Savings-Investment Imbalances Forecasting Approach

CFA Level III
#1

Can anyone explain this clearly? CFAI book was extremely longwinded and unclear.

#2

anyone?

#3

I’ll give it a shot. 1 There is a savings deficit 2 currency must increase to attract investments You would expect a drop in value, the savings investments imbalance approach states otherwise.

#4

Not 100% confident of it but here are my notes 1.The Economy must fund investment through saving 2.Now, if the the investment is greater than the the domestic savings ->deficit, we would need foreign capital to flow in. 3.We increase foreign capital through high interest rates or economic growth. 4. Because of high foreign capital there will be a current account deficit ( imports > exports ) 5. Current a/c deficit would indicate currency will weaken…normally…but the currency must stay strong to attract foreign capital… 6. Usually occurs during expansions when savings decrease. 6. During recessions savings increase and the deficit reduces, currency becomes weak.

#5

all of the above look good, here’s my take: a country’s spending should be financed by domestic savings. If government spending + private spending is > domestic savings, a country needs foreigners to finance the defecit. So to incent foreigners to hold their debt, a country needs to offer a strong currency and strong returns. Therefore, domestic interest rates will move up, and the currency should remain strong, and foreign capital will flow in finance the country’s debt.

#6

And in real life, the US has managed to do so for years.

#7

In the US, we have managed to finance our debt with foreign capital, despite very low interest rates and a weak currency, because of the USD reputation as the world’s Reserve currency and because countries need USD for commodity transactions. The US example though is an exception - this screwed me up for the longest time because I always wondered, “well the US finances its debt and our currency isn’t strong and rates are very low, so what gives?” Well what gives is foreign governments are willing to be shafted on their returns because of the (supposedly) relative safety of our debt.

#8

Euro is difficulty to strong. China doesn’t want to strong.

#9

This is the clearest explanation so far. The only change I would make is that rather than say rates need to increase as a way to attract foreign investors I would say:

  1. As domestic savings are depleated, there is a lack of funds to fuel more growth (i.e., if I want to grow my business there’s less money to borrow because there are no savings for savers to lend out)

  2. So, the cost of borrowing goes up (demand for funds > supply)

  3. Since cost of borrwing is higher, lenders earn a higher return

  4. Foreign investors are attracted by the higher return

  5. In order to provide loans, they need to buy the domestic currency

  6. This demand for the currency is what makes it appreciate

NET RESULT: domestic investment > domestic saving = appreciating domestic currency