By Adrian Ineichen

The Great Contrast
Recently, President Obama travelled to Asia and visited Japan, the APEC summit in Singapore and went to China and Korea. The contrasts were stark, particularly in China: here comes the representative of the world’s most powerful democracy whose people save on average 3% of their disposable income (at some point in recent years, this figure has been negative) to the world’s largest nation whose people save about 20-25% of disposable income which lifts the gross domestic savings rate above the 50% mark. The big saver has (too?) much invested into the debt of the big spender and fears now that the latter’s bad economic conditions (unemployment above 10%, perennial current account and government deficits, etc.) may render the saver’s US assets that are estimated to top US$ 1.5 trillion less valuable (e.g. through potential inflation in the future or a depreciating dollar).

It is remarkable when the joint China-US statement issued on November 17 during Obama’s China stay says this: “United States will take measures to increase national saving as a share of GDP and promote sustainable non-inflationary growth. To achieve this, the United States is committed to returning the federal budget deficit to a sustainable path and pursuing measures to encourage private saving.”

How often have you seen a country pledging to be financially more responsible in a bilateral communiqué? It is not remarkable  that foreign powers prod the US to act, which may seem embarrassing enough, but it is remarkable because they are right and we should act, but have failed to do so for decades. Germany’s finance minister Schäuble warned last Friday against a looming fresh asset price bubble due to low US interest rates – which are expected to stay low for some time to keep liquidity and credit available – and provides the latest addition to the global concerns about US finances.

It Takes Two to Tango
The big spender (aka big debtor) knows that he has to adjust (boosting domestic savings and exports), but faces an uphill battle, given the urgent task to resolve the current crisis and get financial (and other) regulations right, on the domestic front.

Boosting saving is not easy in a consumption culture, and various policy tools have already proven to be ineffective. C. Fred Bergsten proposes three options worth considering. First, the US could switch from taxing income to taxing consumption which would put pressure on consumption. This idea may also be fruitful on its own as textbook economics tells us that consumption-based taxation has less distortionary effects than income-based taxes. Further, this would allow to clean up the US tax code (if Congress really seizes this once-in-a-lifetime chance) and could kill the current inefficient and administratively onerous retail sales taxes by a value-added taxation system.

Second, the introduction of mandatory savings schemes, let’s say of one or two percent on an individual’s income which could be retained in a separate account and used after retirement as a complement to the social security benefits. Third, medical and social security costs are contained e.g. by a comprehensive health care reform (recall, one of the original ideas of the current health care reform was to contain costs) and by a social security reform that may include the increase of the retirement age (a path that Germany has chosen and many Western European countries are likely to adopt in the future as well, given the demographics) and the reform of contribution and benefit formulas.

At the same time, an effective correction of imbalances requires the big debtor to coordinate with its biggest banker/creditor (i.e. the big saver) who himself has some daunting tasks ahead.

To get back on a sustainable growth path, the mainstream opinion suggests that China should boost domestic consumption and reduce its savings rate. At least three policy options could help. First, an increased redistribution could give high corporate profits away to poor Chinese people who may then spend more. At the same time China should reduce excess capacity and over-investment in certain industries (such as cement, steel, coal etc.). This is the Jonathan Anderson story which emphasizes that most of the savings are made by corporations and thus a resolution of the imbalance would require to start with changing the current industrial policy. It is noteworthy that Chinese investments this year have risen (pushed by stimulus). Second, improving the social safety nets, revamping education facilities and access and expanding public health care can increase spending directly, and may reduce the need for people to save as they can expect to have safer income sources when they are old and to be able to cope with health issues.

Third, the big saver allows for external adjustments to take place. In general, a revalued exchange rate would make Chinese exports less competitive and would thus squeeze corporate profits. While some call for a direct renminbi appreciation, others say that this move may not do much to rebalance the global economy (and may not have a large impact on the US current account deficit). It is likely that both sides miss the point. The key is that the current unofficial peg of the renminbi to the dollar (since summer 2008, after an appreciation path since July 2005) is not sustainable. It leads to foreign exchange surplus whose reinvestment has led to high risks and low returns, is a potential source for domestic Chinese inflation (which may arise in the coming years), and it attracts hot money which increasingly finds its way around China’s capital controls.

As China’s role in the global economy rises, the role of its currency is likely to grow too. To avoid adjustment shockwaves, a pragmatic approach could entail the speeding up of the gradual internationalization of the Renminbi, e.g. by expanding trade settlement or the institutional investor programs (QDII and QFII) while easing regulatory burden on cross-border capital flows. It will be interesting to see how the Chinese nomenklatura adjusts its policies when exports start to grow again and global outlooks further improve in 2010.

Nice to read:
Anderson, J. (2009. “The Myth of Chinese Savings”, Far Eastern Economic Review 172(9; Nov 2009), pp. 24-30.

Bergsten, C. F. (2009). “The Dollar and the Deficit”, Foreign Affairs 88(6; Nov/Dec 2009).

U.S.-China Joint Statement, November 2009
http://www.whitehouse.gov/the-press-office/us-china-joint-statement

Germany warns US on market bubbles
http://www.ft.com/cms/s/0/4ec41a1a-d616-11de-b80f-00144feabdc0.html