Mon, Dec 13, 2004 page9

• Low US interest and savings rates don't jive with big deficits

  • By Mike Dolan / REUTERS
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  Have Asia's central banks lulled Americans into a false sense of security?

  While the collapse in US household savings rates over the past decade to near zero make it appear at first as if American consumers have discarded all caution, economists reckon they are responding rationally to increased wealth.

  Housing and equity markets have done workers' saving for them, many argue, freeing families to spend all their income.

  But some experts fret that households have not yet rediscovered prudence after what will likely prove an exceptional decade of asset price gains, particularly given looming economic strains from an aging population.

  The problem now, they say, is the traditional economic mechanisms -- such as rising borrowing costs -- that would encourage a healthy and gradual normalization of savings behavior have been neutered.

  Underpinning 10 years of heavy household borrowing and asset price gains has been sliding long-term interest rates for mortgages, consumer finance and corporate borrowing.

  Ten-year rates are half what they were 10 years ago while the broad S&P 500 index of US stocks has almost tripled. House prices have jumped some 40 percent since 2000.

  While balanced federal budgets and deep Federal Reserve interest-rate cuts justified the drop in long-term interest rates for much of that period, levels look more puzzling now in light of ballooning government deficits and rising Fed rates.

  BOND BUYING A PROBLEM

  What worries some economists is that surging US government bond holdings by foreign central banks, particularly in Asia, may keep long-term interest rates artificially low.

  Efforts by many foreign governments to guard exports from a sliding dollar have swelled central bank dollar purchases parked in US bonds by over US$200 billion this year alone.

  Some have estimated these purchases have depressed long rates by up to 1.5 percentage points, which has helped keep Americans borrowing and spending furiously just as asset prices are leveling off and they should be building retirement reserves.

  "If you have central banks who buy huge chunks of government debt, they in some sense short-circuit this mechanism," said Thomas Laubach, a Washington-based Fed economist temporarily at the Paris-based Organization for Economic Cooperation and Development.

  "This is one explanation why we now get at the same time a very large budget deficit, very low household savings and hence a very large current account deficit but low interest rates," Laubach said.

  If, as Fed Chairman Alan Greenspan says, this pace of central bank accumulation of dollar assets is unsustainable, then there is a mounting risk of a spike in long-term rates.

  CONSPICUOUS CONSUMPTION

  The personal savings rate -- or proportion of money US workers save from disposable incomes -- has been sliding for up to 20 years but has fallen of a cliff since 1995, from about 6 percent to near zero this year.

  October's savings rate was the second lowest on record at just 0.2 percent, which despite some statistical quirks still means households are consuming virtually all their income.

  The concern for the US and world economy is whether this comparative abandon -- savings rates in Europe are well above 10 percent -- suddenly goes into reverse.

  And a sharp drop in US household spending, which almost single-handedly supported both the US and export-dependent Asian and European economies after the dot.com stocks crash of 2000, could presage a worldwide recession.

  A low savings rate is not a problem in itself, say some economists, as long as capital gains on existing investments continue apace. Savings behavior merely reflects economic success, wealth creation and job security.

  And zero is not necessarily a magic number -- the savings rate could in theory go negative. But that would assume the asset price gains of the last 10 years roll on uninterrupted.

  UNREALISTIC EXPECTATIONS

  The question for Richard Berner, chief US economist at Morgan Stanley, is whether expectations of double-digit annual percentage gains in housing and equities are realistic.

  "I think we're now living in a world of single-digit returns," said Berner. "When those [inflated] expectations are frustrated and people realize the markets won't always do their saving for them, I think you'll see savings rise again."

  Other economists see the savings rate drop since 2000 as a result of fiscal deficits coupled with super-cheap Fed money aimed at revitalizing a recession-threatened economy.

  They say the current conundrum is a price worth paying.

  "What we've done is replace an acute problem with a chronic problem," said Bruce Kasman, chief economist at JPMorgan.

  "Acute problems can kill you, chronic problems cause you pain," he added. "I think it was a good-trade off, but it certainly wasn't the trade off that solved all our problems."
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