Bits Bucket For December 9, 2010

Is it OK if I just bury my head in the sand? This scenario is too scary to contemplate.

* CAPITAL
* DECEMBER 9, 2010

Beware the End of Savings Glut

* By DAVID WESSEL

The last few years, we’re told, were an aberration. The end of the credit and housing booms ended in a once-in-a-century bust. Governments rushed to the rescue, and central bankers pushed short-term interest rates very low. Investors rushed to the safety of U.S. Treasurys, helping keep long-term interest rates down even as the U.S. borrowed heavily and, now, the Fed is keeping them from rising.

What next? What will happen when the U.S. economy recovers, as it surely will some day? One likely outcome: a reversal of the global saving glut and an end to the abundance of cheap capital.

Looking beyond the next few years, McKinsey Global Institute, the think-tank arm of the consultancy, foresees a surge in investment by emerging markets, particularly China and India, at the same time as those countries begin to save less. Business, banks, consumers, investors and governments “all will have to adapt to a world in which capital is more costly and less plentiful, and where over half the world’s saving and investment occurs in emerging markets,” McKinsey says in a new report, “Farewell to Cheap Capital.”

As a whole, the world economy can invest only as much as it saves. A farmer in the old days divided his crop between corn that he’d eat or sell (consume) and corn that he set aside (save) to plant next year (invest). The same goes for the output of the global economy. Turning history on its head, much of the increased saving over 25 years has come from China and other poorer countries and flowed to richer countries, particularly the U.S.

Thrifty Chinese workers and peasants put money in the bank. The banks lent to the government which lent to the U.S. Treasury and mortgage giants Fannie Mae and Freddie Mac. And it ended up financing cheap mortgages in the U.S. before the crash and the big Obama fiscal stimulus after the crash. Government, companies and households in China accounted for a remarkable $1 in every $4 of global saving in 2008.

McKinsey says all this is bound to wane in the next several years, as China and India pick up the pace of investment. “China,” it says, “plans to build new subway systems, highways and high-speed trains in its top 170 cities.”

170! To keep pace with urban population growth, China needs to add one New York City’s worth of residential and commercial space every two years; India, one Chicago’s worth every year. With so many Asian factories producing close to capacity, predicts Hong Kong-based HSBC economist Frederic Neumann, a surge in business capital spending is likely. Based on the consensus forecasts for global growth, McKinsey projects global investment—which amounted to a bit more than 22% of world output before the financial crisis—could reach nearly 25% by the end of this decade, a level not seen since the early 1970s.
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