Courtesy of Mish.
Michael Pettis at China Financial Markets taught me much of what I know about global trade. I am very appreciative. I tend to agree with most of his views.
I recommended his book “Great Rebalancing“, and still do.
In a recent email, however, Pettis revives the “Global Savings Glut” thesis and I strongly disagree. This is a somewhat lengthy discussion, but an extremely important one.
“Income Inequality” is a front-page topic so let’s take a close look.
From Pettis …
Reviving the “Underconsumption” School
In the current issue of the newsletter I have decided largely to ignore current events and will try to dig deeper into the model I use to understand the sources of global imbalances, and how they have driven much of what has happened around the world in the past decade. This model rests on an understanding of how distortions in the savings rates of different countries have driven the great trade and balance-sheet distortions with which we are wrestling today, just as they have in most previous global crises, including those of the 1870s, the 1930s, and the 1970s. Rising income inequality is key to understanding this model.
Much of what I am going to argue is not new, and is merely a revival of the old “underconsumption” debate. Before jumping into the argument I want to start by quoting the remarkable former Fed Chairman (1932-48) Marriner Eccles, who may well have been the most subtle economist of the 20th Century, from his memoir, Beckoning Frontiers (1966):
As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth – not of existing wealth, but of wealth as it is currently produced – to provide men with buying power equal to the amount of goods and services offered by the nation’s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations.
But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.
The key point here is that all other things being equal, rising income inequality forces up the savings rate. The reason for this is pretty well understood: rich people consume a smaller share of their income than do the poor. The consequence of income inequality, Eccles argued, is an imbalance between the current supply of and current demand for goods and services, and this imbalance can only be resolved by a surge in credit or, as I will show later, by rising unemployment.
Mish: Despite the obvious casino-like structure of global equity and bond markets, the poker game analogy is an extremely poor one.
From the wheel to the telegraph to the phone it took fewer and fewer people to produce the same amount of output. Today, a single farmer can produce as much wheat as 200 farmers at the turn of the century….
