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Monday, February 4, 2008

Savings v. Investment v. Income -- Podcast Transcript

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It becomes tedious at times to hear people, often well-dressed and well-respected people, discourse on the savings rate and tsk-tsk about the declining financial morality that has overcome our nation since the virtuous Fifties, Sixties and Seventies. Then, as benediction, these people will throw in an alarming factoid on the current precise level of non-saving.

And in fact, I have been one of these people.

Then I began to reflect. The huge volume of 401(k)s and pension funds must not be included. Likewise government debt – which has to be held by at least a few Americans — has been rising by hundreds of billions per year since 1981, except for a brief respite in the last part of the 1990s. Then again, there was five and a half trillion dollars in interest-bearing accounts not too long ago.

Still, as you can see in a chart on the web site, the official savings rate has been trending down since the common turning point of broad economic well-being — 1980 — and the rise of Reaganomics. Prior to that time and consistently since the historic series began in 1959, the rate was nearer ten percent than zero, where it hovers today. More thoughts on that later.

But still.

The first problem is the definition. The Bureau of Economic Analysis, BEA, identifies personal savings as “disposable personal income less personal outlays.”

When you and I think of savings we think of what we have stored away for safekeeping in a bank or investment account or stock of canned tuna. This is characterized by the BEA as “wealth,” not “savings.”

Net worth is what we identify as our savings, with some instinctual alignment to account for the more illiquid assets, such as housing and real estate. Over the past decade as we were spending more and borrowing more our net worth was rising. The figures I have before me here are from Bankrate dot com May 2006. $53.8 trillion in net worth. Compare this to $39.1 trillion in 2002.

We could well give back that $13 trillion while the personal savings rate rises and I doubt whether any one of us would think himself or herself richer. Likely we would experience a queasiness as if we had been told our savings account had been embezzled.

Which brings us to the stimulus package. I repeat that in spite of the tsk-tsk of the well-attired, our instructions are to spend the five or six hundred dollars coming to us in the mail.

Now that I think about it, our current President seems to have cut the cord of inevitability of taxes, at least to the rich. I understand he has an in with the big bearded guy. Do you think he might be persuaded to move the inevitability of death a little as well.

But the point. Our instructions are to spend the checks in the mail. This in the face of crumbling home values and an apparent recession on the way. I don’t know about you, but I’m going to pay down my debts with vigor. That is called “saving” or at least reducing the “dissaving.” But saving will not help the economic downturn.

Any saving by me, of course, will be provided by the government’s borrowing. Fortunately their borrowing rates are low. Or unfortunately. That brings us to the next part. Low interest rates do not entice people into savings, they promote purchase of assets which may have a higher return. The Greenspan housing bubble was to some degree sponsored by this calculation. “I can save at two percent or invest in housing at an annual rate of ten percent. Even if the market softens, at least I have the house.”

If you look at the chart on the blog, and remember when interest rates were high, the downward trend was ameliorated. When they were lower, people looked for other assets with a better return.

Parenthetically, the main thing lower interest rates do is increase the attractiveness of borrowing. Fine if you don’t think we are overextended already. For you and me it means refinancing at a lower, maybe a fixed rate. For the financial sector it means a million dollars today costs only $35,000 when a couple of weeks ago it was forty-two five. In another month it will be even cheaper. Maybe we can start another bubble — oh yes, there is one already. In commodities. Look out Oil Thirty-Six Thousand.

But let us consider the fundamental point of the tsk-tsk-ers. That is that a high savings rate means good things for investment. Everybody is familiar with the national income accounting identity between savings and investment. That identity — that savings equals investment — has almost universally been taken to mean that savings CAUSES investment. This is not correct. Believe it or not.

High personal savings rates under Reagan and Bush I did not produce big investment. Lower savings rates under Clinton did not keep investment from happening. And as we’ve seen the huge investment in passive housing over the past half dozen years came as savings rates were near zero.

We can discuss the source of funds if we want to bore each other, but we’ll lose track of the issue.

What causes investment? The prospect of profit causes investment. The savings rate does not cause investment. A strong economy means a strong demand for investment capital. Companies will go looking for it. Perhaps this would be more intuitive in the old days when individuals saved for the down-payments on their homes.

So how do they equilibrate in a closed economy, which ours is not? How does savings become to equal investment and investment become to equal savings?

A clue is offered inadvertently by the Right Wing apologists for the tax cuts for the rich. The rich save more, they say, and then go into the fallacy above of savings causing investment.

What is REVEALED in this feeble argument is a commonly acknowledged reality. As income goes up, the savings rate goes up. As income goes down, the savings rate goes down. Yes, it is the level of income that determines both investment and savings. My favorite analogy is a hot air balloon. The balloon rises or falls to the level that the air pressure inside is equivalent to the air pressure outside. The pressure inside does not cause the pressure outside to be the same. The pressure inside causes the balloon — income — to rise to an altitude where both are the same.

Income goes up. Better prospects for profit. Better opportunities for savers. Income goes down, not so much investment, not so much savings.

If you look again at the chart and see the downward trend beginning as so many do in 1980, reflect that the peak of the trend line in postwar growth was just a few years earlier, and that wages and income for the bottom half of American workers began to stagnate in this same period. This is the income that is missing. It is not a failing of financial morality, or at least not those at the lower end. It is a reduction in the means of middle- and lower-income Americans. If wages had trended up with productivity, as they should have, the savings rate would have remained stable. Instead, that productivity gain was transferred to the upper strata, and the savings rate stagnated.

Progressive policies to return middle class incomes to the middle class would reorient the savings rate and resurrect opportunity for tens of millions, not to mention reveal investment opportunity for the well-heeled.

Unfortunately, this income explanation means that as incomes go down in the current environment our attempts to pay down our debts or save will be frustrated. Saving in the aggregate will not be realized. Either I or another, perhaps a newly unemployed, will have to withdraw it to cover current expenses, or at these prices borrow again. Or look on the bright side, all those people losing their homes? At least the mortgage debt is off the books. Big new savings! Hooray!

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