Daniel O'Connor | Integral Ventures, LLC
In the midst of declining rates of saving in developed economies, led by their respective household sectors, it appears that businesses have been bucking the trend and actually increasing their saving. With growing profits and relatively weak capital investment over the past several years, businesses have become net savers in the global economy. As reported yesterday in The Economist, J.P. Morgan considers this one of the major factors underlying the conundrum of surprisingly low long-term interest rates in this era of apparent economic growth and monetary tightening.
Beyond the usual suspects for these low long-term rates--a reduction in inflation expectations, an impending recession, and/or a migration to the relative safety of government bonds--the hypothesis gaining the most attention in recent months is Ben Bernanke's account of the "global savings glut" in emerging economies.
Following a series of financial crises, these economies slashed investment and swung from a combined current-account deficit of $93 billion in 1996 to a surplus of $336 billion last year. Since bond yields should reflect the demand and supply for funds, this increase in net saving could indeed have reduced yields. However, a new study by economists at J.P. Morgan concludes that in recent years an increase in saving by companies in developed countries has been far more important than emerging economies' thrift.
Over half of emerging economies' huge swing from external deficit to surplus had occurred by 2000. However, American bond yields were roughly the same in that year as in 1996; the big decline in yields is more recent. Since 2000, the corporate sector has stood out. Companies in the main developed economies have switched, as a group, from being big borrowers to being net savers: ie, their profits exceed their capital spending. The total increase in companies' net saving in the past four years has been more than $1 trillion, 3% of annual global GDP and five times the increase in net saving by emerging economies over the same period. J.P. Morgan estimates that about half of the gap between the current real yield on American ten-year Treasury bonds and its average since 1960 is due to this increased corporate saving.
Firms have been net savers for the odd year in the past, but a run of several years is highly unusual. Since 2002 American firms have had an average net financial surplus of 1.7% of GDP, compared with an average deficit of 1.2% of GDP in the previous two decades. Corporate Japan has run an average surplus over the past three years of no less than 6.2% of GDP, compared with an average deficit of 2.3% in the 1980s and 1990s. In fact Japanese firms have been in financial surplus since 1994, desperately trying to reduce the debts they built up during the bubble economy in the late 1980s. Corporate cost-cutting—in both capital spending and new hiring—has been a persistent drag on Japan's growth rate. The good news is that corporate debt as a percentage of GDP has fallen to the level of the mid-1980s, before the bubble really inflated. Now American and European firms seem to be following in the footsteps of the Japanese, having been forced to cut back on borrowing after a binge in the late 1990s.
Of course, the standard logic of economic growth reveals that households should, on balance, be saving while business, on balance, invest, with the dynamic interaction between the supply and demand for funds being mediated by interest rates--the market prices of saving and investment--determined according to the value functions of households and businesses. Often in the midst of a recession in which value functions shift, households choose to defer consumption in the present in favor of greater consumption in the future, with the resulting increase in saving funding business investment in the additional capital that will, in time, yield the greater product for which households have been saving. Each sector has a critical role to fulfill in the overall process.
It is therefore troubling to note a three-year-long reversal of this traditional growth dynamic during the first three years of a reported economic recovery, wherein businesses are apparently deferring investment in the present in favor of greater investment in the indeterminate future, with the resulting increase in business saving being used to fund greater household consumption (which, outside the Washington beltway, is generally not considered a "growth" activity) and to some extent greater household investment in housing itself (which is putting it optimistically). It is hard to imagine how even the carefully crafted appearance of economic growth can be sustained in the long-term without household-funded increases in business investment that yield greater productivity in service of greater future household consumption based, as it should be, on past saving rather than more borrowing.
This begs the question of why business executives around the world have chosen to moderate their capital investment despite such attractively low costs of capital? Apparently, many businesses flush with cash and with access to credit still cannot find strategic opportunities deemed worthy of a comparable degree of capital investment. To the extent that executives are thinking clearly, they must expect risk-adjusted returns on these bypassed investment opportunities to be even lower than the risk-adjusted returns expected on the very low-rate government bonds they're choosing to hold instead.
What might they know that many householders apparently do not? Perhaps business executives have learned from the last business cycle that market prices, when distorted by central bank monetary policies and credit-based monetary inflation, can provide false signals regarding the attractiveness of long-term investments. Maybe they have added a few points to their hurdle rates of return to account for the additional risk of a mounting instability beneath the veneer of state-managed economic stability.
In other words, perhaps business executives are just saving themselves from the usual suspects: an impending recession, which justifies a migration to the relative safety of government bonds, given that both stocks and housing are likely to suffer in any such recession and governments may engage in increasingly unilateral and therefore destabilizing policies of monetary reflation, currency devaluation, and deficit spending (a.k.a. mutually assured disruption).
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See Also:
- Stable Instability
- Saving Ourselves
- Unprecedented Fundamentals
- Asset Price Bubbles: Monetary Inflation and Leveraged Speculation
- Mutually Assured Disruption
- Debt Trap
- Temporal Conundrum
