The Continuance of the Savings Glut

With President Obama in China and the issue of the dollar-renminbi exchange rate presumably on the agenda, there has been a great deal of commentary about the threatening peril of the Chinese savings glut1. Here was Paul Krugman late in October on how the savings glut — the condition and a leading cause of the 2007-2008 financial crisis — remains unabated, continuing to propagate its distortions throughout the world economy2:

Until around 2001, you could argue that [the target value of the yuan was reasonable]: China’s overall trade position wasn’t too far out of balance. From then onward, however, the policy of keeping the yuan-dollar rate fixed came to look increasingly bizarre. First of all, the dollar slid in value, especially against the euro, so that by keeping the yuan / dollar rate fixed, Chinese officials were, in effect, devaluing their currency against everyone else’s. Meanwhile, productivity in China’s export industries soared; combined with the de facto devaluation, this made Chinese goods extremely cheap on world markets.

The result was a huge Chinese trade surplus. If supply and demand had been allowed to prevail, the value of China’s currency would have risen sharply. But Chinese authorities didn’t let it rise. They kept it down by selling vast quantities of the currency, acquiring in return an enormous hoard of foreign assets, mostly in dollars, currently worth about $2.1 trillion.

Many economists, myself included, believe that China’s asset-buying spree helped inflate the housing bubble, setting the stage for the global financial crisis. But China’s insistence on keeping the yuan / dollar rate fixed, even when the dollar declines, may be doing even more harm now.

Although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable. America needs a weaker dollar to help reduce its trade deficit, and it’s getting that weaker dollar as nervous investors, who flocked into the presumed safety of U.S. debt at the peak of the crisis, have started putting their money to work elsewhere.

But China has been keeping its currency pegged to the dollar — which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead.

And that’s a particularly bad thing to do at a time when the world economy remains deeply depressed due to inadequate overall demand. By pursuing a weak-currency policy, China is siphoning some of that inadequate demand away from other nations, which is hurting growth almost everywhere.

For thirty years now the prevailing grand social bargain in the United States has been that outsourcing and offshoring will be the means whereby capital will capture an increased portion of national income and the resultant consumer goods price deflation will substitute for the also resultant wage stagnation. In shorthand, this might be called the Reagan Revolution, though Reagan only brokered the deal. The conditions that gave rise to parties militating against the preceding post-war social bargain lay much deeper in the structure of the post-war international order. This social bargain is the basis of the financial problems of the U.S. as well as of the China problem.

The savings glut is not merely a problem with China, but in its Chinese component it is driven by two factors, neither of which is likely to be resolved by U.S. action. First, owing to population growth and the massive migration from rural farms to urban wage labor, China needs to create around 25 million new jobs per year. The memory of Tiananmen Square demonstrations of 1989 remains potent in the mind of Chinese Communist Party officials. It is widely believed among Chinese officials that preventing a repeat of the unrest of 1989 and hence the survival of the Party depends on the ability of the Chinese economy to provide jobs for these millions, preventing them from becoming a mass of disaffected urban unemployed. Second, the savings glut exists as a part of China’s long-term grand strategy of pursing peaceful development first and regional political realignment only once they have attained sufficient economic and military weight. For the U.S., the G-8, the IMF or whoever to ask China to abandon its policy of undervaluing the renminbi is to ask the Chinese government to commit suicide and to accept their second-tier world-political status; it is to ask them to run the highest order of political risk as an act of charity to the rest of the world. We cannot rely on China doing the U.S. any macroeconomic favors here. The only way to eliminate the macroeconomic conditions of the next financial crisis is to get our own house in order.

On the right and amidst the Lou Dobbs crowd you here these constant sidelong remarks about China holding the strings of America’s economic future. But this is not the result of some insidious plot on the part of China to acquire a financial WMD stuffed full of T-bills for deployment against the U.S. at some opportune occasion (like a WMD, to actually use it would result in mutually assured destruction). This is result of the Wal-Mart low-wage, low prices, long supply chain model of doing business (surprise: the day-to-day purchasing decisions of millions of people reach up to the commanding heights of world finance). We can try to brow-beat China to forego the opportunities of the system that we have created, but the origin of that system reaches down into what is now, under the midwifery of the right, claimed as the American way of life. And perhaps we have decided that getting off on a bad foot with the world’s next superpower is preferable to confronting our own economic culture.


  1. Dominique Strauss-Kahn, the Director of the IMF, made a speech on the subject in Beijing, The International Monetary System: Reforms to Enhance Stability and Governance, International Finance Forum, Beijing, 16 November 2009; Krugman, Paul, “World Out of Balance,” The New York Times, 16 November 2009, p. A25; Wolf, Martin, “Grim Truths Obama Should Have Told Hu,” Financial Times, 17 November 2009.

  2. Krugman, Paul, “The Chinese Disconnect,” The New York Times, 23 October 2009, p. A35