The saving glut theory has gone out of fashion – unjustly so. In spite of twin financial crises looming on either side of the Atlantic, US Treasury and German Bund yields have declined in recent weeks. This can be explained by not only the dismal economic growth of the US economy in the first semester of 2011, but also the unrelenting build-up in total debt securities outstanding.
After the closing of the markets last Friday, Standard & Poor’s announced that it had downgraded the US’ sovereign’s long-term debt by one notch to AA+. According to the agency, the Congressional accord to restore the sustainability of the US public finances falls short of what would be necessary to stabilise the government’s medium-term debt dynamics. Moody’s had already indicated that it would maintain the AAA rating for US government debt, albeit with a negative outlook.
While the US dollar took a battering when Congress seemingly failed to reach an agreement on the debt ceiling, reaching an all-time low against the Swiss franc, US Treasuries did not follow suit. Any rise in short-term Treasury yields was (more than) offset by a decrease in long-term bond yields. This suggests that any estimate of the cost of a US downgrade, reflected in higher borrowing costs for the federal government and higher mortgage and credit card rates for the US consumer, should be taken with more than a pinch of salt.
According to a 16 June S&P research note, rates on US Treasuries would rise by around 23 basis points in case S&P would downgrade the US to AA and by around 38 basis points in case the US were downgraded to A. Such a rise would imply higher interest rate costs of $2.3-$3.8 billion for each trillion in the US federal government deficit (S&P 2011). Citi’s chief economist Willem Buiter has already cautioned that the estimates, amongst others, do not take into account the special role the US dollar and US Treasury securities have in domestic and international finance and trade (Buiter 2011).
Buiter estimates that the group of investors that is forced to sell their Treasury holdings in case of a downgrade will be relatively small. The group of investors that choose to sell Treasuries is probably larger and likely to rise further over time, as a downgrade will accelerate the attempts of many holders of dollar assets to diversify away from dollar holdings. This analysis, however, does not take into account the fact that the demand for fixed income assets in all likelihood will rise significantly in the coming five years.
The global saving rate will rise 3.3% points from 22.8 to 26.1% of world GDP between 2010 and 2016, according to estimates by the IMF (World Economic Outlook, April 2011). The uptick in the global saving rate reflects the stabilization of advanced economies' savings as a share of global output and the continuing rise of emerging economies' savings. The 3.4% point increase in the global saving rate from 20.5 to 23.9% of world GDP between 2002 and 2007 has by some commentators been blamed for the 2008 financial crisis and ensuing economic crisis (Greenspan, 2010).
Figure 1. Global savings as a share of world GDP
Source: IMF (estimates after 2010)
Figure 2. Advanced, emerging economies and global savings as a share of world GDP
Source: IMF (estimates after 2010)
Though Obstfeld and Rogoff (2010) have argued that the global saving rate was relatively low in the 2002-2004 period, the combination of (a) the rising global saving rate, (b) the increasing share of emerging economies in global savings, and (c) the robust growth of the global economy resulted in a steep growth of total debt securities outstanding from 2002 onwards. While total debt securities outstanding increased between 1997 and 2002 on average by 5.5% per year, its growth rate more than doubled to 12.9% annually between 2002 and 2007.
Figure 3. Total debt securities outstanding and global GDP in US dollars (trillions)
Source: IMF, BIS
In my recent research (Mees 2011a), I show that total debt securities outstanding have an economically large and statistically significant negative impact on Treasury yields. Moreover, total debt securities outstanding explain the 10-year Treasury yield considerably better than foreign purchases of US government bonds. This finding is consistent with recent research into the effectiveness of the Federal Reserve’s quantitative easing or asset purchase programme, which shows that the impact of the Fed’s asset purchase programme is determined primarily by the quantity of securities that the Fed holds rather than by the pace of new purchases (Bernanke 2011).
Emerging economies’ savings are currently heavily skewed towards fixed income assets (i.e. debt securities), resulting in a rising (forward) yield on equity capital (or equity risk premium) at a time that bond yields worldwide are falling (Mees 2011b). Institutional constraints do at least in part account for emerging economies’ preference for fixed income assets over equity capital. These constraints include emerging economies’ underdeveloped financial markets and closed capital accounts, but also the reluctance of most Western countries to allow emerging economies’ sovereign wealth funds and state-owned enterprises to invest in equity capital of Western companies.
At the semi-annual China-US Strategic and Economic Dialogue last May in Beijing, China's leadership demanded greater access to the US market, adding that the worlds largest economy could greatly benefit from Chinese investments. Given the mishandling of the US economy by politicians and central bankers alike, the latter is actually not hard to imagine at all.
Bernanke, Ben S (2011), Semiannual Monetary Policy Report to the Congress on 13 July.
Buiter, Willem H and Ebrahim Rahbari (2011), “Navigating the US Fiscal Swamp”, Citi Global Economics View.
Greenspan, Alan (2010), “The Crisis”, Brookings Institute.
Mees, Heleen (2011a), “US Monetary Policy and the Interest Conundrum”, Working Paper.
Mees, Heleen (2011b), “Lost in transmission”, VoxEU.org, 21 June.
Obstfeld, Maurice and Kenneth S Rogoff (2010), “Global Imbalances and the Financial Crisis: Products of Common Causes”.
Standard and Poor’s (2011), “How Would Lowering The Sovereign Rating On The U.S. Affect U.S. Treasuries?”,.