The Savings Gap
Thrift may not be a welcome topic during the holiday season, but foreign exchange markets are pressing the issue nonetheless. The dollar fell 6% over the past two months relative to other major currencies, and the motive appears to be investor anxiety about America's seemingly insatiable consumption or, conversely, its aversion to thrift.
A useful approach to this subject begins with American savings and investment behavior. Throughout much of the 20th century, savings and investment were closely aligned, seldom varying by even 1 percent of national income. But starting in the 1970s and widening since, a gap has emerged. This year, for example, we’ll invest 7 1/2% of our national income but save only 2%, meaning that the difference -- a record high 5 1/2% -- will be financed by foreign investors.
One aspect of this reduced national saving rate has been the emergence of persistent government deficits. But at least as important is the decline in personal savings, now scraping along at roughly 1% of national income. During World War II, for example, the federal government ran far higher budget deficits than in recent years. But a stratospheric personal saving rate meant that Americans financed those deficits. Alternatively, today foreign investors, especially central banks, are the largest buyers of U.S. government debt.
Of course, all this is not intrinsically bad. After all, without these massive capital flows America wouldn’t have the means to sustain high rates of investment. But it does pose a risk. What happens if foreign investors lose their appetite for U.S. assets?
In particular, U.S. assets generally yield less than those in other countries because they're considered to be less risky. But what if that low-risk assumption becomes dubious? What if America’s fiscal future is perceived to be shaky or simply less secure relative to other countries? What if foreign investors decide they’re holding enough American assets and choose to lighten up that concentration?
In fact, the persistence of this savings gap has turned America from a net creditor as recently as 1985 to a net debtor of growing proportions. Net foreign ownership of U.S. assets will equal 23% of national income this year, and that figure is certain to rise in the years immediately ahead.
And this, or course, takes us back to the dollar. One way to sustain the inflow of foreign capital amidst waning foreign interest is to cheapen U.S. assets, which a falling dollar handily accomplishes. Another option is to sweeten their returns, a lá higher interest rates. And then of course, we may do a bit of each.
