Getting real
The savings glut was really an investment dearth
Dec 9th 2010 | from PRINT EDITION
NEWS bulletins feature the stockmarket’s daily movements or the rise and fall of European government-bond yields. But they very rarely mention an important economic measure; the very low level of real interest rates (ie, after allowing for inflation). In October America even managed to issue an inflation-linked bond with a negative real yield.
Low real rates have propped up asset markets this year as investors have been forced into riskier assets like equities, corporate bonds and even commodities in search of higher returns. But a new report* from the McKinsey Global Institute argues that real rates are bound to rise in the coming years. That is because an investment boom is taking place in developing countries, which will place a strain on global savings.
It is an economic truism that savings must equal investment. However, desired savings can be greater or less than desired investment: the two are equalised via the level of interest rates.
Ben Bernanke, the chairman of the Federal Reserve, has explained the low levels of real rates over the last decade in terms of an Asian savings glut, with central banks recycling their foreign-exchange reserves into government-bond markets. But McKinsey argues that the explanation lies in a downturn in investment, which dropped from 26.1% of global GDP in the mid-1970s to a low of 20.8% in 2002.
Between 1980 and 2008 global investment was some $700 billion a year less than it would have been had the trend of the 1970s persisted. The investment decline was caused, according to the McKinsey study, by the end of the post-war rebuilding programme in Europe and Japan and a decline in the economic growth rate, which reduced the need for more capital expenditure.
But global investment started to pick up in 2003 as Asian countries ploughed more money into infrastructure. This investment surge was halted, probably temporarily, by the recession. On average, developing countries spend twice as much on infrastructure (as a proportion of GDP) as developed countries do. As the weight of emerging markets in global output increases, the report forecasts that investment will hit 25% of GDP by 2030. In constant prices, that will be an increase from $11 trillion today to $24 trillion by 2030.
Meanwhile, the level of desired savings is set to decline as China attempts to switch to a more consumption-led model. (It would be extraordinary if China managed to maintain its recent national savings rate of 53% of GDP.) In the developed world, age-related spending on health care and other services is likely to reduce savings rates as the baby boomers retire.
The imbalance between savings and investment will result in higher real rates. Over the past 140 years, the achieved real rate on Treasury bonds (comparing yields with the realised inflation rate over the subsequent decade) has been 2.3%. Since the Bretton Woods system of fixed exchange rates collapsed in 1971, the average has been 3.3%. In 2009, real rates averaged 1.7%.
Moving back to the post-1971 average would thus require an increase in real rates of more than 150 basis points, says McKinsey. This shift could occur within the next five years, as investors anticipate the demands of higher capital spending in Asia. If asset prices have been propped up by low real rates, then a rise in rates will be bad news for stockmarkets.
McKinsey suggests that governments should try to offset the problem by offering tax breaks to encourage saving. That may be good in theory but, given weak demand in the developed world, governments are more focused for now on encouraging consumption. Pension funds are seen as a cash cow to be milked, as the Hungarian government demonstrated recently by, in effect, nationalising private-sector schemes.
How does the report’s analysis stand up? It is worth remembering that any future shortfall in desired savings versus desired investment represents the gap between two estimates of some very large numbers. But when rates are below the historical average, it is surely sensible to anticipate an increase.
Real rates will stay at today’s low levels only if the global growth outlook is gloomy for the foreseeable future. That is not an alluring prospect. But if real rates rise, those borrowers, public and private, that have yet to deleverage are bound to face some nasty moments. Stagnation or a renewed debt crisis: it is an unappetising choice.
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