Saturday, May 06, 2006

Australia's high savings rate

The Reserve Bank of Australia’s recent claims regarding our savings habits are intriguing. Conventionally-defined household savings (disposable income less consumption less depreciation) has become negative in Australia in recent years – close to the lowest observed among countries like the US, Britain and Italy. However if savings is redefined to include both superannuation and the accumulation of stock market wealth, our savings rate has virtually doubled over the past few years and, at 24% of disposable income, is among the highest of any developed economy.

Moreover the RBA suggest that the increase in wealth is not an ephemeral phantom that reflects an illusory stock market boom since the increase in stock market prices is well-justified by increased company earnings. Note also the strong savings performance of the US in these same terms - it outforms even Australia. Presumably both economies are now revealled to have good potential to deal effectively with population aging issues. But why are both countries running such huge current account deficits – I thought these reflected inadequate savings - as Ben Bernanke states 'That inadequate U.S. national saving is the source of the current account deficit must be true at some level; indeed, the statement is almost a tautology'.

Update: Access Economics has criticised high levels of government spending as a $35 billion bet on an unending continuation of the commodities boom (Commonwealth Budget Monitor, #69). The implication is that all such booms come to an end so it is an unsound bet so government should be more prudent. But, if this is so, then is not the RBA also gambling on a continuation of the boom in claiming that Australia's savings rate is high? Even if equity prices have risen to reflect improved commodity prices, so P/E ratios are not high, the market will fall if commodity prices decline. Even if the current situation in the stock market does not correspond to a bubble, valuations can still be myopic. Then, if commodity prices do decline as the Treasurer says they will, households will experience capital losses and using the new measure, savings will fall.

There is a distinction between lodging savings in a bank and saving in the stock market because the latter is riskier and capital gains or losses are more important. To say that high capital gains offset increased foreign borrowing will not be true if capital gains on equity turn into losses. The distinction between old and new savings definitions hinges on the distinction between debt and equity contracts. This also means that the current account as a measure of our increasing indebtedness needs to be rethought.


Eco Student said...

Maybe current deficits are at times not reflective of inadequate national savings but of a relative abundance of investment opportunities in countries like Australia and the United States relative to the rest of the world.

If you constructed an old fashioned supply and demand diagram for financial markets, supply would be savings and demand would be investment opportunities (investment opportunities would exhibit a diminishing marginal return; the more that is invested the lower the return would be) and the "price" would be the risk adjusted returns on investment. In a closed financial market, this price would see domestic savings and investment find equilibrium.

However in an open financial market, if the risk adjusted return on investment available globally is higher than the domestic "equilibrium" then domestic savings will flow out of the financial market. Vice versa, as in Australia and the United States, if the domestic risk adjusted return on investment is higher than that elsewhere in the world, global savings will flow into the market, creating a current account deficit.

Australia and the United States are nations with extremely low sovereign risk, histories of steady economic growth, relatively lightly regulated economies and lots of room left for further economic growth. Maybe capital account surpluses are the financial markets rational response to these economies advantages.

hc said...

Hi eco student. Isn't the current account equal to the difference between investment and savings so a deficit can be either too much investment or too little savings?

Yes and there is an investment boom gooing on pretty well throughout the Australian and US economies so a plausible explanation is just that the boom is dragging all this money in. But it must be one hell-of-a-boom if the savings rates as recalculated by the RBA are insufficient to meet local investment needs.

Or is it that while the new savings rates include unrealised capital gains they aren't available for investment? At this point my brain goes fuzzy - I need some good macroeconomic help.

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