How the US is ‘pushing on a string’

As both the most technologically intensive economy in the world and its largest consumer, the US has carried the burden of global growth for the past fifteen years. The trouble is that the US is still living with the legacy of this spending spree and continues to grapple with a secular investment overhang in the form of unused manufacturing capacity and a personal spending overhang reflected in a negative savings ratio.

Last week (see: How will the US housing slump affect stocks?) we pointed out that, in the US, a decline in consumer spending would go hand in hand with a decline in business investment. These overhangs are largely to blame for making the US economy generally unresponsive to traditional monetary stimulation when the forthcoming slow down gets underway in earnest. This is what Keynes meant by the phrase “Pushing on a string”. Note, however, that the rest of the world, particularly Japan and Europe, did not participate in the 1990’s spending spree to anything like the same extent. As a result they do not face the same degree of overhang. As a consequence economic recovery in these regions should follow a more normal course, albeit at a tentative pace.

Saving rates: confidence in the future

Changes in savings ratios have a profound impact on growth and earnings. Typically, the first sign of monetary policy effectiveness lies in a change in the savings ratio, not an improvement in growth. While US savings are showing signs of rising and are, we suspect, likely to be unresponsive to the forthcoming period of monetary stimulation given already vast levels of personal indebtedness, savings ratios in Europe, Japan, Asia and critically China, are beginning to fall. This represents a sign of confidence in the future and room exists for savings ratios to keep falling.

Impact on Global Growth Shifts in global savings rates have a lot to do with changes in global growth, leading the way in most cases. Savings rates are (ex USA) now falling, indicating stronger future growth, at the same time that the sustainability of current growth rates are being called into question. This is paving the way for a major growth surprise, but not in the
West…in Asia.

Saving rates: Impact on Corporate Earnings

Shifts in savings ratios have also had a lot to do with long-term trends in world earnings growth. Since savings represent the difference between consumer spending and consumer income and since consumer income represents a company’s labour cost while consumer spending is a company’s revenue, changes in savings rates represent a very loose proxy for corporate profit margins. This, in addition to the direct impact of changes in savings ratios on spending, means that changes in savings ratios exert a strong influence on corporate earnings.

Saving rates: Impact on Equity Returns

For similar reasons, changes in the savings ratio also influences equity returns. Of course, equity returns also influence savings ratios via the wealth effect so this relationship tends to be self-reinforcing. With global equity prices rising, while global savings ratios are falling, the self-reinforcing trend is exerting a positive influence in Europe and Asia, a less benign influence in prospect for the US and UK?

By Jeremy Batstone, Director of Private Client Research at Charles Stanley

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