What the world needs now is love – and more spending

What would be particularly welcome would be more spending by business enterprises on capital equipment. This lack of demand for capital expenditure, combined with a rising global savings rate, has created an abundance of saving that explains the exceptionally low-interest rate rewards for saving in developed economies. This glut of savings followed the global financial crisis (GFC) of 2008-09 that made managers more fearful to spend or lend, while additional regulations restricted their freedom to do so.

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The story of the global glut of savings can be told in a few pictures provided by the World Bank, shown below. However, the bond market in the US may be indicating an initial revival of the animal spirits of US corporations, who are being encouraged by lower tax rates and much more sympathetic regulators.

Figure 1 charts gross global savings as a percentage of gross global incomes (GNI). The share of savings of income has been rising steadily over the years. The GFC hit savings even harder than incomes (upon which savings depend), but since then savings have made an ever-larger claim on incomes (26% in 2015). The global savings rate was only about 21% of incomes in the fast-growing and higher interest rate world of the mid-1990s, and it has been on a generally upward trend since, as the chart shows.

Gross savings (savings before amortisation of capital that turns gross into net savings) are dominated by the cash retained by corporations. Households may save, but other households over the same period may be large borrowers and reduce the net contribution households make to the capital market. Most governments are net borrowers, borrowing even more than they spend on infrastructure, which is counted as saving.

As we show below in figure 2, the rate at which real capital – plant and infrastructure – has been accumulated has been trending in very much the opposite, lower direction. There was a brief surge in the rate of capital formation in 2005 – a boom year for the global economy – but this was not sustained and was but 24% of global incomes in 2016, compared to a higher global savings rate of 26%.

The SA situation is a little different. We have a low gross savings rate of less than 18% of GDP, but the cash retained by the corporate sector (including state owned enterprises) accounts for more than 100% of all gross savings. The household sector’s net contribution to gross savings flows is barely positive and the government sector is a net dissaver. We show the trends in the SA savings rate below. The profits from the gold booms of the 1970s and early 1980s were responsible for the high savings rates then.

SA cannot realistically hope to raise its savings rate significantly, but it can hope to raise the rate at which capital expenditure is undertaken. It can do this by reducing the risks of investing in SA, growing faster and attracting the savings to fund more rapid growth. Funding would come from the large pool of global savings anxiously seeking better returns, assuming the right incentives and protections are in place. There is, as indicated, no global shortage of capital – only of attractive investment opportunities.

The current rate of capital formation in SA is only slightly higher than the low savings rate – hence the small net inflows of foreign capital. The difference between any nation’s gross savings and capital formation is approximately equal to the net capital inflow and so to the current account deficit on the balance of payments. The item that balances the current account deficit (exports - imports + debt service) is the change in forex reserves – usually a comparatively small number.

SA could do with much faster growth, which would encourage more capital formation and attract the foreign savings needed to fund this growth. Higher corporate incomes would mean more corporate savings. It is slow growth that is at the core of SA’s economic issues, not the lack of savings. If we grew faster, both the current account deficit and capital inflows would be larger and the rate of capital formation higher. A larger capital stock would bring more employment and higher incomes for a more productive labour force.

The US, despite a relatively low and fairly stable savings rate (currently also around 18% of GNI, as in SA) is, given the scale of its economy, a large saver. The US economy is by far the largest drawer on the global capital market and the flow of global savings, as we show in figure 8. The US has been saving absolutely more recently, given this slower growth. Chinese savings have now overtaken US savings in absolute magnitude. Germany is another large saver, adding significantly to global savings in recent years, as we show below.

The Chinese are not only the largest contributor to global savings, saving an extraordinary 45% of their GNI (a rate that has in fact been declining, from above 50% previously), but they are also undertaking by far the largest share of global capital formation. They created plant and equipment – real capital – worth over US$5 trillion in 2016 or at a rate equivalent to 45% of GNI, similar to the investment rate – meaning that most of the Chinese savings were utilised domestically.

This raises a very important issue for the Chinese. Given the rate at which they save and invest in real capital, the realised growth in Chinese incomes must be regarded as poor, even at a rate of about 7% a year. It suggests that much of the capital formed is still unproductively utilised. The full discipline of Western-style capital markets is surely something still to be introduced to China, to improve returns on savings. But for all the relative inefficiency of Chinese capital, the sheer volume of Chinese capital formation has made it the dominant force in the market for the minerals and metals that are used to create capital goods.

In figure 8 below, we show how the US dominates the demand side of the flows through global capital markets and how the thrifty Europeans dominate the supply side. These trends that made US economic actors the dominant utilisers of global capital are predominantly a post-2000 development. It is these capital flows that drive the US dollar exchange rate and by implication all other exchange rates. Trade flows react to exchange rates, rather than the other way around. This is also the case for SA, with one important difference: whereas foreign trade for the US economy is equivalent to about 25% of GDP, in SA it is about 50% of GDP.

The flows of savings into the US have not only moved the dollar, they have moved interest rates. Perhaps the best measure of the global rewards for saving are the real rates of interest offered by an inflation-linked bond issued by the US Treasury. Such a bond may be regarded as free of default and inflation risk. The risks of inflation are reflected in the yield on a vanilla bond. In figure 9 below we compare the yield on a 10-year US Treasury bond and its inflation-protected alternative with the same duration. The nominal and real yields have both trended lower. The vanilla Treasury bond was offering over 5% in 2005, now the yield for a 10-year loan provided by the US government is about 2.9%. Real yields were over 2% in 2005-06 and they are now about 0.7% – after a period of negative returns in 2012-2013. More importantly, these yields have been rising in 2018, indicating a small degree of increased demand for capital. The real and nominal yields however remain very low by historic standards. Normality – that is any sustained higher move in global growth rates – must mean higher real yields. Higher nominal yields will also depend on how much inflation comes to be added to real yields.

In figure 11 below, we show the difference between these nominal and real interest rates. These differences represent the extra compensation that bond investors receive for taking on inflation risk. It is an objective measure of inflationary expectations: the more inflation expected, the wider the spread between nominal and real yields. Excluding the impact of the GFC, this spread or inflation expected has remained between 2% and 3%. It’s important to recognise that these inflationary expectations remain subdued, despite a recent increase.

Equity investors, as well as bond investors, must hope that inflation expectations remain subdued enough to hold down nominal interest rates, even as real yields rise to reflect a stronger global economy and a revival of capital formation. Low inflation, with faster growth, is an especially favourable scenario for equity markets.