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Most bank wholesale funding comes, directly or indirectly, from the current-account surpluses of the savings-exporting countries. China, Japan, Germany, Saudi Arabia, Kuwait and the others are the major source of the ‘hot money’ that has now been scared away, and will no longer finance bank holdings of structured securities. Their surpluses provided a large share of the cash deposited with banks through shortterm money markets (this can happen in many ways, through sale and repurchase or ‘repo’ lending, through purchase of asset-backed commercial paper, by investing in money market mutual funds or, most directly, by holding bank deposits).
There are other linkages as well. Government, companies or banks from the surplus countries also hold some bank-issued securities directly (shares, bonds or mortgage-backed and other structured securities). In addition to this direct funding surplus, country savings are invested in many non-bank securities, for example equities, government bonds, corporate bonds or short-term bills and commercial paper. This pushes down their returns and makes them less attractive.
As a result there is displacement of other domestic funds, from companies, insurance companies and pension funds into both short-term funding of bank portfolios through the money markets and bank- issued securities.
This pattern of world savings and investment, with high-saving countries, including Germany and Japan and the emerging market manufacturing exporters and resource exporters such as China, Russia and Saudi Arabia, lending large sums to the high-consuming countries has been a feature of the global economy for several years. Instead of shrinking, these imbalances have risen over the years.
Increasing global trade has opened up tremendous opportunities for growth. The rapidly growing economies of south-east Asia, including South Korea, Malaysia, Taiwan and Thailand, have all benefited, and, more recently, so have India and China. These rapidly growing economies should be the ones with the most attractive business investment opportunities. Yet the world’s savings are being channelled mostly from these fast-growing economies to mature developed economies, ones where the prospects for productive investment are relatively poor.
Why have savings been channelled to governments and consumers in the West rather than to productive investment in the emerging markets? One reason is that returns to investment in emerging markets are surprisingly low, due among other reasons to weak enforcement of property rights in the courts and bankruptcy laws that provide little protection to lenders.
A further part of the answer is the different operation of their banking systems. Banks in the United States, the United Kingdom and other developed countries have been extremely skilful in persuading households to borrow freely in order to finance both house purchase and general consumption. Meanwhile banks in emerging markets have been much less successful at finding opportunities to lend in their own countries, either to companies or to individuals. This reflects both much stronger social security systems in Western countries (households worry less about saving for old age) and more effective systems of credit referencing and credit scoring to identify creditworthy borrowers – systems that have been developed over many years.
The export of savings has also been encouraged by the fiscal and monetary and exchange-rate policies in the exporting countries, for example in China, where the exchange rate has been maintained at a very competitive level to encourage export growth.
This borrowing, or ‘capital importing’, has not just been used for household consumption. It has also financed government expenditures, including, for example, the large increase in military expenditure, especially in the United States, because of the campaigns in Iraq and Afghanistan. Companies and governments have borrowed directly from overseas investors. But the most important destination for this flow of savings has been households, borrowing money from banks through mortgages, credit cards and other forms of personal credit, in turn financed on wholesale funding markets.