Friday, October 24, 2014

Euro Glut: A Global Look

If you have not already read the latest note from Michael Pettis, then please do.

And also do read the note from George Saravelos on what he terms as "Euro Glut".

These are not particularly fresh new ideas, but definitely worth mulling over and have got much less attention in the media, as well as in the blogospehere, than the "new normal" and "secular stagnation" theories. In fact the original piece from George Saravelos also has a scary graph of the current account of Euro area, China and the US.

However, this graph becomes less scary in a slightly expanded perspective. Below is what I gleaned from IMF database (via Bloomberg) on excess domestic savings vs investment (equivalent to the graph mentioned above).

When you take a closer look, the "Euro glut" post 2010 is worryingly out of line. But if your focus is global, then perhaps you should also not miss the sharp drop for China post 2008 and Japan two years later. The gap between required investment and savings for emerging markets have grown stronger and the rest of the Anglo-Saxon world (the UK and the dollar-bloc) still provides a good demand for exported savings. Although it is not clear how much of it is sustainable in a world where Europe continues to build up and export excess savings. And China heads for a soft landing.

What is truly remarkable is the correction in the US, which is equivalent in magnitude in Europe. Nobody seems much concerned about it as correcting a negative current account balance is supposedly good for the economy. The question is if the US stops buying, then who else?

As pointed out in Mr. Pettis' note, there should be plenty of opportunities to invest surplus savings. The trouble will be if the excess savings export remains focused on the return of capital, than return on capital. And of course positive return investment globally can perhaps more than match exported savings from Europe in magnitude, but not necessarily in speed.

In the short run, it is speculative to worry about this. For one, apart from Europe, the world as a whole is already moving towards balance. And European imbalance is a recent phenomenon. It is not clear how long it will continue to build up. Even including Europe we are much closer to a balance than we have been in a long time among the developed economies. Which is good, as balance is good. Cheap capital for proper investment is good. But this is also a bad news, as the US apparently now have a lower capacity to absorb investments. The CAPEX figures from the Fed Flow of Fund data have been less than encouraging for years now. Excess savings in an environment of less investment opportunities mean basically a globalized version of Japan. So it all depends on if this will continue, and if yes, how much it will build up and where the savings will head to.

Of course, this assumes only the flow matters, but stock is important too. We do not know how much Chinese or European investment stock is on the sideline and waiting to be exported. (or conversely, how much unmet demand in peripheral Europe is being neglected by banks unwilling to lend, and how fast this "Euro glut" can reverse on active policy and optimism.) If they do flow out, it is positive for foreign assets in the short run. And if they do find a home in real positive return investments it is great in the long run too. If they overcrowd economies with little investment opportunities, it will push the real rate down and impact investment. So on the optimistic side, this is positive for emerging market economies (including India) in the long run. And as long as we can keep the global demand up, it is positive for pretty much everyone.

And finally, yes the absolute numbers are large. But when you compare them to world GDP, this total imbalance appears much less benign (less than 1% of world GDP for Euro area, China and Japan combined). In a world with perfect trade and capital flow, this should take care of itself. In real world, this is large, but not earth shattering!

So short the euro by all means, but not solely because of "Euro Glut". It is perhaps way too complicated than that. At least more than what Mr. Pettis seems to suggest how important the trade balance is. And more than just exports of savings. In fact in early 90s, the yen and the Japanese current account balance (as a percentage of GDP) moved in pretty much lock-step. In the way a simple trade model would suggest, currency strengthening in auto-correction when current account surplus builds up. Exactly opposite of what Mr Saravelos suggests.

People were way too complacent about Europe a decade back. And now way too pessimistic!


  1. How much risk do you think an ageing EU population will want to take? Matt Levine says on Bloomberg that US foreign asset yields better than EU because they invest in equity while EU prefers debt. These dotards need WW3 to wake up.

  2. ah that is a very interesting point. I will see if the data suggests Europeans indeed avoid foreign equities!