Monday, January 20, 2014

Personal Savings Rate and the Balance of Payments

Personal Savings Rate & Current Account Balance. Source: FRED
One of the most common--and yawn-worthy--criticisms of my December post outlining why the rise of labor bargaining power was going to be very negative for corporate profits (my estimated CAGR for the next 20y is 1.65% nominal on the upper end) was that corporate profits would be able to survive an increase in real wages because nominal demand would expand at a greater-than or equal-to rate as wages. When confronted with the fact that this would necessitate a lower savings rate, an anonymous reader stated that the savings rate would decline because, "it's demographic." This is, of course, total nonsense. Although the baby-boomers will indeed draw down their stock of savings as they retire, these are most likely to be offset by rising stock of savings of the echo boom and millennials resulting from higher employment and real wages.

Arguing for a decline in the personal savings rate means--by definition--an increase in the rate of growth of one or more of the following in excess of the rate of growth in personal income:
  • Corporate savings (profits - dividends)
  • Government savings (budget balance)
  • Foreign savings (current account deficit)
The first, as I indicated in my December post, is not happening.The second one, a contracting deficit is currently taking place as a result of the labor recovery and the last is actually in contraction. It is this last one I want to talk about here.

Although the causality is bidirectional, the savings rate is intimately tied to the balance of payments by the accounting entity CA= NS-NI (Current Account Surplus =  National Savings - National Investment). As such, a revisiting of the low savings rates associated with the 2000s would need to be coincident with a much much larger current account deficit and tighter fiscal policy. The main driver in the 2000s for this were the so-called "Clinton surplus" followed by the large current account deficit.

Source EIA
As increases in petroleum production cause imports to decline, the portion of the trade balance associated with petroleum declines. Additionally, the ongoing rebalancing of the Chinese economy towards consumption (as well as the ongoing RMB revaluation) will continue to drag on China's current account surplus--and, in my opinion, turn it into a deficit--making the return of 6% current account deficits highly unlikely.

There is quite a few reasons to be bullish on increases in nominal final demand, but a decline in the personal savings rate is not one of them. The gap in quality between the mean and median household balance sheets (wealth skew) has probably peaked and is headed nowhere but down. As I have said before, the accumulated stock of corporate sector savings is about to be transferred to the household and public sectors.

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