In public debate, the fact that interest rates are not just a policy tool of the Federal Reserve, but also a market-determined price of capital, is often overlooked. Here, we explore historical trends in various sources of capital (not all of them) and briefly list the various current large demands for capital. A low supply relative to demand creates pressures that usually lead to higher interest rates.
US Savings Rate
Total net savings in the United States, as a percentage of U.S. Gross Domestic Product, has been declining since the mid-1960s (see Figure 1). From 1947 to 1956, the first decade of the Figure 1 period, it averaged 10.1%, but over the past decade (2014 to 2023), it was 2.3%. It is not clear whether the savings rate continues to decline or has stabilized. The past five years indicate a continued decline. However, the longer period through the early 1990s suggests that stabilization with large fluctuations may also have occurred. The source of data used to examine the U.S. savings rate is the Federal Reserve Economic Data File (FRED) maintained by the Federal Reserve Bank of St. Louis.
US Sectoral Savings Rates
The US savings rate can be broken down into savings rates for domestic businesses, households and institutions, and government (mainly the federal government, but also state and local governments). The US domestic business savings rate has averaged +3.4% since 1947 (see Figure 2). There is no clear trend, with year-to-year fluctuations ranging from +1.7% (2008) to +5.8% (2010). The average rate over these two years, both of which occurred during the US housing crisis, was +3.7%, close to the long-term average.
The US household and institutional savings rate averaged +7.7% from 1947 to 1985. It then began a long-term downward trend before stabilizing in the +3-4% range. The spike in 2020 and 2021 coincided with large government transfer payments during the COVID pandemic. The savings rate in 2023 is +3.3%. If the US household and institutional savings rate remained stable in the +3-4% range, it would roughly match the long-term savings rate of US domestic corporations.
The US government savings rate averaged -0.3%, or slightly negative, from 1947 to 1969. Since 1970, it has averaged -4.6%, with large year-to-year variations. The range was -13.1% (in 2020, the year of the COVID lockdown; savings were also clearly negative during the housing crisis) to +1.2% (also positive in 2000 and 1999). The US government savings rate in 2023 is -6.6%.
Volatility makes it difficult to assess recent trends reliably, but there has been a notable increase in deficits since the 1970s. Moreover, the decline in the U.S. government savings rate has been a major factor in the decline in the overall U.S. savings rate since the 2000 surplus.
Foreign Investment in the United States
Foreign investors have been a major source of capital throughout the history of the United States. Figure 3 shows new foreign direct investment in the United States as a percentage of U.S. Gross Domestic Product. The data comes from surveys conducted by the Bureau of Economic Analysis. Data begins in 1999; no surveys were conducted from 2009 to 2013. The average percentages for the pre- and post-interruption periods are nearly identical at 1.5% and 1.4%, respectively, indicating the absence of a trend. New acquisitions, on average, account for 94% of new foreign direct investment.
Figure 4 shows the share of U.S. federal debt held by foreign and international investors since 1970, when FRED first reported data. This share increased from 1970 to 2014, peaking at 34%, before declining to 23.5% by 2023. This decline does not appear to be slowing.
Notably, foreign and international investors’ dollar-denominated holdings of U.S. federal government debt have not decreased. Holdings have increased from $6.1 trillion in 2014 to $7.7 trillion in 2023. However, the percentage decrease is large enough to raise the question: What caused it? Does it represent a loss of confidence in the U.S. government? Whatever the answer, the percentage is worth monitoring. If the percentage had remained at 34%, foreign and international investors would have held $3.4 trillion more in U.S. federal debt. This money likely came from other sources in the U.S.
US capital needs
There are currently several large demands for capital in the United States, both from government policy and from private markets.
Reconfiguration of supply chains due to heightened international political risks, which often result in supply chains moving closer domestically, especially in critical industries (see, for example, Council of Economic Advisers, November 30, 2023); A transition from carbon-based to renewable energy, driven by government policy and private markets, and requiring significant investments in production and distribution facilities (see, for example, Appendix, August 21, 2023); Investments in replacing and upgrading the U.S. transportation infrastructure (see Infrastructure Investment and Jobs Act of 2021); The rapid growth of artificial intelligence, requiring significant investments in the data centers and energy networks that support it (see, for example, Goldman Sachs, May 14, 2024). Discussion
Interest rates are not just a policy tool of the Federal Reserve: they are the price of capital.
Moreover, in conducting monetary policy, Congress has directed the Federal Reserve to pursue not only the widely recognized goals of promoting maximum employment and price stability, but also the economic objective of moderate long-term interest rates (Federal Reserve Board).
While this article is not an exhaustive review, given the large demand for capital-intensive projects in the transportation, energy, supply chain, and artificial intelligence sectors, the declining U.S. savings rate, and weak international investor demand for U.S. federal debt, U.S. interest rates may need to remain high to meet current and near-term U.S. capital needs, even if inflation falls to the Federal Reserve's 2% target rate.
In other words, the Fed manages, but does not control, interest rates, which are ultimately determined by the market.
Savings rates for U.S. households, institutions, and the government have been on a long-term downward trend, so it will be important to monitor future developments.
It would also be useful to understand why the savings rate for U.S. domestic companies has remained stable at 3-4 percent per year and what this says about U.S. capital markets and interest rate policy.
References and data sources
Annex, M. August 21, 2023. Renewable Energy Investment Hits Record Breaking $358 Billion in 1H 2023. BloombergNEF. https://about.bnef.com/blog/renewable-energy-investment-hits-record-breaking-358-billion-in-1h-2023/
Department of Commerce, Bureau of Economic Analysis. July 10, 2023. New Foreign Direct Investment in the United States. https://www.bea.gov/data/intl-trade-investment/new-foreign-direct-investment-united-states
Board of Governors of the Federal Reserve System. July 2024. Monetary Policy. https://www.federalreserve.gov/monetarypolicy.htm
Federal Reserve Bank of St. Louis. May 2024. Federal Reserve Economic Data (FRED). https://fred.stlouisfed.org
Council of Economic Advisers. November 30, 2023. Issue Brief: Supply Chain Resilience. https://www.whitehouse.gov/cea/written-materials/2023/11/30/issue-brief-supply-chain-resilience/
Goldman Sachs. May 14, 2024. AI will drive 160% increase in power demand in data centers. https://www.goldmansachs.com/intelligence/pages/AI-poised-to-drive-160-increase-in-power-demand.html
117th U.S. Congress. November 15, 2021. Infrastructure Investment and Jobs Act. https://www.congress.gov/bill/117th-congress/house-bill/3684