Saturday, March 10, 2012

Notes on savings and wealth

What happens when grasshoppers turn into ants?

One theme that seems underemphasized in our economic debate is the importance of desires for saving in structuring the economy and generating the swings of economic activity. It sounds so nebulous, even touchy-feely, but has very real effects.

As the fable goes, the ant diligently stores up its little grains and other food for the winter, while the prodigal grasshopper fiddles and sings its summer away, then has nothing to eat come winter. The grasshopper asks the ant for a morsel, but the ant says no, and that is the bitter end of the tale. (Though a biologist adds that in reality, grasshoppers lay eggs that hibernate just fine, so not to worry!)

But in macroeconomics, a better metaphor might be that of a river as the normal course of economic activity, and a dam, which stores a reservoir of money saved in arbitrary amounts. To complete the analogy, the river would feature a prepetual motion system where outflows magically return as inflows to the system, completing the cycle. While the savings of ants are limited to their own insurance needs over relatively short periods of time, (however long those seeds keep), and are to that degree an unquestioned virtue, the advent of money allows unlimited stores of wealth to be accumulated, with dangerous consequences.

If everyone suddenly decides to save all their money, the stream down from the dam runs dry, no money is spent / returned, everyone is fired from their jobs, and the economy grinds to a halt. This is of course an extreme thought experiment. Most people have necessities that require ongoing spending, whether they like it or not. And there are always people being born and getting old, evening out the demographic savings cycle.

Additionally, the financial industry mediates the transformation of savings into new spending, via loans, stocks, bonds, and other investments. But when investors / gamblers head for safety, like in our current downturn, making fewer loans, fewer investments, and bidding down yields on the safest bonds, then a similar effect takes place- lots of inert money storage, and economic seizure.

There are also distributional issues. Is the stored money used to insure everyone's prosperity in lean times in equitable fashion? Or is it, by other rules, captured and used by a minority with military, political, or ideological power? Is it inherited by people with no claim to such wealth other than being born lucky? Or is it recognized as the patrimony of our forebears in common who painstakingly built our current wealth over generations in forms large and small? Should wealth and power be transmutable into each other? Who decides when to turn the spigot when times are lean and more flow down the river is needed? Is it the few with great wealth, or the many who have built it up, drop by drop?

Savings by different sectors of the economy have very different characteristics. I will discuss four sectors- individuals, businesses, banks, and the federal government. My discussion will mirror MMT viewpoints, as recapped recently by Bill Mitchell. One could also mention a fifth sector, of ecological savings, which has the biggest, baddest impact of all, but that is quite another topic!

Savings by individuals are removed from their consumption and may go to consumption by others depending on how they are invested. They could go to a personal loan to a relative, who founds a business and promises to make more money to repay in the future. Net spending hasn't been affected, and future economic growth may have been increased. If the money goes to the stock market, it increases that liquid store of wealth, with unclear future ramifications, but no immediate spending is implied.

If the savings are deposited at a bank, they may or may not be put to further use and spent as loans, depending on the mood of the bankers and the demand of their clients. Lastly, if the money buys government bonds, government spending is not affected in the least, as will be explained below. So individual saving definitely reduces the saver's own consumption, which may be replaced by other consumption or not, depending on how the saving is done.

Businesses save much like individuals. After Apple's near-death experience sixteen years ago, they were clearly eager to maintain a cushion to fall back on in their dotage, and by now have $80 billion lying around, which investors are eager to see as dividends. Other companies in the US are also sitting on very large piles of cash, adding their measure of pro-cyclical non-investment to our problems of economic growth.

Banks, on the other hand, are an entirely different beast. To them, loans are assets and savings, liabilities. All they need is capital, not savings from individuals. If a bank has $100 of capital, and no depositors at all, it can make $1000 of loans, which then instantly become deposits when the loan is "funded" (for retail banks, funding typically comes from borrowing in turn from other institutions, [the interbank market], whose rate is ultimately based on government bond rates, and which ultimately involves someone up the line creating money by leverage). This power of literally making money means that individual savings play an optional role for a bank, despite its historical importance from when money was not so easily conjured. In the dam analogy, banks might require a foray into science fiction, being able to produce water by the magical means of writing some words on paper, which matches each conjured drop of water with an anti-water debt certificate, the two of which mutually anihilate when brought together again.

But banks don't have to make loans, and can get by in today's environment where the Fed pays them to take a couple trillion in reserves, and where the spread between government bond rates and deposit rates remains positive. They can make do during a downturn with little loan activity.

As other businesses do, however, banks would like to have savings for one thing- to insure themselves against calamity. But since their business is leverage and their loans are always in the hands of others, it is impossible to do so significantly. Their safety revolves around their capital ratio. It is their appetite for risk, and their regulators, which decide whether 1:1, 10:1, 30:1, or 50:1 leverage is a prudent cushion of capital. Fluctuating opinions about this risk insure that banks will create the least amount of water just when it is needed most.

Last is the government, which is typically supposed to go into debt by deficit spending and to save by accumulating surpluses. When looked at from the perspective of the larger economy, however, the exact opposite is the case. The currency-issuing government can't run out of money, so to it, saving money has no meaning. It could just as well burn whatever comes in as tax receipts and print anew whatever it spends.

To the rest of us, federal deficit spending adds to the flow of income. (The associated bond sales have little net effect, transferring private savings from one to another form). Conversely, federal surpluses directly subtract money from the economy, reducing incomes and wealth. In the dam analogy, government is the sky which either rains down water or takes it back from the parched earth, limited by nothing other than its wisdom.

Putting all this together, economic conditions (or less tangible "mood", when considering future prospects) dictate whether individuals and businesses increase their savings, or whether they invest and demand loans. Our recent "little depression", where loss of wealth and unwise lending & borrowing created an enormous "debt overhang", requires excess saving for long periods of time, can depress this mood for years, even decades, as in the case of Japan. A population may be very savings-minded, again as in the case of Japan.

All this means that, even without economic bubbles, bank fraud, and complete regulatory breakdown as we saw over the last decade, swings in the economic system can result from changes in savings behavior. The government is in the position to address those swings, accommodating higher savings desires with higher deficit spending, allowing the inert pool of savings to grow while maintaining stable economic activity.

It is also worth noting that the government's capacity for deficit spending expresses implicit wealth, since such a practice can only avoid causing inflation when other balances are positive, such as population growth, people producing more than they consume, or other countries saving our dollars and giving us goods in return.

The bigger the reservoir of money gets, the better managed it needs to be, protecting us in common both from inflationary excess (dam breaks, monsoons of rain), and from deflationary evaporation. Nor is saving always a virtue. We eat bread, not money, so tending the systems of real production is what will sustain us in the long term. By this time in developed countries, we have far more money than we know what to do with. Yet it is so unevenly distributed that those with money can hardly find enough ways to spend it, let alone invest it, and those without flirt with insurrection and contemplate changes to the rules of acquisition.

"But fiscal flows – spending and taxation – are accounted for but once they exit the economy – as a surplus (spending less than taxation) then they are gone for good. There is no storage shed in Canberra or Washington or anywhere else where the surpluses are saved up and available for the government to drive a truck down and pick up some dollars to spend.
Surpluses destroy financial assets that were previously in the hands of the non-government sector and these assets are gone forever."
"The reality is that most of the gains in good times – and until the PSI ['private secotr involvement' in Greece's slow motion default] were privatised while most of the losses have been now socialised. Taxpayers of Greece’s official creditors, not private bondholders, will end up paying for most of the losses deriving from Greece’s past, current and future insolvency."

No comments:

Post a Comment