Thursday, March 09, 2006

Does the Chinese Save Too Much?

Morgan Stanley chief economist Stephen Roach is usually one of the more insightful among prominent economists, yet his Fortune essay "The U.S. and China's savings problem" were not particularly good.

I basically agree with him in his analysis of the U.S. savings shortfall, except for his call for a consumption tax as a partial solution to it. A consumption tax would, contrary to his assertions, not improve the incentive for savings even assuming for the sake of the argument that the entire burden of the tax falls on consumers. The reason is that the ultimate end of savings is future consumption. And a consumption tax would not only punish current consumption, it would punish equally the future consumption which savings are meant to enable. Only assuming that the consumption tax would be reduced in the future or that people are planning to emigrate would it have any such effect, but neither of these seem plausible for the vast majority of Americans.

More serious are the problems in his analysis of China's "excess savings". How could you have "excess savings"? It is possible to over-save of course, if you save so much that you consume so little that you cannot survive or at least that you feel greater uncomfort with your current consumption being too low, then with the alternative of reducing future consumption.

But while the still relatively poor Chinese would presumably be quite anxious to increase their low level of current consumption, there is no evidence that they really feels this is more important than increasing their future income by saving. After all, unlike another high-saving majority ethnic Chinese country, Singapore, China does not have a forced savings scheme, so the high savings rate is a voluntary choice, meaning it really reflect their current time preference .

But what about Roach's contention that the trade surplus resulting from the high savings rate sparks asset price bubbles in both China and America? This is however not really true as it is not the high savings rate but the Chinese central bank's purchases of U.S. government bonds that causes these problems. That in turn is mainly a function of how the Chinese government attempts to only gradually raise its exchange rate, something which entices foreign speculators to move capital into China to benefit from the certain future appreciation of the yuan. This capital inflow in turn forces the Chinese central bank to accumulate dollar assets.

While it is true that the high savings rate in China would likely raise asset price both in China and elsewhere even in the absence of the distortions created by the fiat money system, it would in that case not be a problem. Lower interest rates and thus higher asset prices that reflect lower time preference are unlike the lower interest rates and higher asset prices caused by inflationary credit not unsustainable and do not create any distortions. It will in fact help increase growth worldwide.

The high Chinese savings rate is good -not bad- for the world economy. What is bad is the distortions created by the policies of both the American and Chinese central banks as well as Bush's reckless deficit spending.


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