artificial boom: Steve Hanke July 2006

Another economist who identified what was happening prior to the 2007-2008 bust:

Excessively low interest rates and excess credit have generated other distortions and imbalances. Those schooled in the business cycle models developed by Friedrich Hayek in the 1930s know that excessively low interest rates result in a widening gap between savings and investment. People are unwilling to postpone consumption if the return to savings is meager, and users of capital are too prone to finance borderline projects when the cost of money is low. Sure enough, gross savings was 16.7% of gross national product in 2000.

By 2005 it had fallen to 13.8% of GNP. Gross investment (that’s investment before a deduction for capital consumption) as a percent of GNP held its own during this period, starting at 20.7% and ending at 20%. Consequently, the savings-investment gap ballooned from -4.0% of GNP to -6.25%.

At the national level, that savings minus investment in the U.S. is equal to U.S. net foreign investment. And this is equal to the balance on the U.S. current account, which is broadly the difference between U.S. exports and imports. If domestic investment exceeds total savings by Americans, as it now does, imports will be greater than exports, and we will acquire foreign capital to finance the difference. In simpler terms, our increasing trade deficit is a function of the negative differential between our saving and investment rates.

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