Fire and Ice*

Marc Shivers of The Talking Fed notes the following new material from Ben Bernanke’s speech on Tuesday (referring to the way that current global imbalances might end, given Bernanke’s argument that they are caused by a global savings glut):

What implications would a gradual rebalancing have for long-term real interest rates? The logic of the global saving glut suggests that, as the glut dissipates over the next few decades and thereby reduces the net supply of financial capital from emerging-market countries, real interest rates should rise

Upon which the blogger comments:

He presumably leaves it as an exercise for the reader to figure out what implications a sudden rebalancing would have on long-term interest rates, like might happen, for example, if U.S. consumers collectively decided tomorrow that they no longer wanted to be the consumers of last resort for the rest of the world. I'm guessing this is what the FOMC was referring to on Aug 17 when they said "the FOMC judges that the downside risks to growth have increased appreciably."

Despite Bernanke’s research linking the two, though, I think we should be careful to separate conceptually the issue of the savings glut from that of the international imbalance. In principle it is possible to have either one without the other. One might ask separately the questions, “How (and when) will the savings glut end (and will it ever end)?” and, “How (and when) will the international imbalance end (and will it ever end)?”

In my own mind, I have an easier time imagining a more-or-less “permanent” savings glut than I do imagining a “permanent” international imbalance. The case that comes to my mind is the 1930s, when the world had a prolonged savings glut. Indeed the glut might have gone on indefinitely if the brilliant economists in Nazi Germany and Imperial Japan had not hit on an ingenious method for coordinating international policies.** During the course of the savings glut in the 1930s, however, there were some successful attempts to alter the international balance.

Ben Bernanke imagines that the global rebalancing will be the result of the elimination of the savings glut (just as – in his view, anyhow – the original imbalance was itself the result of the savings glut). Marc Shivers, on the other hand, imagines what might happen if the global rebalancing resulted from an intensification of the savings glut – that is, if the US joined the glut instead of the rest of the world ending the glut. He imagines that scenario as a sudden change, but it could also happen gradually.

In the sudden scenario, I think long-term interest rates would go down, but there is some ambiguity, because the inflationary impact of sudden weakness in the dollar might lead the bond market to anticipate tight money. In the gradual scenario, there isn’t much ambiguity: a gradually weakening dollar would not have a dramatic inflationary impact, so the bond market should anticipate easy money to stimulate an economy weakened by slowing consumer spending.

I see at least one reason to expect that “gradual widening of the savings glut” scenario: demographics. The children of the baby-boomers are now at the point of graduating from college or otherwise experiencing full emancipation. Without the expenses of caring for their children, baby-boomers – that bulge in the US age distribution – will have surplus income at a time when it is becoming increasingly difficult to ignore the specter of retirement. That realization isn’t something that happens overnight to everyone at once, but I imagine it will happen faster than the matter of decades over which Ben Bernanke sees the rest of the world regaining its appetite for real investment.


*The title is an allusion to Robert Frost, but frankly, I like Pat Benatar’s version better

**UPDATE: I guess the US has tried something similar recently, but the international coordination doesn't work unless you attack a country that has allies. Just like George W to screw things up ;)