Tuesday, March 12, 2013

Foreign Demand For Domestic Savings: Part I

In 1974, the Interest Equalization Tax, a tax first levied in 1963 on both foreign borrowing and foreign investment of American capital, was repealed.  The tax was initially intended to reduce capital outflows in order to correct the negative balance of payments.
Reduction in both the personal saving rate (left) and the 10-year treasury (bottom).
Repealing the equalization tax should have increased the demand for US savings by reducing foreign borrowing costs, and it should have created an increase in borrowing costs for all borrowers.  

By the early-1980s, the interest rate on one-year treasuries was peaking at 17.5%, and personal savings was peaking at nearly 25% the size of the liquid money supply (MZM).

According to the law of supply and demand, as the demand for savings rises the price of savings (borrowing costs) should rise.  Relatively speaking, rising interest rates should mean that there is a lack of savings relative to the demand for savings.

Peak interest rates did roughly coincided with peak saving rate.  I guess in some ways, rising interest rates is due to both a deficient supply of savings and a surplus demand for savings.
Personal savings as a percent of the liquid money supply (MZM).

PMSAVE/MZMSL (blue) and the one-year treasury (red).

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