Global Economics Paper No: 202. Current Accounts and Demographics: The Road Ahead. Dominic Wilson and Swarnali Ahmed

Transcription

1 Global Ecoomics Paper No: Goldma Sachs Global Ecoomics, Commodities ad Strategy Research at Curret Accouts ad Demographics: The Road Ahead Demographics are a maor determiat of log-term curret accout treds. Coutries with a high proportio of prime savers (those aged betwee ad 9) are more likely to ru curret accout surpluses. We show how demographic shifts have iflueced global curret accout treds i the past years, ad what they imply for the ext years ad beyod. We have see some rebalacig from the extremes i 8 but the process is ot yet complete. Demographic shifts poit to a cleaer split betwee emergig markets (mostly i surplus) ad developed markets (mostly i deficit) i the future tha is evidet i the curret, more complicated picture. Emergig markets (EM) could cotiue to led to developed markets (DM) o average. Demographic forces may help keep global real rates low. The developmet of EM capital markets may be importat i offsettig demographic pressures for capital flows from the EM to the DM world. Importat disclosures appear at the back of this documet Thaks to Jim O Neill, Kevi Daly, Stacy Carlso, Tim Toohey, Be Broadbet ad Mike Buchaa for helpful commets Domiic Wilso ad Swarali Ahmed August,

2 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper Cotets Demographics ad Curret Accouts: Key Results A. The impact of demographics o curret accouts ad capital flows B. A demographic perspective o curret imbalaces Box: Why the World is More Complex Tha a EM/DM Split C. Demographic pressures o curret accouts D. Demographics ad the savigs glut E. Implicatios of the shifts ahead 7 Why Demographics Affect Savigs ad Curret Accouts 7 Box: Life-Cycle Savigs ad Liks betwee Demographics ad Capital Flows 8 A Demographic Model of Curret Accouts 9 A Perspective o Curret Imbalaces Lookig Ahead: Towards a More Uiform EM/DM Split Box: Curret Accout Pressures i the Maor Markets A Demographic View of the Savigs Glut Box: Global Versus Local Drivers of Real Iterest Rates ad Asset Prices 7 Offsets to These Pressures: Sustaiability, Capital Markets 8 Implicatios for Markets ad Policy Appedix I: Demographic Treds ad the Prime Savig Populatio Appedix II: Modellig Curret Accout Imbalaces Bibliography 9 Recet Global Ecoomics Papers Issue No: August,

3 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper Curret Accouts ad Demographics: The Road Ahead Over the past few years, global capital ad curret accout imbalaces have played a maor role i a umber of importat macro debates. The perceptio of usustaiable imbalaces betwee the US ad the rest of the world; the uusual flow of capital from the emergig (EM) to the developed world (DM); ad the so-called global savigs glut ad its impact o real iterest rates have all bee key forces that may have played a role i the recet global recessio. We have focused o the loger-term drivers of shifts i the world ecoomy, particularly i our work o the BRICs ad the N-. Demographic treds are a key compoet of that work. As we show here, demographic shifts also play a importat role i determiig log-term treds i global curret accout balaces ad the flow of global capital. A ecoomy s curret accout is literally equal to its et savig (total savigs mius total ivestmet). So a tedecy to save more across a ecoomy will traslate ito pressure for curret accout surpluses ad a flow of capital to other coutries. Because people s savigs behaviour is geerally differet at differet poits i their life, the relative age structure of a ecoomy plays a sigificat role i explaiig their borrowig ad ledig to the rest of the world. Usig a model that liks demographics, growth ad curret accouts, we illustrate here how demographic shifts have drive global curret accout treds i the last years, ad what they imply about curret imbalaces. We the look at how the ifluece of demographics over the ext years ad beyod may affect curret accout positios. Importatly, it is the portio of a populatio of prime savig age (o our estimates, roughly -9 years old) that matters most, ad ot the size of the workig age populatio, as is commoly discussed i policy debates. That group is still growig globally, eve i the developed world, ad will likely rise i most of the EM world, icludig Chia, for at least two decades. Iterestigly, the commo ituitio that Chia is demographically more like a developed market tha a typical emergig market is oly true with respect to workig age populatio. I terms of prime savig dyamics, Chia is more like a EM tha a DM ecoomy. Our results cofirm that the recet situatio ivolved what look like excessive curret accout surpluses i some of the oil producers, ad i parts of Norther Europe ad Chia, with excessive deficits i some of the well-kow offeders, such as the US, Greece ad Spai. Those imbalaces have arrowed substatially i the past two years but are still visible to a degree. However, demographic treds have also bee ifluecig what is a appropriate balace, ad will likely cotiue to ifluece chages i the future. I particular, demographics have geerally reiforced a shift towards greater surpluses i some large EM coutries ad deficits i some DM ecoomies, eve if today s reality is poorly captured by a simple EM/DM split (see box o page ). Ad although that dyamic has overshot, demographic proectios suggest that pressure for capital to flow from EM to DM far from beig a aomaly may be more persistet tha people realise ad may become more uiform over time. Demographic shifts play a importat role i determiig log-term treds i global curret accout balaces ad the flow of global capital Demographics have geerally reiforced a shift towards greater surpluses i some large EM coutries ad deficits i some DM Pressure for capital to flow from EM to DM may become more uiform over time The rise i prime age savers globally may also have played a importat role i the story of the savigs glut, puttig dowward pressure o global real iterest rates. Here too, the demographic uderpiigs of that story could itesify i the ext - years. Pereial worries about the impact o asset markets of dis-savig by US (ad other OECD) retirees also eed to be see i this global cotext, both because curret accout shifts may provide a safety valve ad because global pressures are likely to move i the other directio. As with our work i may of these areas, the global picture looks quite differet to the (usually better-kow) US or OECD story, give that the importace of o-oecd ecoomies cotiues to icrease. Issue No: August,

4 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper % Total Populatio 8 8 Number of Prime Savers i Developed Coutries Will Peak before Emergig Markets Prime Savig Populatio (%, Share of Populatio Aged -9) DM EM World (rhs) % Total Populatio Source: US Cesus Bureau, GS Global ECS Research Calculatios. Coefficiets* Demographic Profile of Net Savig Age Distributio Coefficiets* CA Surplus CA Deficit PRIME SAVERS Age profile *The age-distributio coefficiets represet the chage i curret accout associated with a uit chage i the correspodig log populatio age shares.. Demographics ad Curret Accouts: Key Results We start by highlightig five key aspects of the topic before explaiig i more detail the uderlyig model ad the outlook that it geerates: A. The impact of demographics o curret accouts ad capital flows Demographics are a maor determiat of log-term treds i curret accout balaces. Despite the popular otio that curret accouts are determied by relative growth prospects, demographics seem to play at least as large a role. The evidece suggests that those ecoomies with a large proportio of prime savers a rage we idetify as aged betwee ad 9 are more likely to ru curret accout surpluses. Ecoomies with a large proportio of prime savers (aged -9) are more likely to ru curret accout surpluses These shifts i the group of prime savers are ot idetical to the more commoly followed story of shifts i the workig age populatio. Most strikig is that Chia whose workig age populatio is widely kow to be ageig faster tha those of most EM markets is much less distictive i terms of prime savers ad looks more like a typical EM tha a DM. B. A demographic perspective o curret imbalaces Prior to the global crisis i 8, the world s curret accouts appear to have drifted a log way from their log-term demographic achors. Covetioal wisdom that the US, the Souther Europeas ad several EM ecoomies had deficits that were too large, while Chia, Japa, several Norther Europea ecoomies ad the oil producers were ruig excessive surpluses looks fair relative to what slow-movig demographic ad growth treds would say was appropriate. We have see sigificat progress i reducig these imbalaces ad are closer to the uderlyig equilibrium predicted by our model. But these shifts take the world oly partly back to the levels that uderlyig demographics suggest. Although there are excessive surpluses ad deficits withi both the EM ad DM uiverses, EM surpluses o average have looked too large. That said, demographic pressures have drive larger surpluses i EM ecoomies ad validate the otio that they should be ruig surpluses ow. What looks odd about the world is ot that EM coutries have let to the developed world o average, but the scale of that ledig. The world s curret accouts appear to have drifted a log way from their log-term demographic achors Issue No: August,

5 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper Why the World is More Complex Tha a EM/DM Split Throughout the presetatio of our results, we refer to some of the key treds i the Emergig Market (EM) ad Developig Market (DM) groups o aggregate. I part, this is out of coveiece it is too difficult to talk coheretly about chages across a very large rage of coutries. Partly this is because, as we show, the uderlyig chages o the demographic frot ad their implicatios for categories are quite differet across these two broad categories. We also take this approach because some of the importat puzzles of global capital flows have historically bee framed i this way i the broad debate. It is true, for istace, that there has bee a proouced shift from EM coutries borrowig o average from DM coutries to a situatio i which they led. Ad the improvemet i curret accouts across the EM uiverse sice the late 99s has bee relatively broad-based, eve for those that have remaied i deficit. It is also true that this is more of a puzzle to covetioal ecoomics tha the imbalaces withi the DM or EM worlds. Still, the risk of usig broad groupigs is that they obscure importat differeces that cut across them. That is certaily the case i the discussio of the curret situatio of global borrowig ad ledig. While EM coutries are ledig to DM coutries o average, the patter of global capital flows is ot best described i this way. As our research o the topic ofte ackowledges ad the chart below shows, it is better to thik of a group of surplus coutries that icludes Germa, Japa, Switzerlad ad the Nordic ecoomies i the developed world, alogside large parts of Asia icludig Chia ad the oil producers. Ad these are balaced by the US, Spai, Greece ad the UK, alogside Idia, parts of Easter Europe ad Lati America i the EM world. I may cases, surplus ad deficit coutries have persistetly bee i deficit or i surplus. As a result, while we refer to the EM ad DM groupigs, it is importat to focus too ad our model does o the broad differeces across them. Although we cautio agaist classifyig the curret situatio ito these buckets too eatly, oe key reaso why we thik it is still importat to referece them is that the demographic story we tell here is more uiform withi the DM ad EM groups (see Appedix I). Ad this serves to push them away from the curret, more complicated mix ad towards a more uiform split over time. I fact, as we show later (see page ), based o the results of our model, demographic profiles suggest that all of the BRICs ad N- (bar the most developed, Korea), icludig those that have bee systematically i deficit, could potetially be i surplus i years time, whereas all of the largest developed markets, icludig those i surplus today, could potetially be i deficit. As a result, the characterisatio of EM ledig to DM may become icreasigly apt, eve if it is ot so today. EM/DM Split Vague i 9 But Becomes More Distict with Time EM DM Malaysia Norway Switzerlad Swede Chia Korea Germay Russia Bagladesh Japa Ira Idoesia Mexico Uited Kigdom Brazil Frace Idia Turkey Egypt Caada USA New Zealad Italy Australia Spai Pakista Vietam Source: IMF Curret Accout i 9 (Actual) EM DM Ira Russia Switzerlad Turkey Chia Brazil Korea Egypt Idoesia Norway Vietam Malaysia Idia Bagladesh Pakista Italy Germay Spai Swede Japa Caada Mexico Frace Uited Kigdom USA New Zealad Australia Curret Accout i C. Demographic pressures o curret accouts Demographics hit at fresh curret accout shifts i the ext years. Demographic treds push towards larger surpluses across a broad group of EM coutries (icludig Chia) ad larger DM deficits (icludig the US), because the proportio of EM prime savers rises more ad peaks later tha for DM. Because the world is startig from a poit where several large EM ecoomies are ruig excessive surpluses ad several large DM Issue No: August,

6 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper % GDP Curret Accout Imbalaces Have Narrowed But Not Completely Excessive CA Surplus Swede Norway Philippies Switzerlad Netherlads Chia South Africa Germay Japa Korea New Zealad Mexico Hog Kog Australia Uited Kigdom Idia Italy USA Frace Spai Brazil Caada Russia Turkey Vietam GS Forecasts Mius Model Predictio () Excessive CA Deficit EM DM EM Ra Excessive Surplus ad DM Excessive Deficit From Late 99s Model Predictio Mius Actual coutries deficits are excessive, those shifts eed to be balaced agaist a tedecy for the world to move further back to the uderlyig equilibrium. If both developmets occur, this could blut the demographic pressures betwee DM ad EM groups. These forces potetially show the biggest shifts withi DM ad EM groups, with big declies i the maor surplus groups (the oil producers, Chia, Japa, Germay) matched by arrower deficits i Idia, Brazil, Turkey, Greece ad Spai. With the exceptio of Chia ad the oil producers, most EM ecoomies could potetially see improvig curret accout positios. These shifts could push towards a cleaer split betwee EM (mostly i surplus) ad DM (mostly i deficit) tha is the case i the curret, more complex picture. I particular, demographic pressures could see the largest DM surplus coutries (Japa ad Germay) move ito deficit ad the largest EM deficit coutries (Brazil, Idia ad Turkey) move ito surplus. D. Demographics ad the savigs glut Demographic forces may have played a importat role i the savigs glut ad may have cotributed to fallig global real iterest rates over the last years, as the proportio of prime savers globally has rise over that period. Most EM ecoomies could potetially see improvig curret accout positios......with a cleaer split betwee EM ad DM tha is curretly the case 7 USD Bil DM Both EM Surplus ad DM Deficit Will Cotiue to Icrease (i Level Terms) EM BRICs N- Chage i Curret Accout From 9 to Level (7 USD Bil.) (RHS) Issue No: Germay USA Japa Chia % Total Populatio Share of Prime Savig Populatio i DM Will Start to Shrik i the Next Years DM Prime Savig Populatio (%, Share of Populatio Aged -9) DM Curret Accout (Model Predictio, RHS) Source: US Cesus Bureau, GS Global ECS Research..... August,

7 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper % Total Populatio EM Prime Savig Populatio Likely to Peak by EM Prime Savig Populatio (%, Share of Populatio Aged -9) EM Curret Accout (Model Predictio, RHS) Source: US Cesus Bureau, GS Global ECS Research % Demographic Pressures Towards Higher Savig % May Have Helped Push Real Rates Lower GDP Real Log Term Global Bod Yield -. Model Predicted Global Net Savig Pressure (Iverted, RHS) The global pool of prime savers is expected to keep risig, ad peak i years. As a result, the ex ate tedecy will be for more, rather tha less, et savig globally, ad the savigs glut (ad lower real rates) may become a more persistet feature of the world tha may thik. E. Implicatios of the shifts ahead Eve after recet progress, currecies ad demad profiles may eed to move further to support further rebalacig across the maor ecoomies. Real rates may stay lower for loger globally tha geerally expected, ad may fall further The likely ogoig flow of capital from EM ad the demographic compoet of the savigs glut story suggest that real rates may stay lower for loger globally tha geerally expected, ad may eve fall further. While local markets i DM could see more pressure (ad DM real iterest rates rise relative to EM rates), icreased EM savigs could remai a importat part of fudig DM dis-savig as the populatio ages, mitigatig log-stadig worries about the impact o asset markets of ageig populatios i developed markets. Demographic pressures for capital flows make it eve more critical to improve fiacial/regulatory ifrastructure to hadle large cross-border flows. The developmet of EM capital markets a cosistet theme i our research may be importat i offsettig the uderlyig demographic pressures for cotiued capital flows from the EM to the DM world. Why Demographics Affect Savigs ad Curret Accouts Curret accout imbalaces ad capital flows are at the heart of may of the big macro issues of today. Was there a savigs glut globally, as a result of a highsavig group of ecoomies drivig dow global real rates or cotributig to the credit bubble? Has the US bee borrowig too much or Chia too little? Is the curret patter accordig to which EM ecoomies led to developed ecoomies either sustaiable or appropriate? Will the ageig populatio ad dis-savig by baby boomers push asset markets lower, as some have feared? The developmet of EM capital markets may be importat i offsettig the uderlyig demographic pressures for cotiued capital flows from EM to DM To aswer these questios, we eed a view o the log-term drivers of curret accouts ad capital flows. Demographics ad log-term growth ca, to a sigificat degree, provide such a view. Our ow work o the BRICs, the N- ad the Expadig Middle Class has bee drive to a large extet by demographic treds. But we have focused largely o growth ad icome developmets ad ot, util ow, o likely shifts i global capital flows. Issue No: 7 August,

8 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper Life-Cycle Savigs ad Liks betwee Demographics ad Capital Flows The life-cycle hypothesis of savigs (LCH), origially proposed by Fisher (9), Harrod (98) ad Modigliai & Brumberg (9), is based o the savig decisios of cosumers over their lifespa. LCH posits that idividuals ted to save while they work to fiace cosumptio after retiremet. Cosequetly, the savig patter of idividuals over their lifetime is hump-shaped, with idividuals savig more durig their workig years ad dis-savig after retiremet. Oe of the products of the empirical work o the lifecycle hypothesis was the observatio that with savigs ad ivestmet schedules both likely to deped o age structure, the curret accout balace (which is the differece betwee a ecoomy s savigs ad ivestmet) may also shift alog with demographics i particular ways. Ivestmet demad is closely related to the share of youg people i a ecoomy, through its coectio with labour force growth, whereas savigs supply should be related to the share of mature adults, through its coectio with retiremet eeds (Blachard ad Fischer (988) ad Higgis ad Williamso (99)). This implies that, for a fiacially ope ecoomy, a shift i the populatio age distributio towards youger cohorts should produce curret accout deficits as the icrease i ivestmet demad outweighs the fall i savigs. Similarly, as the age distributio shifts towards the older workig populatio, there would be a curret accout shift to a surplus as the rise i savigs becomes more proouced. A rage of studies (we would ote Higgis (998), i particular, ad Lae ad Milesi-Ferreti ()) have explored that otio, ad have produced proectios o that basis, as we do here. Ecoomists have log uderstood that demographic treds ifluece savigs ad ivestmet behaviour. The most famous isight ito that likage comes from the so-called Life-Cycle Hypothesis of cosumer spedig, which posits that savigs patter are differet at differet poits i a perso s life. Early o i life, whe icomes are low, people are more likely to borrow ad ivest (i themselves or their childre). They the move through a period of prime savigs towards middle age to accumulate assets, ad the to gradual dissavig as those assets are spet i retiremet. The life-cycle theory provides some clues as to how the demographic structure of a ecoomy (i.e., how may youg people, how may of prime savig age, how may elderly) may ifluece the geeral desire to save or ivest across a etire ecoomy. By defiitio, the curret accout ad the flipside of it, the capital flows that fiace it is the differece betwee a ecoomy s savigs ad ivestmet. Whe ecoomies are closed to trade ad capital flows, savigs ad ivestmet must be equal ad iterest rates move to brig them ito balace. Ad that is true for the world as a whole, which is a closed uit. But i practice, the vast maority of the world s ecoomies are relatively ope ad curret accout imbalaces ad capital flows are sizeable. So it makes sese that those ecoomies that have youger populatios or have fewer prime savers could o average borrow from those who have more. Ad, as a result, it is also plausible that relative demographic profiles ca have importat effects i determiig savigs ad ivestmet outcomes across coutries, ad hece the curret accouts ad capital flows betwee them. Evidece suggests that demographic profiles ca have importat effects i determiig savigs ad ivestmet outcomes across coutries, ad hece the curret accouts ad capital flows betwee them There is ow a host of evidece that strogly suggests that they do. This basic isight has bee show to be importat i a wide umber of studies (the box above discusses a few iterestig oes i more detail), which have looked at the way i which demographic shifts help to explai chages i growth, savigs rates ad global curret accout patters.. A log history of macro research has also looked ito how the passage of geeratios affects ivestmet, savigs ad growth (icludig the socalled overlappig geeratio models). Issue No: 8 August,

9 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper Coefficiets* Demographic Profile of Net Savig Age Distributio Coefficiets* - - CA Surplus CA Deficit PRIME SAVERS - - Age profile *The age-distributio coefficiets represet the chage i curret accout associated with a uit chage i the correspodig log populatio age shares.. A Demographic Model of Curret Accouts Our goal here as with our earlier work o the BRICs ad beyod is to set out a framework for thikig about log-term treds i global curret accout balaces. Like all of our log-term proectios, this exercise is fraught with ucertaity ad the results should ot be iterpreted as forecasts. That said, they do provide a cosistet meas to examie the key issues ad some isight ito how they may evolve. Our startig poit is to come up with a straightforward ecoomic model of curret accouts across the maor ecoomies over the last years. Appedix II describes the model i more detail but, i the wake of earlier studies (i particular Higgis (998)), we attempt to explai curret accouts (as a percetage of GDP) as a fuctio of: Demographics to capture the forces we have already discussed. GDP growth per capita to capture the commo otio that high-growth coutries are more likely to attract more capital (ad ru curret accout deficits) tha lower-growth coutries. The relative price of ivestmet goods, which has bee show to ifluece real ivestmet levels ad potetially, through that chael, curret accouts. A variable to capture oil price exposure for the maor oil exporters, where oil prices are the maor determiat of curret accout swigs ad therefore eed to be adusted for. The model geerally does a good ob of explaiig the broad shifts i curret accouts across the coutries we look at over the last years. It also validates the importace of each of these variables. As expected, higher GDP growth per capita teds to push coutries towards ruig curret accout deficits. But the ifluece of demographics is particularly strikig. Havig more prime savers teds to improve a ecoomy s curret accout positio The formulatio that we have used allows us to map the impact of havig people at particular age groups o the curret accout positio. As the chart above shows, it strogly supports the basic isight from the life-cycle theory. Up to the age of, the populatio appears to be a drag o the curret accout positio i other words, people ivest more tha they save, o average. Betwee ages ad 9, people o average appear to save more tha they ivest. These are the so-called prime savers, ad havig more of them i the populatio would ted to improve the curret accout positio. Above 9, the Issue No: 9 August,

10 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper %Total The Peak i Workig Age ad Prime Savigs % Total Populatio Age Varies Cosiderably i Chia Populatio 7 7 Workig Age (Populatio Aged -) Prime Savigs Age (Populatio Aged -9) RHS Source: US Cesus Bureau, GS Global ECS Research Calculatios populatio agai teds to become a drag o the curret accout, spedig more tha they ear. The relative proportios of these groups (ad as a summary measure, the proportio of prime savers ) across differet coutries are essetially what the drives predictios for et savigs ad capital flows i differet ecoomies. The relevace of the prime savig group is importat because much of the commo discussio of demographic issues focuses istead o the workig age populatio (usually defied as ages -) or the related otio of the depedecy ratio (this group relative to the rest). As Appedix I shows i more detail, the two cocepts are differet ad that differece matters i some places. Most of all, the commo ituitio that Chia is demographically more like a developed market tha a typical EM market is oly true with respect to workig age populatio (where its workig age share peaks i, aroud the same time as developed ecoomies such as the US, UK ad New Zealad, ad earlier tha key EM markets such as Idia, Idoesia, Brazil, Mexico, South Africa ad Turkey). It is much less clear i terms of its prime savig populatio (which peaks i compared with a EM peak i the same year ad a DM peak i ). I terms of prime savig dyamics, Chia is more like a EM tha a DM ecoomy A Perspective o Curret Imbalaces The model we have described essetially maps out a slow-movig uderlyig curret accout, which shifts i these loger-term factors (growth treds ad demographics) would ormally predict. It does ot, of course, take ito accout Large Imbalaces i 8 Excessive CA Surplus Actual - Model Predictio (8) Chia Swede Germay BRICs Oil EM Japa Developig Asia N- Uited Kigdom Idia Eurozoe Australia Caada G7 Brazil DM Russia Switzerlad Italy New Zealad USA Spai Greece Source: IMF, GS Global ECS Research Excessive CA Deficit Issue No: August,

11 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper the large cyclical swigs that we commoly observe, or is it strictly a equilibrium curret accout give that there is o real assessmet of sustaiability embedded here. But it provides a good bechmark agaist which to assess the potetial pressures from the shiftig growth ad demographic profiles across coutries. Sice the model s predictios are clues as to where the curret accout should be, they provide a useful bechmark to assess recet imbalaces. How do actual curret accouts compare to the model s predictio of the uderlyig equilibrium? The charts show those differeces for 8 (before the crisis bega i earest) ad for 9 (the last actual year of curret accouts), as well as our forecasts for this year, sice there have bee sigificat shifts i curret accout positios ad there are likely to be further shifts ahead. These cofirm that comig ito the crisis i 8, a umber of ecoomies were a log way from their estimated uderlyig positio. I particular, the surpluses i may oil producers, Chia, Malaysia, Norway, Swede ad Germay were larger tha the model predictios, balaced by larger deficits i Greece, Spai, Portugal ad several importat EM ecoomies (Turkey ad South Africa), as well as i the US, of course. Those results match the geeral view that the world has bee too ubalaced ad the broad groupigs (Chia/Asia/Europea surplus ecoomies versus US, Europea deficit coutries ad some emergig markets) are also largely i lie with our overall views of where the problem areas have bee. These imbalaces have corrected somewhat over the last two years ad the model shows this too. I particular, the declies i surpluses i the oil producers ad Chia, alogside arrower deficits i the US, Spai ad Turkey, are all otable features of the ladscape. But i may cases, these adustmets serve oly partially to correct the gap. I the US, for istace, uderlyig demographic ad growth treds poit to a curret accout balace i 9 at -.% of GDP (actual, -.9% i 9); i Chia, a surplus of.% of GDP (actual,.8% i 9); i Japa, a surplus of.% (actual,.8% i 9); i Germay, a surplus of.% (actual,.8% i 9); ad i Spai, a balace of -.% of GDP (actual, -.% i 9). So, while we have made progress towards equilibrium, there may still be work to do. Although the recet mix of deficit ad surplus coutries is much more complicated tha a EM surplus versus a DM deficit, oe of the big shifts of the last decade has bee the move towards a average EM surplus ad a DM deficit, after a log period whe the DM world o et let to EM ecoomies. Curret accout imbalaces have corrected somewhat over the past two years......but these adustmets serve oly partially to correct the gap Oe of the big shifts of the last decade has bee the move towards a average EM surplus ad a DM deficit Some Narrowig by Actual Mius Model Predictio (9) Swede Germay Chia Switzerlad Developig Asia Japa New Zealad N- EM BRICs Uited Kigdom Eurozoe Australia Idia DM G7 Brazil USA Oil Italy Spai Russia Portugal Greece Excessive CA Surplus Excessive CA Deficit % GDP Curret Accout Imbalaces Have Narrowed But Not Completely 8 Excessive CA Surplus GS Forecasts Mius Model Predictio () - - Excessive CA Deficit - -8 Swede Norway Philippies Switzerlad Netherlads Chia South Africa Germay Japa Korea New Zealad Mexico Hog Kog Australia Uited Kigdom Idia Italy USA Frace Spai Brazil Caada Russia Turkey Vietam. I lookig at these, we would dowplay the results for the oil producers, where our predictios are less refied. A detailed model of their balaces would pay much more attetio to the idividual eergy situatios i each ad their precise exposures. We aim here simply to strip out the mai impact of oil prices i a way that allows us to iclude them i the broader estimatio. Issue No: August,

12 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper % GDP Eve After Correctio Sice Crisis, Coutries Still Not i 'Uderlyig' Balace 8 GS Forecasts Model Predictio 7 EM Surplus ad DM Deficit Both Look Excessive Sice Late 99s EM Actual EM Model Predictio DM Actual DM Model Predictio - - Chia Russia Germay Japa UK Frace Caada Italy Idia Brazil USA Despite big differeces withi each group, our model does suggest that o average both the EM curret accout surplus ad the correspodig DM deficit have both bee too large, after a period i the early 99s whe EM deficits looked excessive. O average betwee 998 ad 8, our model suggests that the EM surplus was aroud.% of GDP too big, while the DM deficit was aroud.% too large over the same period. Like the coutry rebalacig that we have see, those excesses have falle but ot yet disappeared. But while the sharp shift towards EM surpluses has led to puzzlemet over why capital is flowig uphill from poorer to richer ecoomies (the commo ituitio is that returs are higher i capital-poor EM ad so capital should flow towards them), the model predicts that EM ecoomies o average should be ruig surpluses, albeit smaller oes, ad has predicted this for several years. So, eve accoutig for differetial growth performace as we do here, allowig for demographics (ad oil prices), it may ot be iappropriate for DM ecoomies to borrow from emergig markets. What is more, the model shows that those forces have teded to push EM towards surplus ad DM towards deficit sice 99. The EM uderlyig surplus has rise by early % of GDP over that period, with the BRICs ad other oil producers as part of that story, while the uderlyig balace i the G7 ad other developed markets is predicted to have deteriorated by close to % of GDP. This model suggests that it is ot the directio of chage that is iappropriate but the magitude. As we shall see shortly, this challege to the covetioal wisdom about EM/DM balaces may itesify i the future. Our model predicts that EM ecoomies o average should be ruig surpluses, albeit smaller oes......so it may ot be iappropriate for DM ecoomies to borrow from emergig markets % Total Populatio EM Prime Savers Growig Much Faster tha DM Prime Savers Sice Early 99 DM Prime SavigShare Mius EM Prime Savig Share Source: US Cesus Bureau, GS Global ECS Research Calculatios Evolutio of Curret Accouts for Maor Groupigs DM EM BRICs N- Chia USA - Issue No: August,

13 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper The pressure mirrors the demographic shifts i the two areas. As the chart shows, the share of DM prime savers rose faster tha the share of EM prime savers betwee 9 ad 99, the period of DM surpluses. But over the last years it has begu to reverse ad the process has accelerated. Relative to the stability of the 9-99 period, the sharp shifts i the relative proportio of those of prime savig age i EM is dramatic. Somethig has clearly chaged. Lookig Ahead: Towards a More Uiform EM/DM Split How is this story likely to chage with time? To assess this, we use the model to look at the uderlyig shifts i curret accouts globally out to, matchig our forecasts for GDP growth ad icome that we have published i our BRICs-related research. We use our existig log-term paths for GDP growth ad the demographic proectios from the US Cesus Bureau that uderpi them (see Appedix I for more details). Agai we stress that these are ot forecasts but a framework for describig key log-term treds uder reasoable assumptios that ca act as a baselie for what may actually happe. There are a host of coutry-specific ad other developmets that caot be captured by this kid of exercise, as we describe below. As the Appedix describes i detail, this exercise is the balace of two (ofte opposig) forces. The first is the ifluece of the chagig demographic ad growth profiles o the uderlyig equilibrium that the model estimates. As the charts show, the pure impact of those demographic ad growth shifts is to improve EM curret accouts further (for aother years or so), i particular i the BRICs ad N-, ad to worse them i oil-producig coutries ad developed coutries, particularly the US, Frace ad Japa. Those shifts are closely related to the proected shifts i our prime savig groups for each ecoomy or regio. The share of prime savers peaks much earlier i DM (aroud ) tha i EM (aroud ), ad while Chia peaks earlier tha some i EM, it still looks much more like the other EM ecoomies o this particular measure tha like a developed market. However, curret accouts i may places are startig a log way from the uderlyig equilibrium the model s predictio for where curret accouts should be give a coutry s demographic ad growth treds as we described i the previous sectio. So, the secod force is the gradual covergece back to that uderlyig equilibrium over time. Cosistet with the results of the previous sectio, this covergece pressure teds to lower the curret accout surplus for coutries that curretly have excessive surpluses (otably oil Chagig demographic ad growth profiles likely to improve EM curret accouts further (for aother years or so), i particular i the BRICs ad N ad worse them i oilproducig coutries ad DM, particularly the US, Frace ad Japa Two Forces Drive the Curret Accout Path From Here to Factor : Demographics Factor : Covergece Net (Chage From 9 to ) DM EM BRICs N-Germay USA Japa Chia Gradual Covergece o Demographic Forces EM Actual (Baselie Proectios from ) EM Model Predictio DM Actual (Baselie Proectios from ) DM Model Predictio - Source: GS Global ECS Reseach. For oil prices, we use a simple proectio patter over the log term from our Commodity Research team (we have o official forecasts for this kid of time horizo, for obvious reasos). Issue No: August,

14 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper Curret Accout Pressures i the Maor Markets Our baselie outlook suggests that the curret accout deficit i the DM group will cotiue to declie till ad at a faster pace after. The surplus i EM is likely to declie but remai firmly positive till. But the shifts withi the larger EM ad DM groups are more strikig tha the shifts betwee them. The mai impact is to make the split betwee maor EM ad DM ecoomies more uiform over time tha it is ow, with large EM ecoomies almost all i surplus ad the large DM ecoomies i deficit. We summarise below some of the mai shifts i maor markets: 8 Evolutio of Curret Accouts for BRICs BRICs: Chia ad Russia s fallig surpluses are offset by rises i Idia ad Brazil, with both markets movig ito surplus over time (ad all four of the BRICs i surplus by aroud ). The curret accout surplus is likely to peak earliest i Chia but remai positive, while Idia s should cotiue to grow util. The shift i Idia is particularly dramatic, as its demographic divided boosts et savig over time. N-: The oil-producer surplus declies will be balaced by other o-oil producig EM, especially the N-. Withi the N-, Korea is proected to peak earliest ad (uiquely) fall ito egative territory by the late s. Egypt s curret accout is proected to rise; Idoesia s (ad Vietam s to some extet) are proected to have a flattish profile. As a aggregate, N- s curret accout surplus is proected to rise util 7, ad the gradually declie but remai i positive territory. - - Russia Idia Chia Brazil - Source: GS Global ECS Reseach G-7: The uderlyig curret accout positios of all G-7 coutries are proected to deteriorate over time, but at a varyig pace ad with a varyig profile. Germay, Japa ad Caada are proected to move from surplus to deficit. Curret accouts i Caada, Frace, the UK ad the US are show stabilisig i egative territory by late, while Japa ad Italy will likely face pressure for further declies give more challegig demographics. Evolutio of Curret Accouts for Key N- - Evolutio of Curret Accouts for G-7 Frace USA Uited Kigdom Germay Italy Japa Caada Idoesia Korea Mexico Philippies Egypt Vietam producers, Chia, Malaysia ad Norway). O the flipside, the curret accout balace of those with excessive deficits (Greece, Spai, Portugal ad the US) should see pressure to improve. Because the EM surplus is o average too large curretly, these same forces work to offset the demographic pressure towards eve larger EM surpluses. This meas that the outlook we describe here particularly i the iitial stages is drive by a combiatio of two forces, which i places couteract oe aother.. The pace of covergece i our proectios is derived from the actual covergece speed i the past that the model predicts. Issue No: August,

15 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper Large Shifts i Curret Accouts Likely i Both EM ad DM by More Uiform DM ad EM Pressures From Owards (Baselie) Mius 9 (Actual) (Baselie) Mius (Baselie) Vietam Greece Turkey Spai Brazil South Africa Italy Idia Caada Russia BRICs USA Uited Kigdom Mexico Idoesia Eurozoe N- EM DM G7 New Zealad Oil Developig Asia Chia Japa Swede Norway Source: IMF, GS Global ECS Research - South Africa Oil Norway Idia Mexico Russia N- Idoesia Developig Asia Vietam EM Brazil Turkey Swede New Zealad BRICs Caada USA Uited Kigdom Chia G7 DM Eurozoe Japa Greece Italy Spai That outlook ivolves potetially large shifts i global curret accout positios. I thikig about these shifts, we focus o the 9- period, which is more immediately iterestig. But we also look at the developmets from -, by which time ay impact from curret imbalaces will have receded, ad so the outlook here is almost completely drive by the demographic ad growth shifts that uderpi our model. The box o the previous page describes some of the key developmets i the maor markets, but the most obvious are: Potetially sigificat declies i surpluses betwee 9 ad from may of the maor surplus groups (the maor oil producers, Chia, Japa, Germay, Swede), matched by sigificat improvemets i the curret accout positios of may of the higher-deficit developed market ecoomies, such as Greece, Spai, Portugal ad, more modestly, the US. However, the basic patter of surplus ad deficit coutries may ot reverse completely over this period, although the surpluses ad deficits may shrik. The outlook is for potetially large shifts i global curret accout positios The model (with all the obvious caveats) shows the US deficit at -.% of GDP by ; Chia s surplus decliig to.%, roughly where it was before the structural break higher i ; ad Germay ad Japa eterig deficit territory. South ad South-East Asia, whose demographics are favourable, also see sigificat pressure for stroger curret accouts. Chages i the EM ad DM aggregate positios are modest (-.ppt for DM % Total Populatio 8 USA Prime Savig Populatio Versus Curret Accout USA Prime Savig Populatio (%, Share of Populatio Aged -9) USA Curret Accout (Model Predictio, RHS) Source: US Cesus Bureau, GS Global ECS Research Calculatios % Total Populatio Chia Prime Savig Populatio versus Curret Accout Chia Prime Savig Populatio (%, Share of Populatio Aged -9) Chia Curret Accout (Model Predictio, RHS) Source: US Cesus Bureau, GS Global ECS Research Calculatios 8 - Issue No: August,

16 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper % Total Populatio Japa Prime Savig Populatio versus Curret Accout Japa Prime Savig Populatio(%, Share of Populatio Aged -9) Japa Curret Accout (Model Predictio, RHS) % GDP Source: US Cesus Bureau, GS Global ECS Research Calculatios 7 ad -.9ppt for EM), ad the same is true for the BRICs as a bloc. This meas that the model does ot predict ay sigificat shift i the picture of EM ecoomies sedig capital to the developed world, ad by it still shows EM as a group potetially ruig a surplus ad DM a deficit. (It may seem couterituitive that the curret accouts of both DM ad EM ca deteriorate as a percetage of GDP but EM GDP is risig much more rapidly.) What does chage is that the picture withi the EM ad DM blocs becomes more uiform. I particular, the fact that Germay, Japa ad Caada may move ito deficit, but that Brazil ad Idia could oi Russia ad Chia i surplus as their prime savigs groups expad, meas that the exercise evisages a world where all of the large EM coutries move ito surplus ad all of the large DM ecoomies ito deficit over time, ulike today. The picture withi the EM ad DM blocs is likely to become more uiform A Demographic View of the Savigs Glut The flow of capital from EM to DM ecoomies which we have show here may cotiue is closely idetified with the otio of the savigs glut, a widely debated issue ever sice the-fed Goveror Be Berake coied the phrase i a speech o global imbalaces i. As we metioed earlier, the global curret accout balace has to be zero. If there is a tedecy for the world s ecoomies o average to wat to save more tha they ivest (i.e., ru a global curret accout surplus), i priciple this should be resolved by a fall i global real iterest rates. The rise i desired global savigs about which Fed % Total Populatio 9 7 Pressure to Save is Likely to Itesify Further Globally Global Prime Savig Populatio (%, - 9 Share of Populatio Aged -9) 7 Global Net Savig Pressure (Curret - Accout, RHS) Source: US Cesus Bureau, GS Global ECS Research % Real (ex-ate) Log-term Rates Have Treded Dowwards 7 US EMU UK Source: Goldma Sachs estimates % 7 Issue No: August,

17 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper Global Versus Local Drivers of Real Iterest Rates ad Asset Prices We metioed above that our models cast some light o how demographics may ifluece global real iterest over time. At a simple level, as we describe i the mai text, the global real iterest rate ca be thought of as the rate that makes desired global savigs ad desired global ivestmet equal. All else equal, if demographic or other forces push for a icrease i desired savigs relative to desired ivestmet, global real iterest rates should fall ad vice versa. It is importat to thik about what the global real iterest rate meas, however. If all goods ca be traded ad capital accouts are ope, the (log-term) real iterest rates should be equal everywhere. But, i practice, eve with relatively ope capital accouts, may goods caot be traded across coutries. Ad it is easy to show that this meas that real iterest rates i each coutry eed ot be equal. I those circumstaces, a simple framework would defie a coutry s real iterest rate as a weighted average of the global real iterest rate (for the traded goods sector) ad a locally determied oe (for the o-traded goods sector ). Our Bod Sudoku models of G bod yields have some of this flavour, usig both local ad global iflueces as determiats of yields. I the cotext of the demographic approach here, the global compoet of real iterest rates (real rates i terms of tradable goods ) would be determied by the global demographic profile. But those ecoomies where et savig is predicted to fall (ad curret accout deficits to rise) would ted to see higher real rates ad stroger real exchage rates tha otherwise, with the reverse true i those where et savig is predicted to rise. O our outlook, the demographics poit to upward pressure o DM real rates relative to EM, i the cotext of dowward pressure o overall global real rates. I additio to the implicatios for iterest rates, a umber of studies i recet years have worried about the otio that dis-savig by retirig workers i DM will push real rates higher ad asset prices lower. This demographic fear has bee expressed periodically with respect to equities ad housig markets i the US most particularly. Makiw ad Weil (989) made a wellkow predictio that the declie i the baby boomer geeratio ad their dis-savig would put dowward pressure o US housig markets. Ad similar predictios have bee made about dowward pressure o equities as the baby boomers hit retiremet age. There are may reasos why those fears are overstated (the Jackso Hole Symposium by the Kasas Fed i saw this issue widely discussed). But the logic described above with respect to global iterest rates also applies here. While the demographic profile of the US ad some other developed markets may push towards lower et savigs ad so coceivably to asset liquidatio the global perspective shows that this cocer eeds to be offset partially agaist the prospect of icreased global (pricipally EM) et savig, which could potetially provide capital iflows to balace that dyamic. Those markets that are more local (otraded) would i theory be more vulerable to that dyamic tha those that are globally traded, but the overall picture would certaily be more beig tha a purely local view would suggest, ad more of the adustmet would occur through capital flows tha through asset prices. Chairma Berake speculated is ot directly observable, so the prima facie evidece give was the surge i EM curret accouts alogside lower real iterest rates, which might poit to icreased savigs supply from that source. Explaatios for why exactly the desire to accumulate savigs may have surged vary (Berake poited to the scars of fiacial crises ad risig commodity scares). Ad there has bee a extesive debate about whether the theory is correct ad if it will prove fleetig or persistet. The framework for global capital flows ad curret accouts set out here provides a iterestig perspective o this issue. Our mai exercise imposes the costrait that the global curret accout must add up to zero, as ay sesible predictio must. But if we relax that costrait ad aggregate the idividual coutry predictios, we ca get a sese of how the shifts i demographics ad growth may be ifluecig the ex ate balace betwee global savigs ad ivestmet. Lookig at the predicted global excess savigs (or global curret accout surplus ) from this ucostraied model shows that sice the mid- 98s, demographic ad growth shifts globally have steadily ad sigificatly pushed i the directio of higher excess savigs over that period. The predicted ex ate global curret accout balace has rise from -.7% of GDP i 98 to.% i 9, acceleratig betwee 988 ad 9. The demographic couterpart to that shift is easily idetified. The proportio of prime savers ad we are talkig about et savigs here globally (agai weighted by GDP) Issue No: 7 August,

18 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper has rise over that period. This coicides with the sigificat declie i global real iterest rates that we have see sice the mid-98s ad suggests that demographics may have played a role. While there is o easy way to prove that this likage exists, ecoomic logic supports it. These pressures appear to be itesifyig rather tha reversig, if we ru the model forward o this basis. This exercise predicts a further.% of GDP (from 9 to ) icrease i the ex ate global curret accout surplus, smaller tha that see over the last years but still large, before a modest reversal. This meas that a purely demographic model of global real iterest rates would predict further dowward pressure as desired savigs globally rise further relative to ivestmet. Both i the past ad i the future, these shifts appear to result largely from a icrease i desired savigs i the EM world. As a recet Global Ecoomics Paper 8 by Be Broadbet ad Kevi Daly showed, the simple story of a savigs glut does ot explai all of the maor features of the recet global ladscape. They argue that the icrease i global savigs alogside icreased returs o capital is probably also due to the itegratio of large high-savigs emergig market ecoomies ito the global ecoomy. That story is highly plausible ad is a remider that the persistet demographic pressures that we idetify are likely to be oly part of the story. But their paper also highlights that the compositio of the rise i global savigs (skewed towards cetral baks i EM with coservative portfolio prefereces) may also have acted to raise the global equity risk premium. Our proectios suggest that this too could be persistet. While the rise i prime savers globally suggests that demographics may cotiue to put dowward pressure o global real iterest rates, differeces across the various coutry groups could lead to persistet differeces i relative iterest rate treds. As the box o the previous page describes, theory would predict that those whose curret accout positios are forecast to deteriorate (largely i the DM world) could see upward pressure o real iterest rates relative to those who see a improvemet (mostly i EM). So, while demographic forces may work to keep real iterest rates low across the world, our proectios imply that, o average, this dowward pressure may be larger i EM. But these same dyamics also imply that the periodic worries that the wave of retirig (ad dis-savig) baby boomers i the developed world will hurt asset prices (bods ad equities) eed to be offset agaist the prospect of a cotiued (ad perhaps icreasigly) strog desire for savig (ad capital flow) from the EM world ad globally. The rise i prime savers globally suggests that demographics may cotiue to put dowward pressure o global real iterest rates But differeces across the various coutry groups could lead to persistet differeces i relative iterest rate treds Offsets to These Pressures: Sustaiability, Capital Markets As we have said i our BRICs-related work, there are may reasos why the outlook we describe here might ot be bore out. I the case of curret accouts evolutio, two issues are particularly importat, both of which may mitigate the uderlyig demographic pressures. The first is that the pressure we describe may lead to foreig fiacig eeds that prove excessive, particularly i some DM ecoomies. Nothig i our proectios addresses the aggregate ratioality or sustaiability of the paths that we proect. They are simply the outcome of what the demographic ad growth proectios would ormally lead to. So they are best see as guides to the uderlyig pressures tha as a true forecast of what may occur. I that sese, they are remiiscet of the global eergy demad forecasts that we made. Iterestigly, Matthew Higgis s 998 paper aalysed curret accout ad demographic liks i a similar framework to the oe we use here. He coducted some simple proectios that showed exactly this effect. The paper argued, correctly it turs out, that global real iterest rates could come uder dowward pressure.. Because we predict et savig here, i.e., savigs less ivestmet, the demographic pressures do ot ecessarily imply that actual savigs rates (or the clearig levels of savigs) will have to be higher too, as some other explaatios require. Demographics ifluece both ivestmet ad savigs profiles, ad it is possible demographic shifts reduce both desired ivestmet ad desired savigs but reduce the latter by more. Issue No: 8 August,

19 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper Likely Net Foreig Asset Profile () Australia Spai New Zealad Greece Portugal Net Foreig Asset Positio () usig idetity NFA(t) = (-g)*nfa(t-) CA w here g = assumed omial GDP grow th. Source: IFS, Natioal Sources, GS Global ECS Research Calculatios i our earlier BRICs research, which were desiged to show where pressure poits would emerge but ot ecessarily whether those pressures could actually be satisfied. Oe simple way to see this is to look at what our exercise for the evolutio of curret accouts would imply for the et foreig asset (liability) positios of the relevat coutries. Give that the demographic pressures i may cases push for further curret accout deterioratio i the developed markets, foreig liabilities i those that are already sigificat debtors would be set to deteriorate further uder these forecasts. The most obvious examples are Australia, New Zealad, Spai, Greece ad Portugal. The pace of deterioratio is ot dramatic relative to their curret situatio. Ad if these ecoomies ca ear returs that are sufficietly higher tha the cost they pay to borrow, the i priciple this borrowig may prove more sustaiable ad appropriate tha it looks. Much of the had-wrigig about US foreig liabilities over the last years, for istace, has ot yet bee bore out, ad similar exercises for may of these ecoomies coducted i the past would have overstated their problems ow. Ad it may simply be that the surplus coutries come to ow larger portios of the capital stock of the deficit coutries over time. But eve with those caveats, the profiles here suggest that some developed coutries that already have large foreig liabilities may ultimately eed to ru smaller deficits tha curretly predicted (presumably through some combiatio of exchage rate depreciatio ad demad restrait). The secod issue is the prospect of fiacial market deepeig i the big EM ecoomies. There is ow a wide body of work suggestig that uderdeveloped local fiacial markets i the EM are part of the reaso why savigs are larger tha they should be, ad why curret accout surpluses (capital outflows) are also surprisigly large. Caballero et al (8), for istace, ratioalised the sustaied rise i US curret accout deficits, the declie i real rates ad the rise i the US assets i global portfolios as a ratioal respose to differig capacities to geerate fiacial assets from real ivestmets. Uder this theory, the EM crises at the ed of the 99s ad their subsequet rapid growth prompted them to search for soud ad liquid fiacial istrumets, which the US markets were positioed to provide but their ow markets were ot. Ad of course the US exorbitat privilege from its positio as a reserve currecy may also help i this regard. Others have foud supportig evidece for that dyamic. 7 Some developed coutries that already have large foreig liabilities may ultimately eed to ru smaller deficits tha curretly predicted Our ow research has focused over a exteded period o the challeges of buildig capital markets i the BRICs ecoomies ad the deepeig i capital markets i the developed world. I, we showed how the developmet of the BRICs might lead to a sharp rise i the equity capitalisatio of the BRICs ad broader EM world, a process that is already uderway ad that may act to mitigate some of the iheret weakesses i local market developmet (see Global Ecoomics Paper 8). Sice the, Fracesco Garzarelli, Sadra Lawso ad others have focused o what is arguably a larger challege, the developmet of local debt markets, particularly i Chia ad Idia but with 7. See Gourichas ad Rey (), Cooper (7). Issue No: 9 August,

20 Goldma Sachs Global Ecoomics, Commodities ad Strategy Research Global Ecoomics Paper applicability beyod (see Global Ecoomics Paper 9 ad ). Their work highlights the potetial for sigificat expasio i debt markets if cotiued progress o supportig reforms ca be made (i 8, we predicted that Idia s o-public debt market could grow sixfold by ). More recetly, but i a similar vei, Christopher Eoyag ad team have highlighted the eormous potetial for growth i Shaghai as a fiacial cetre, ad the prospect of much deeper ad more liquid markets there (see Global Ecoomics Paper 98). Broader fiacial liberalisatio, which might chage access to credit i EM markets, could also be a importat developmet i chagig aggregate savigs. If further progress is made o these issues of local capital market developmet, it might plausibly act to reduce savigs i some of the large EM markets, ad reduce the pressure for capital outflows ad curret accout surpluses that stem from higher savigs rates. It is also a remider that o-demographic forces are hugely importat to the overall path of savigs, as Hele Qiao described i detail i Global Ecoomics Paper 9. It is importat to remember that i ay give coutry, a host of chages ot captured by our models may be i operatio. Ad i Chia with the trasitios i social security provisio ad the SOE system sice 99s these forces may be larger tha i may other maor ecoomies. Because our models allow for covergece towards uderlyig balaces i some of the large EM coutries ad because they accout for ay persistet effects for ay give coutry 8, some of these issues are probably partially captured. Ad oe of this alters the fact that relative demographic profiles across EM push towards larger ot smaller surpluses. But there is much that the models leave out. Sigificat progress i capital deepeig i the BRICs ad beyod might act to offset that tedecy ad reduce the size of global curret accout balaces. The developmet of domestic bod ad broader capital markets is a importat goal i its ow right i terms of the efficiecy of local capital allocatio. But it could also be a useful safety valve i limitig the challeges of maagig eve larger global capital flows. The developmet of domestic bod ad broader capital markets could be a useful safety valve i limitig the challeges of maagig eve larger global capital flows Implicatios for Markets ad Policy Returig to the issues that we raised at the outset, we would highlight three maor implicatios of this demographic perspective o capital flows ad curret accouts. First, there is strog cofirmatio that recet imbalaces were overshoots of the slow-movig uderlyig determiats of global capital flows. While we are makig progress to reducig them (i particular i the US), it is still oly partial progress towards what the uderlyig equilibrium should be. This meas that further adustmets i global demad ad currecy patters may still be eeded, as with the ecouragig shifts i Chia recetly. Secod, while those ear-term adustmets o average argue for lower EM surpluses ad lower DM deficits, uderlyig demographic ad growth dyamics push towards a situatio where the EM world cotiues to export savigs to the richer ecoomies. We fid this eve after explicitly allowig for the differeces i growth rates across the groups. While those pressures may ultimately push some developed coutries towards usustaiable paths, they also cautio agaist assumig that what is goig o curretly is a aomaly waitig to be corrected. Third, at a global level, demographic pressures seem to push towards cotiued icreases i desired savigs relative to desired ivestmet. That force may already have bee more importat i pushig real iterest rates dow globally over the last - years tha is ofte ackowledged. But it 8. Through the coutry dummies i the pael. Issue No: August,