Abstract

The recent turbulence in global stock markets has added to the problems facing monetary policy authorities worldwide. The analysis in this contribution suggests that the core of the problem is the bust of an over-investment cycle in China. The overinvestment had been propelled by a self-reinforcing cycle of higher investment and higher growth. But this cycle is now operating in reverse: lower investment leads to lower growth and to lower growth expectations. The credit expansion that accompanied and financed the over-investment will make the bust worse, but it does not in itself constitute the root cause of the problem. It will take some time to resolve the savings-investment imbalances in China because they involve both stock and flow problems. The stock of investment has overshot its medium-term equilibrium level and the flow supply of savings remains at extremely high levels. These imbalances have such a strong global impact because China now accounts for 28% of global savings and investment (similar to the US and the euro area combined), and the looming imbalance within China is likely to be larger than has ever appeared in any other country experiencing excess savings.

In short, the slowdown in China today is a reflection of an underlying ‘real’ domestic investment/savings imbalance that is so large that it will impact the global economy. But this imbalance is unlikely to be solved by monetary policy. The best that can be hoped for is that the central banks will manage to ‘paper over’ some of the unavoidable symptoms in credit markets.