finance Professor Kenneth Kopecky sent me this note:

“… We need to understand the implications of the high savings rates in Japan and China. The opposite side of the US deficit on current account is savings exceeding domestic investment in countries like China and Japan. How did this influence the onset of the world-wide recession? Are they the principal cause in the sense that very high savings in China and Japan were responsible for very low long-term interest rates, which in turn induced very risky lending/borrowing behavior?”

Kopecky may be on to something. For many years now, China has been saving as much as 40 to 50 percent of its national income, the income generated by its production of goods and services. During the current decade, Japan has been saving more than 25 percent – 27.5 percent in 2006 - of its national income, the income from the goods and services that it produces. In contrast, the American savings rate, has been declining almost steadily from the average of 11 percent of American national income during the period 1960 to 1979 to as little as one percent of national income in 2005.

So we are not a nation of big savers. But could this be a cause of our current trouble, a possible cause of the big world financial melt down and recession? Well here is the point that Kopecky and others have been making, including Professor Martin Feldstein of Harvard. The high savings rate in China and Japan (and we could add South Korea, Singapore and Malaysia as countries with high savings) has caused two related problems that may have contributed to our current world-wide problems.

First, when Japan and China produce so much more than they consume and invest domestically, they must necessarily export the excess production. It turns out that the United States is one of their biggest markets. If the U.S. didn’t buy much of China’s and Japan’s (and South Korea’s and Singapore’s and Malaysia’s) excess output, these countries would have to save less and consume or invest more of it themselves. To the extent that they could not use all of the excess production for themselves, they would face a deficiency in demand causing a fall in their growth rates and a rise in domestic unemployment. Chinese and Japanese savings would have to become smaller. It is American over consumption that allows the Chinese and Japanese to save so much. And by buying and over consuming as much as we have, we Americans have been propping up their economies and much of the world’s economy.

Second, Japan and China (and South Korea and Singapore and Malaysia) have received many trillions of U.S. dollars as payment for the goods and services that they export to the United States. Much of those trillions get invested in financial securities – U.S. government and corporate bonds and more recently in U.S. mortgage backed securities. With so many foreign dollar holdings chasing U.S. financial securities, interest rates in the United States have been exceedingly low, and this, in turn, has fueled U.S. consumer debt and U.S. mortgage debt and thus has been a large factor in the housing boom in the United States.

The U.S. housing boom led to large increases in mortgage debt and then to mortgage backed securities, some of which ended up in the portfolios of the Chinese and Japanese and others around the world. The bubble burst when delinquency rates on U.S. mortgages increased to higher than expected rates, thus causing a devaluation of U.S. mortgage backed securities and the current world financial and economic crisis.

So there you have it. Perhaps, we can blame the Chinese and the Japanese. But I still wouldn’t let those U.S. originators of the fancy new mortgage backed securities called collateralized debt obligations (CDOs) and the credit rating firms on Wall Street completely off the hook.

And I wouldn’t bet on China suddenly deciding that they must do their part in propping up the world’s economy, and that they must export a smaller percentage of their domestic output. And heaven forbid, that they decide they should buy more American goods and services.

No, the only way out of this, once we get over the initial crisis of lack of deficient demand at home (that is why we need the fiscal stimulus) is to invest in American capital, both human and physical, so that we become more productive and can offer the world an offer they cannot refuse – high quality, competitive American goods and services.

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