As both the most technologically intensive economy in the world and its largest consumer, the US has carried the burden of global growth throughout the 1990's and 2000's.
The trouble is that, even amidst the cyclical economic boom, the US continues to live with the legacy of earlier spending sprees. It also has to grapple with a secular investment overhang in the form of unused manufacturing capacity - the consequence of a dramatic loss of competitiveness, particularly to Asia.
The US personal savings ratio remains in negative territory. When monetary policy is stimulative, such legacies tend to make an economy fairly unresponsive to monetary stimulation. This was why the US economy struggled to make much headway despite such stimulation imparted when the Fed Funds Rate was cut to just 1.0% in 2002.
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Belatedly, the US economy got the bit between its teeth again and is now growing strongly. Despite a now prolonged period of monetary tightening, consumers continue to spend on a heroic scale, the savings ratio remains stubbornly in negative territory, and manufacturing spare capacity is increasing.
Changes in savings rates 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 in an impact on growth. Following the most aggressive period of monetary tightening in twenty five years, the savings ratio remains in negative territory, suggesting that consumers are probably indulging in a tidal wave of mortgage equity withdrawal purely to support their desire to have everything now!
This spending is helping to keep activity levels higher than they would normally be, but a serious problem is being stored up and the longer prevailing conditions persist, the worse the downturn will be when it happens.
Changes in global savings rates are heavily influenced by changes in monetary policy. Typically, easing produces lower savings ratios and tightening produces higher ratios. Over the period 1999-2000 global monetary tightening led to a universal rise in the savings ratio and slower growth. The period 2000 2003 was generally characterised by easy monetary policy and Western savings ratios fell (while remaining robust in the Far East).
More recently, monetary policy has been tightening, yet global growth remains strong as Western consumers have continued to spend heavily and as demand from booming Asian economies has increased.
We see this condition as being less about traditional relationships breaking down and more about consumers, particularly US consumers (given their position at the hub of Western demand) teetering precariously along an imaginary tightrope suspended between the Federal Reserve building and Shangri-La!
The savings ratio: impact on global growth
We firmly believe that shifts in global savings rates still have a lot to do with changes in global growth. Just because savings ratios have fallen and growth is booming doesn't mean that it will always be that way! The environment is being created for a major growth shock in due course.
The savings ratio: impact on corporate earnings
Shifts in savings ratios have also had a lot to do with major 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 rates exert a strong influence on corporate earnings.
The savings ratio: impact on equity returns
For similar reasons, changes in savings rates also influence equity returns. Of course, equity returns also influence savings rates via the wealth effect ,so this relationship tends to be self-reinforcing. With global equity prices rising while global savings rates are not, this self-reinforcing trend has been exerting a positive influence thus far.
By Jeremy Batstone, Director of Private Client Research at Charles Stanley
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