Brad DeLong summarizes the presentations of Carmen Reinhardt and of Richard Koo at last weekend conference in Bretton Woods. Is there a world shortage of savings vehicles of moderate and long duration, as argued by Richard Koo, or is the world desperately short not of savings vehicles but rather, due to overleverage, of safe financial assets, as explained by Carmen Reinhardt?
In the first case households and businesses cut back on their spending in order to rebuild their balance sheets, and since the interest rates could not fall any further (being close to zero for the short term) to clear the market for savings vehicles, recession followed. In the second case households and businesses cut back on their spending to try, in vain, to build up their holdings of safe financial assets that just were not there. Hence recession.
DeLong believes that governments should provide the necessary assets by spending, investing, and borrowing “in order to boost the market supply of savings vehicles”. But Reinhardt would then conclude, according to DeLong, that “if the government tries to do so it will crack its status as a safe debtor and we will have a bigger sovereign debt crisis on our hands which will make the recession worse. Basically, we are all Austria and it is 1931.”
I find these conclusions overly pessimistic. Indeed an economic recovery is already under way in several countries, including the US. But it is clear that there is a global supply of savings, especially from China and other emerging countries, in search of investment opportunities. This flow has contributed to asset markets booms in developed countries through excess leverage, at a time when real investment opportunities became rather scarce. Hence the following purges when leverage proved unsustainable.
An adjustment process is already under way, however, with China encouraging more consumption at home, less lending abroad, and with a forecast of reduced growth rate in several emerging economies. As in the thirties, the full adjustment will take time because the deleveraging process is slow and the creation of new assets has to wait for the next innovation wave on the one hand, and the institutional changes that will allow more creation of relatively safe assets in emerging countries, on the other hand. But the time will come for both.