The world is experiencing an unprecedented glut of savings,
driving down real interest rates. It is a good time to borrow
rather than lend, and to buy equities rather than bonds. This has
implications for central banks, corporations and individual
investors.
China is investing $3 billion, a tiny fraction of its $1.2
trillion of reserves, in Blackstone, a U.S. private equity company.
More such equity investments will surely follow. India, OPEC
members, and other developing countries with large foreign exchange
reserves should emulate China’s strategy.
Foreign exchange reserves are typically invested in bonds of G-7
countries, above all in U.S. Treasury bonds. Former Treasury
Secretary Larry Summers estimates that developing countries are
holding more than $2 trillion of reserves in excess of their needs
to combat currency volatility. If this excess is invested in
equities rather than bonds, the resultant gains could exceed $100
billion.
In the 20th century, developing countries struggled to
accumulate enough forex reserves for bare safety. They had low
savings rates, and needed funds from rich countries to meet
investment needs. The two-gap theory of development economics
portrayed poor countries as suffering from a chronic savings gap
and trade gap.
But today things have changed dramatically. Several developing
countries are running large current account surpluses (representing
an excess of savings over investment). So they are accumulating
surplus dollars. China has the biggest surplus of $1.2 trillion,
but other developing countries put together have accumulated almost
as much. And oil exporters are accumulating reserves at the rate of
$300 billion per year.
Rapid growth leads to high savings rates: people save a large
fraction of additional income. In India, GDP growth has accelerated
from 6% to 9%, lifting the savings rate from 23% a decade ago to
33% today. China’s savings rate is a dizzy 55%. Not even the
investment boom in Asia can absorb these huge savings, which are
therefore put into U.S. bonds.
When a poor country buys U.S. bonds, it is in effect lending to
the USA. It is paradoxical for the poor to lend to the rich,
especially at depressed interest rates. Chastened, developing
countries are now creating special financial vehicles to park part
of their excess reserves in equities, real estate, and hedge funds.
Singapore has led this fashion, and others like Korea, Qatar, Abu
Dhabi, and India are following suit.
However, equities and real estate have skyrocketed globally.
China’s stock market has quadrupled in two years, with a
ridiculously high price-earnings ratio of 50. Property prices have
tripled in some Asian cities in five years. The saturation of
conventional asset markets explains why individual investors as
well as governments are now turning to private equity funds, the
new stars of the financial firmament. Private equity funds borrow
to finance acquisitions, hoping to sell these after reorganization
at a profit. This has proved spectacularly profitable in recent
years, yielding returns of up to 25% per year. Private equity funds
are now big enough to contemplate taking over any company in the
world, even General Motors or Exxon.
Is this the right time for developing countries to switch from
the safety of bonds into private equity? Are they wise
diversifiers, or suckers entering a bull market at its peak? The
answer depends on whether the savings glut will continue.
I believe it will. Globalization and new technology are creating
steady, sustainable increases in world productivity. This should
translate into exceptionally high growth for the world economy,
leading to exceptionally high savings. The U.S. is running a record
trade deficit with developing countries, underpinning the savings
surplus in those countries.
The current global upswing will not last forever. It has lifted
even sub-Saharan Africa to 6.3% GDP growth, and nobody believes
that is sustainable. Sooner or later, a global downswing will come.
GDP growth will slow down, and so will excess savings. At that
point equity markets will fall, and highly leveraged private equity
funds (and corporations and private investors) could be in
trouble.
Yet in the new era of globalization and technical change, the
average rate of global savings should be much higher through the
ups and downs of the business cycle. In which case borrowing to buy
real assets will continue to be a good long-term strategy, despite
attendant risks.
Top Indian and Chinese companies certainly think so, and are
buying Western companies in leveraged deals. Tata Steel recently
acquired Britain’s Corus for $13.2 billion, of which two-thirds
will be borrowed. Birla acquired Novelis for $6 million, of which
$2.4 billion will be borrowed. Global financiers are happily
financing Indian minnows to take over Western whales. They believe,
implicitly, that the savings glut is here to stay.
