The U.S. and China's savings problem
The Chinese have taken thrift to excess, while profligate Americans have spent their way into debt.
(FORTUNE Magazine) - The two major players in the global economy, the U.S. and China, are operating at opposite ends of the saving spectrum. Thrifty Chinese have taken saving to excess, while profligate Americans have spent their way into debt.
Neither of these trends is sustainable -- they lead to destabilizing economic and political developments for both nations -- and a better balance must be struck. China needs to convert excess saving into consumption, while the U.S. needs to end its buying binge and rediscover the art of saving.
The numbers leave little doubt as to the extraordinary contrast between the two economies. Last year China saved about half of its gross domestic product, or some $1.1 trillion. At the same time, the U.S. saved only 13% of its national income, or $1.6 trillion. That's right, the U.S., whose economy is six times the size of China's, can't manage to save twice as much money.
And that's just looking at national averages that include saving by consumers, businesses, and governments. The contrast is even starker at the household level -- a personal saving rate in China of about 30% of household income, compared with a U.S. rate that dipped into negative territory last year (–0.4% of after-tax household income).
These are extreme readings by any standard. The U.S. hasn't pushed its personal saving rate this far into negative territory since 1933, in the depths of the Depression. And the Chinese rate is higher than it has been at any point in the past 28 years, since its modern reforms began.
Similar extremes show up in the consumption shares of the two economies -- the mirror image of trends in personal saving rates. U.S. consumption has held at a record 71% of GDP since early 2002, while Chinese consumption appears to have slipped to a record low of about 50% of GDP in 2005.
In China's case, relatively weak consumption means its growth dynamic is skewed heavily toward exports and fixed investment. These two sectors account for more than 75% of Chinese GDP and are growing by more than 25% a year.
If China stays with this growth mix, any further increase on the export side would be a recipe for trade frictions and protectionist responses. That's certainly the direction Washington is heading in these days. Moreover, a continued burst of Chinese investment could lead to excess capacity and deflation at home.
Using homes as ATMs
The U.S. saving shortfall is equally stressful. American consumers have mistaken bubble-like appreciation of their homes for saving. Facing anemic growth in labor incomes -- real compensation paid out by the private sector has lagged behind the norm of past business cycles by more than $360 billion -- they have turned to debt-financed equity extraction from their homes in order to keep consuming. And the binge has reached record highs in terms of both the amount consumers owe as a share of their incomes and the interest expenses they incur to service those obligations.
America's lack of saving has also put unprecedented demands on the rest of the world, since the U.S. must import surplus saving from abroad in order to grow. America's current account deficit hit a record of nearly 6.5% of GDP in 2005 and could well be headed north of 7% this year. That translates into a lifeline of foreign capital totaling about $3 billion per business day.
There is a more insidious connection between the saving postures of China and the U.S.: Chinese savers are, in effect, subsidizing the spending binge of American consumers. In order to fuel its export-led economic growth, China has decided to keep its currency relatively cheap and tightly pegged to the dollar. To do so, it must constantly recycle a large portion of its saving into dollar-denominated financial assets -- an investment strategy that helps keep U.S. interest rates low and an interest-rate-sensitive American housing market in a perpetual state of froth.
That's dangerous for the U.S., but it's also an increasingly risky proposition for China because it bloats that country's money supply. This excess liquidity then spills over into the Chinese financial system, leading to asset bubbles, such as those in its coastal property markets. China is also exposed to the potential fiscal costs of a sharp markdown of its portfolio of dollar-based assets in the event of a depreciation of the U.S. currency.
It is in neither country's best interest to stay the present course. Instead, there must be a role reversal: China's savers must be turned into consumers, and the excesses of U.S. consumption must be converted into saving. This won't be an easy task for either nation, but it sure beats the increasingly treacherous alternatives.
In the U.S., it will take nothing short of a major campaign to boost national saving. That will require a reduction of public-sector dissaving (i.e., outsized federal budget deficits) and the enactment of some form of consumption tax.
A pro-saving agenda
A national sales tax would be the simplest and most efficient prescription, provided there are exemptions for low- and lower-middle-income families. It would reduce incentives for consumption, freeing up income to be saved, and also help reduce the federal deficit.
Sadly, there is little reason to be optimistic that Washington is about to embrace a pro-saving policy agenda. The budget deficit is going the other way, and the lack of political support for tax reform effectively quashes any immediate hopes for private-saving incentives.
In China, it will also take major policy initiatives to spark consumption-led growth. Actions are needed on two fronts -- the establishment of a social-welfare safety net to deal with job and income insecurity arising from reforms of state-owned enterprises; and the creation of new jobs, especially in the undeveloped services sector, to expand the purchasing power of China's enormous population.
The good news is that the Chinese leadership is focused on shifting its growth mix toward private consumption. Pilot projects already have been established setting up a social security system. And under the terms of China's WTO accession, the opening of domestic services to foreign investors in areas like retail and insurance is likely to accelerate over the next three to five years.
China's determination stands in sharp contrast to Washington's inattentiveness to saving initiatives. That could spell trouble. As Chinese saving is converted into consumption, it will have less surplus capital that can be used to fund America's saving shortfall. That means China will be reducing its support for the American consumer. And that would raise the odds of a hard landing for the dollar and the U.S. economy, with dire consequences for a still U.S.-centric global economy.
The U.S. and China need to get their saving agendas in order before it is too late for them -- and for the rest of the world.
Stephen S. Roach is chief economist at Morgan Stanley.