April 2016

LPL RESEARCH P R I VA T E C L I E N T

THOUGHT LEADERSHIP

ALTHOUGH WE MAY NEED TO BUILD UP OUR SAVINGS INITIALLY, THE IDEAL OUTCOME FOR CONTINUED GROWTH IS FOR THOSE SAVINGS TO LEAD TO INCREASED SPENDING IN THE FUTURE.

THEMATIC INSIGHTS

THE GLOBAL SAVINGS GLUT Can savings be a bad thing? Many people think of saving money as a best practice when it comes to managing their finances, but if everyone in an economy (or even just a single saver that controls much of the wealth) saves at the same time, spending is likely to decline, leading to slower near-term economic growth. This concept also applies to countries. When countries save more than they “spend” (e.g., invest), they may actually cause problems related to slower growth, including downward pressure on interest rates, deflation, and weaker stock market performance. Economists who believe we’re in the middle of a “global savings glut” think that’s exactly what’s happened in recent years. Figure 1 shows some of the potential implications of a global savings glut, which will be discussed in more detail later.

WHAT IS A SAVINGS GLUT? The global savings glut hypothesis, which was popularized by Former Federal Reserve Chair Ben Bernanke more than 10 years ago, states (in basic terms) that the world is dealing with an excess of savings, and, as a consequence, insufficient investment. The theory is controversial and competing theories exist, but it does help to explain some of the issues faced by the world economy in recent years.

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POTENTIAL IMPLICATIONS OF A GLOBAL SAVINGS GLUT Slower Economic Growth

Spending fuels economic growth. Saving reduces spending now, in favor of potential spending later.

Interest Rates Lower for Longer

More savings lead to competition for perceived safe havens such as Treasuries and high-quality sovereign debt. At the same time, high bond valuations mean little potential for capital appreciation, making (now lower) yields a more important driver of returns.

Benign Inflation or Deflation

More savings equal less spending now, resulting in fewer dollars chasing the same amount of goods.

Weaker Stock Market Performance

Slower economic growth acts as a drag on earnings growth, a key driver of stock market returns.

Source: LPL Research 04/14/16

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The negative impact of saving too much makes more sense when considered from an economic perspective. Spending, whether from consumers, businesses, or governments, ultimately drives economic growth. The major benefit of saving from an economic perspective is that it allows us to push spending forward, whether we’re “saving up” for something or planning for a time when our income levels might decline, such as retirement. Thus, although we may need to build up our savings initially, the ideal outcome for continued growth is for those savings to lead to increased spending in the future.

One way a country’s “savings” can be measured is through its current account balance, which economists think of as the amount a country saves minus what it invests domestically. This difference is reflected in trade relationships, which is another way of looking at the significance of the

Just like a consumer can have a savings account, a country can place its savings in reserve, which recently has led to a net current account surplus for the world.

THE GLOBAL SAVINGS GLUT Benign Inflation or Deflation Weaker Stock Market Performance

Interest Rates Lower for Longer Slower Economic Growth

P o t en t ial Implic a t ions

Fiscal Policy (Increase Spending to Boost Investment)

Aging Populations

Potential Solutions

Primary Drivers

Incentivize Corporate R&D Spending

Eurozone

Promote Balanced Demographics by Incentivizing Immigration and Child Birth

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Emerging Market Countries

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current account balance. A country with a trade surplus is exporting more than it imports, or saving more than it invests back into its country. Just as a consumer spending less and saving more will result in slower economic growth today, the same is true for any individual country. How a country disposes of its savings also matters. Over time, the total of all of the individual current account surpluses and deficits in the world should net out to zero, meaning if one country “borrows” through a current account deficit, another country will “lend” from its surplus. But over the short term, the numbers don’t always net out; because just like a consumer can have a savings account, a country can place its savings in reserve. In fact, this is what has happened in recent years, leading to a net current account surplus for the world [Figure 2].

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THE WORLD HAS HAD SEVERAL YEARS OF A NET CURRENT ACCOUNT SURPLUS Net World Current Account Balance, Billions of U.S. $

$500 400 300 200 100

Estimated

-100

‘90 ‘92 ‘94 ‘96 ‘98 ‘00 ‘02 ‘04 ‘06 ‘08 ‘10 ‘12 ‘14

Source: LPL Research, International Monetary Fund 04/14/16

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The primary drivers of the global savings glut originate in both emerging market (EM) and developed countries, with several contributing factors, such as a need to reduce debt, low demand for investment, aging populations, and the large amount of cash held by corporations.

EM Countries: Historically Big Savers EM countries, led by China, were historically big savers and ran large current account surpluses over time. In response to the late 1990s Asian financial crisis, EM countries set out to reduce debt and increase savings. EM countries also tend to have higher savings rates than developed nations, given weaker social safety nets. Additionally, the commodities boom of the 2000s boosted revenue for many EM countries, especially heavy commodity exporters in the Middle East. For years, China has been perhaps the most significant driver of global savings. Current account surpluses increased given its historically heavy reliance on exports, but its reserves, at more than $3 trillion, are still the largest in the world. China’s foreign reserves have been falling recently, though, due to a slowing economy, investment in a transition to a more consumer-oriented economy, and most recently, using reserves to weaken its currency.

Eurozone: The New Source of Surplus

0

-200

DRIVERS OF THE GLOBAL SAVINGS GLUT

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China’s slowdown has been offset by Germany, which has quietly become the new current account surplus champion of the world, first taking the crown in 2011. This surplus is in large part being caused by the “one-size-fits-all” approach of the euro. If Germany, which has one of the stronger economies in the Eurozone, had an independent currency, it would likely be stronger than the euro is now, which would make German exports more expensive. But given that the European Central Bank’s (ECB) easy money policy — mainly intended

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to help slower-growing peripheral nations — also applies to Germany, the weakened euro is helping boost demand for German exports, leading to a large current account surplus. Many countries in the Eurozone periphery have also seen increased surpluses; however, in contrast to Germany and EM countries, the surpluses are largely due to economic weakness, where demand for investment remains low. Figure 3 shows how the sources of global surpluses have changed over time.

growth environment for years. The amount of cash held by corporations may also be having an impact, with much of the cash held overseas to avoid repatriation taxes. Although surpluses are the main subject here, no discussion of surplus and deficit could be complete without addressing why the U.S., the largest economy in the world, has (and continues to run) a current account deficit. The major reason is that investment in the U.S. has continued to outpace savings due to an attractive business environment, liquid and developed financial markets that attract foreign capital, and the dollar’s position as the world’s preeminent reserve currency.

The Role of Aging Populations and Corporate Cash Aging populations in developed countries are one of the main drivers of the savings glut. An increasing proportion of employees are in the later years of their working lives, and on average, savings rates are highest in preparation for retirement. This behavior may help explain why Japan has experienced years of current account surpluses, even though it has been mired in a slow

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China’s slowdown has been offset by Germany, which has quietly become the new current account surplus champion of the world, first taking the crown in 2011.

THE EUROPEAN UNION HAD THE LARGEST 2015 CURRENT ACCOUNT SURPLUS OF ANY AREA IN THE WORLD Emerging and Developing Asia

European Union

Middle East and North Africa

$500

Estimated

400

Billions of U.S. $

300 200 100 0 -100 -200 -300

‘97

‘98

‘99

‘00

‘01

‘02

‘03

‘04

‘05

Source: LPL Research, International Monetary Fund 04/14/16

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‘06

‘07

‘08

‘09

‘10

‘11

‘12

‘13

‘14

‘15

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WHAT ARE THE POTENTIAL IMPACTS OF A SAVINGS GLUT? Slower Economic Growth In the short term, a current account surplus can be viewed as deferred economic growth, as savings do not contribute to consumption or investment today. Additionally, investments in new equipment, processes, and technology tend to increase economic growth over time, so a lack of current investment means future growth is also likely to be impacted. Slower economic growth in response to too much savings has several potential implications.

Lower Interest Rates One of the largest impacts of the global savings glut is falling, or low, interest rates. Countries generally don’t seek to make money on their foreign reserves, and therefore, they invest in perceived safe-haven securities that can help preserve their buying power, such as Treasuries and high-quality sovereign debt of other developed nations, or gold. However, as the demand for savings has grown over time, it has led to more competition for the limited supply of highquality sovereign debt. In 2014, world reserves totaled more than $77 trillion, while the supply of Treasuries was only $39 trillion. Figure 4 shows how the increase in world reserves compares against the average interest rate for a 10-year bond for G10 countries (minus Sweden, which didn’t have data available prior to 2005).

Deflation Inflation is often referred to as too much money chasing too few goods; but in a world with a savings glut, the opposite is true, leading to the potential for deflation. All else equal, higher savings lead to weaker aggregate demand and consequently, downward price pressures to attract new demand. Central banks across the world have been working to avoid this outcome, placing interest rates near, or even below, the zero bound, 05

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and also using quantitative easing (QE) to spur demand for risk assets such as stocks. However, even with this extraordinary monetary stimulus, inflation rates have remained stubbornly low, and are still below central bank targets in many areas of the world, including the U.S., Europe, and Japan. These consistently low inflation rates suggest that other factors, such as a savings glut, are helping to maintain downward pressure on prices.

Lower Stock Market Returns Sub-par investment and slower economic growth means weaker earnings growth, a primary driver of stock prices. Business capital spending has been weak during the current recovery, as companies funneled cash raised from increased borrowing into share buybacks rather than investing into their businesses. Buybacks may help boost returns in the short run by spreading the same amount of earnings over fewer shares, but aren’t likely to boost long-term earnings power. So while stock markets may still manage positive returns, the savings glut likely diminishes their potential.

AS WORLD RESERVES HAVE INCREASED, INTEREST RATES HAVE FALLEN

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World Reserves as % of GDP (Left Scale) Average G10 Interest Rate, Excluding Sweden (Right Scale) 20 %

10%

18

9

16

8

14

7

12

6

10

5

8

4

6

3

4

2

2

1

0

0 ‘90 ‘92 ‘94 ‘96 ‘98 ‘00 ‘02 ‘04 ‘06 ‘08 ‘10 ‘12 ‘14 Source: LPL Research, FactSet, World Bank 04/14/16

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WHEN WILL THE GLUT END? Though the contributors are changing, the global savings glut is not likely to disappear soon, and few solutions are on the near-term horizon. One driving factor is that deficits are widely viewed as negative, while surpluses, which actually cause much of the problem, are seen as positive. This encourages countries to follow policies that encourage surpluses, such as attempting to weaken currencies to boost exports. The upcoming retirement wave in developed countries will help, but individuals, for a number of reasons, are working longer in life than prior generations. Eventually late-career workers will transition to spenders, but this is likely several years away and will postpone any meaningful decline in the savings glut. Another way that developed countries can help reduce the glut over time is to improve the ratio of older to younger workers. Loosening restrictions on immigration, especially for highly skilled workers, is a near-term solution, while improving incentives for having children may help in the longer term.

Fiscal policy to boost investment, and therefore, overall demand, is one way to counter the global savings glut. Fiscal policy to boost investment, and therefore, overall demand, is one way to counter the global savings glut. So far, developed country governments have relied on monetary policy, including extraordinary measures such as QE, to stimulate growth, but this medicine has likely run its course. An increase in fiscal spending, such as a broad infrastructure program spread over several years, may boost efficiency and create beneficial knock-on effects to boost demand. China was able to prop up its growth during and following

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the Great Recession by pulling infrastructure investments forward, creating additional jobs and related spending, but going too far can also have its drawbacks. Furthermore, not all countries are able to exercise this option. Austerity measures in the Eurozone leave governments with very little to spend on such projects. The last major fiscal policy initiative in the U.S., the American Recovery & Reinvestment Act (ARRA), expired five years ago in 2011. Such policies are not without controversy, because they increase budget deficits and carry potential for abuse and fraud. Still, other policies, such as incentivizing corporate R&D spending, are another way to kick-start projects that may boost investment opportunities and improve aggregate demand. Ultimately, countries will need to find a way to increase aggregate demand and reduce the demand for savings. Central banks, as mentioned previously, are trying this by targeting low interest rates and QE programs; but so far, these efforts don’t appear to have gone far enough, and the global savings glut remains a threat to global growth.

CONCLUSION The issues related to—and to some extent, the very existence of—a global savings glut, can be difficult to untangle. Though complicated, the possibility of a global savings glut is one plausible explanation of persistently low interest rates and weak global demand. It also explains the global trend toward low inflation or even deflation, despite predictions of rampant inflation following the post-crisis expansion of central bank balance sheets through QE programs. These issues, regardless of the cause, are creating challenges for longer-term investors or retirees seeking steady portfolio income, and may continue to as long as the glut remains. n

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IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for your clients. Any economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market. Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

DEFINITIONS Quantitative easing (QE) refers to the Federal Reserve’s (Fed) current and/or past programs whereby the Fed purchases a set amount of Treasury and/or mortgagebacked securities each month from banks. This inserts more money in the economy (known as easing), which is intended to encourage economic growth.

This research material has been prepared by LPL Financial LLC. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity. Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

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