The economic relationship between saving and investment is examined in a nifty little paper not long out of the Reserve Bank of Australia (RBA).

Entitled Patterns and Trends in Global Saving and Investment Ratios, the paper explores changes in current account balances of major developed and emerging market economies over recent years and how these can be explained by underlying saving and investment behaviour.

Ratios of saving and investment are expressed as percentages of gross domestic product (GDP) and are diagnostic of the health or otherwise of the economies to which they apply.

Saving is income held back from consumption, while investment is wealth used to finance production of goods and services.

Saving can be directed into funding investment, and in the globalised economy is readily exported to other countries for that purpose.

Much of the trouble created by the global credit crisis had its roots in international imbalances between saving and investment.

The paper starts out from three basic economic equalities or identities.

“Three identities underpin an analysis of world financial flows,” it states, “a country’s current account balance equals the difference between its national saving and its investment; the sum of all the current account surpluses around the world equals the sum of the deficits; and, by implication, the level of world saving equals that of world investment.”

From out of these presuppositions the analysis proceeds to trace how things managed to get so out of kilter as to lead to the global economic crisis and where they are now as allegedly we are climbing out from the other side of the abyss.

Implications are that if a country’s national saving and investment are approximately the same, then it will have a small current account surplus or deficit.

If the country’s saving exceeds its investment, then it can export the excess savings abroad for foreign countries to invest and become a creditor nation in the process.

If the country’s investment exceeds its saving, then it must import the savings of other countries to make up the difference and becomes a debtor nation.

Most famously in the run up to the global credit crisis, the US was a big debtor nation which imported foreign surplus savings willy-nilly to finance its real estate bubble in both residential and commercial property.

China was the country that copped most of the blame for being the source of these surplus savings, as it had vast amounts of saving pent up in the household, government, but most particularly corporate sectors that it could not invest domestically.

The RBA’s paper, however, unmasks some interesting facts about what really went on.

In the US, the saving ratio fell over the late 1990s to the mid-2000s while at the same time its investment ratio went up as it funded the then nascent property bubble.

In response, the US current account deficit started to balloon.

Then from the mid-2000s, US saving and investment ratios started to move in tandem, causing the current account deficit to flatten out and hold fairly steady, albeit at bloated levels.

China had a fairly modest current account surplus until the mid 2000s because its saving and investment ratios were about equal.

From the mid-2000s on, however, China’s saving ratio took off, vastly exceeding its investment ratio.

The result was that China ended up with a current account surplus of 10% of GDP and became the world’s largest exporter of capital in 2008 to the tune of $US440 billion.

By contrast India also had a sharp increase in its saving ratio, but that was matched by a rise of its investment ratio and meant its current account balances remained modest.

India was not a big exporter of savings during this period.

The countries that did send large amounts of their surplus savings overseas because their saving ratio outran their investment ratio included Asian countries such as Japan, the newly industrialised countries (NICs) - Hong Kong, Singapore, Korea and Taiwan - as well as the ASEAN group.

Another group of savings exporters were the oil producing countries of the Middle East and Russia, whose saving ratios soared versus their investment ratios as the price of oil headed for the stratosphere.

The Asian and oil producing nations collectively produced the greatest surplus savings export bubble in history because they were awash with funds they were unable to invest fully at home.

Without that savings bubble, the corresponding runaway excesses of debtor nations would not have kicked off and taken the global economy to the brink of ruin.

The US was not the only beneficiary of surplus savings seeking a home away from home.

The RBA paper lists also the euro area, emerging Europe, Latin America and the Anglo area as net borrowers who cashed in on the savings glut.

The RBA tips some significant trend changes for saving and investment ratios, and current account balances over 2009.

The global economy’s aggregate saving and investment ratios are falling fast this year.

“The recent sharp downturn in global economic activity is projected to lead to a significant fall in the global saving and investment ratios,” the RBA paper states, “and large shifts in the current account positions of some major countries and regions.”

“Most of this reflects the sharp fall in the investment ratio in the US in 2009 – driven by a slump in domestic demand and tight financial conditions – as well as sharply reduced saving in the oil exporters following the large fall in oil prices since mid 2008.”

“The current account of the oil exporters is expected to be in broad balance in 2009.”

“In comparison, the projected changes in current account positions in other economies and regions in 2009 are fairly small.”

“Like in the US, the investment ratio in emerging Europe is expected to decline, with an accompanying reduction in the size of the region’s current account deficit.”

“While the investment ratio in Japan is also projected to fall, its saving ratio is expected to decline somewhat faster.”

“In contrast, the investment and saving ratios and the size of the current account surplus in China are expected to remain very high in 2009.”

Interpreted in terms of global economic recovery conditions, outside China investment is slumping significantly, which has negative implications for a return any time soon to rising employment trends.

Corresponding falls in saving will reduce international credit supply, especially as China has committed to applying its high level of saving to domestic investment in urbanisation and infrastructural development.

The wealth destruction effects of the global credit crisis have yet further to go, with debtor nations in many cases struggling to meet their obligations and creditor nations no doubt worried about the lengthening odds of being repaid in full.

An old banking adage goes that if someone owes you a little money, you own him, whereas if he owes you a lot of money, he owns you.

Creditor nations will be sweating at the thought that far from coming out on top in the credit crisis, they may have ended up ever more firmly pinned under the thumbs of their profligate borrowers.