Normal consumption patterns are likely years, rather than months, from returning, meaning a boom in savings and depressed interest rates
By Mike Bird
Three months after Western nations began locking their cities down to prevent the rampant spread of the new coronavirus, and with many in East Asia further along in the recovery process, one enduring effect of the pandemic is becoming clear.
Consumer demand has been crushed, and savings are rising in an unprecedented manner.
That now seems likely to have long-lasting effects on financial markets, depressing interest rates for years and creating a beggar-thy-neighbor effect for the international economy.
Shoppers waited to enter a Bloomingdale's in New York on Monday. Only a fraction of savings would have to remain to keep it at historic highs. / Photo: Jeenah Moon/Bloomberg News .
The U.S. personal-saving rate—personal incomes less personal outlays and taxes—touched 33% in April. In the eurozone, the differently calculated household-saving ratio is expected to rise from 13% to around 19% this year and remain at historically high levels into 2021.
The accumulation of savings will undoubtedly slow sharply as purchases that were simply impossible during full lockdowns are completed. But only a fraction would have to remain to keep savings at historic highs.
Research published by the San Francisco Federal Reserve in March addressed the long-term economic consequences of pandemics from history. Unlike wars, where the destruction of physical capital means real interest rates tend to rise afterward, pandemics seem to cause real interest rates to slide for decades afterward, consistent with rising precautionary savings.
Developments in financial markets lend some credence to this theory, with assets both risky and low-risk feeling a relentless bid since the lows of late March. Investors have piled into money-market funds in extraordinary volumes, a development that usually signals a fearful atmosphere.
But the fear is harder to see in the equity market, with U.S. stocks lingering at roughly flat levels for the year.
Foreign investors flooded into dollar-denominated bank accounts in March in particular, driving the largest inflows into U.S. accounts and securities on record.
The makeup of the plunge in economic activity is another concerning signal on the prospects for a full rebound in consumption.
The J.P. Morgan Global Manufacturing PMI, produced by IHS Markit, has never been stronger relative to the equivalent index for services, in data going back to 1999.
In China, the picture remains the same even for a country that has largely exited coronavirus-related lockdowns and entered a partial economic recovery. In May, retail sales were still down 2.8% year over year, while industrial production was up 5.2%. Exports fell 3.3%, but imports fell by 16.7%.
These trends can’t be sustained. Some countries can export their way to growth, as China did from the late 1980s until the mid 2000s or as Vietnam does today. But as a matter of logic, not all countries can have export-led growth at the same time.
John Maynard Keynes wrote about a paradox of thrift. When everyone attempts to save or reduce borrowing at the same time, an economy must contract. Households don’t buy as much from businesses, which in turn don’t hire as many people, depressing tax revenue and government spending. The cycle is vicious and can be easily applied to an international arena. All countries trying to save at once makes the world worse off.
The original idea of the savings glut applied largely to East Asia, where precautionary savings built up after the 1997 Asian financial crisis were plowed into U.S. assets. That depressed U.S. interest rates, so the theory went.
Investors should be wary of overinterpreting the international push and pull of savings gluts.
The idea that when a country imports more than it exports it must sell its trading partners financial assets to fund its deficit is a mistake of international accounting.
Aggressive stimulus programs could counteract the pernicious effects of the beggar-thy-neighbor shrinking consumption, but to do that they must be continued in earnest for some time after the virus is fully defeated, not abandoned at the first plausible opportunity.
That is particularly important for the U.S., given its uniquely dominant role in providing consumer demand globally.
A change of course from China would also help. More generous expenditure on welfare, income support and health care could raise consumption. China’s government spends just 1.8% of gross domestic product on health care and 0.9% on social assistance.
That is not only far below figures in the rich world, but south of the respective 3.2% and 1.6% spent by upper-middle-income countries, those with gross national income of $3,996 to $12,375 per capita. Worryingly, the Chinese government is instead preoccupied with the scale of its fiscal deficit.
Even in the case that the most optimistic forecasts for economic recovery are fulfilled, normal consumption patterns will be the part of the economy slowest to return to normal.
And that means savings will likely remain elevated, leaving a lingering mark on global financial markets.
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