INTEGRAL ECONOMICS

Saving Themselves

Daniel O'Connor | Integral Ventures, LLC

With growing profits and relatively weak capital investmentover the past several years, businesses have become

net savers

in the global economy, a signal that the apparenteconomic recovery may be weaker than it appears.

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Saving Themselves

Daniel O'Connor | Integral Ventures, LLC

In the midst of declining rates of saving indeveloped economies, led by their respectivehousehold sectors,

it appears that businesses havebeen bucking the trend and actually increasing theirsaving. With growing profits and relatively weakcapital investment over the past several years,businesses have become

net savers

in the globaleconomy. As reported yesterday in

The Economist

,J.P. Morgan considers this one of the major factorsunderlying the conundrum of surprisingly low long-term interest rates in this era of

apparent

economicgrowth and monetary tightening.Beyond the usual suspects for these low long-termrates—a reduction in inflation expectations, animpending recession, and/or a migration to therelative safety of government bonds—the hypo-thesis gaining the most attention in recent monthsis Ben Bernanke's account of the "global savingsglut" in emerging economies.

Following a series of financial crises, theseeconomies slashed investment and swungfrom a combined current-account deficit of $93 billion in 1996 to a surplus of $336billion last year. Since bond yields shouldreflect the demand and supply for funds,this increase in net saving could indeedhave reduced yields. However, a new studyby economists at J.P. Morgan concludesthat in recent years an increase in savingby companies in developed countries hasbeen far more important than emergingeconomies' thrift.Over half of emerging economies' hugeswing from external deficit to surplus hadoccurred by 2000. However, American bondyields were roughly the same in that yearas in 1996; the big decline in yields is morerecent. Since 2000, the corporate sectorhas stood out. Companies in the maindeveloped economies have switched, as agroup, from being big borrowers to beingnet savers: ie, their profits exceed theircapital spending. The total increase incompanies' net saving in the past fouryears has been more than $1 trillion, 3% of annual global GDP and five times theincrease in net saving by emergingeconomies over the same period. J.P.Morgan estimates that about half of thegap between the current real yield onAmerican ten-year Treasury bonds and itsaverage since 1960 is due to this increasedcorporate saving.Firms have been net savers for the oddyear in the past, but a run of several yearsis highly unusual. Since 2002 Americanfirms have had an average net financialsurplus of 1.7% of GDP, compared with anaverage deficit of 1.2% of GDP in theprevious two decades. Corporate Japan hasrun an average surplus over the past threeyears of no less than 6.2% of GDP,compared with an average deficit of 2.3%in the 1980s and 1990s. In fact Japanesefirms have been in financial surplus since1994, desperately trying to reduce thedebts they built up during the bubbleeconomy in the late 1980s. Corporate cost-cutting—in both capital spending and newhiring—has been a persistent drag onJapan's growth rate. The good news is thatcorporate debt as a percentage of GDP hasfallen to the level of the mid-1980s, beforethe bubble really inflated. Now Americanand European firms seem to be following inthe footsteps of the Japanese, having beenforced to cut back on borrowing after abinge in the late 1990s.Of course, the standard logic of economic growthreveals that households should, on balance,be

saving

while business, on balance,

invest

, withthe dynamic interaction between the supply anddemand for funds being mediated by

interest rates

—the market prices of saving and invest-ment—determined according to the value functionsof households and businesses. Often in the midst of a recession in which value functions shift, house-holds choose to defer consumption in the present infavor of greater consumption in the future, with theresulting increase in saving funding businessinvestment in the additional capital that will, intime, yield the greater product for which

It is hard to imagine how even thecarefully crafted appearance of economic growth can be sustainedin the long-term without household-funded increases in businessinvestment that yield greaterproductivity in service of greaterfuture household consumptionbased, as it should be, on pastsaving rather than more borrowing.