A post by Edward Harrison
Recently, I wrote a post which examined three different reasons the savings rate in the US could have been falling over the last year. Rebecca Wilder thinks this is a meaningless exercise:
Edward Harrison at Credit Writedowns is theorizing why the saving rate is falling when it should be rising, as households scram to deleverage their balance sheets. My reaction to this is twofold: first this is a meaningless exercise; but second, and worse yet, there’s likely something very "unhealthy" going on here.
Meaningless: The BEA conducts a comprehensive revision of the NIPA tables every five years. The saving rate is usually revised upward, and by a fair amount, as was the case for most of the 2000s.
So in "roughly" 5 years from 2009 (it’s not uniformly 5 years between each revision), you will see a higher saving rate than you do today. As I said in July, the
"BEA has "found" that households have been in fact saving roughly 1% more of their disposable income per quarter since 1995, 0.9% per quarter in 2008."
They will "find" it again.
The thing is that we are not looking at savings rate levels but changes in those levels. I have seen the NIPA revisions and I even mentioned the fact that some pundits feel the savings rates will be revised upward:
Note that some pundits believe the data are inaccurate and that the decline has been nowhere as large as the data now indicate. Time will tell.
I reckon that when the revision do come in, regardless of whether they are revised higher, they will show that the savings rate did in fact still dip precipitously from mid-2009. That IS indeed what we saw in the revisions in 2004 after interest rates were dropped as indicated in Wilder’s charts. The question is why.
Understanding why savings rates are dropping in the midst of a still severe economic shock, weak credit growth and sustained high levels of unemployment will tell you something about the durability of the policies used to goose GDP over the past three quarters. So, this is not meaningless in the least.
I have proffered three potential reasons why. Wilder offers another: the black market for labour:
With an employment-to-population ratio a shocking 58.5% in February (it was 63.4% as recently as March 2007), there’s got to be a growing supply of labor that is "working under the table" just to get by. This non-market income would flow through the spending accounts but not the income accounts. Therefore, you have official consumption going up with official income (doesn’t include non-market income) stalling, which reduces the saving rate.
Implicitly, what Wilder is suggesting is that the savings rate actually is not dropping, that what we will see later is that a revised savings rate will be relatively flat from 2009 to 2010. Obviously, I disagree. But as I stated above, time will tell.
However, more important in my analysis is the conclusions about stimulus one could reach. If I am right about asset prices being responsible for a downshift in the reported savings rate, we shall see that the withdrawal of stimulus leads to a fall in asset prices and a relapse into recession.
Moreover, in a post on the recent personal income data, I wrote:
The challenge the US faces is how to maintain consumption growth in the face of continuing pressure on income. Businesses are enjoying a huge resurgence in profit and this has contributed to their savings and low debt levels. Yet, households remain indebted. Moreover, after the 2009 stimulus shot in the arm, disposable personal income is not going anywhere.
Unless US policymakers solve this problem – the divergence in the benefits of economic policy for business and households, consumption growth will have to slow. If consumption does slow and asset prices stall, the US will be headed back into recession.
If you understand the financial sector balances approach, the increase in the government’s deficit must be balanced by a concomitant increase in the combined private sector and capital account surplus. Put simply, if the government goes into greater deficit, this increase must be balanced by an increased surplus of private sector savings or capital account inflows.
Clearly the aim of the deficits should be to increase household sector savings. But what I am stating rather clearly I believe is that this is NOT the aim of the deficits in the least. Nor is it the aim of monetary policy. Instead we have:
an industrial economic policy in the US which is predicated simultaneously on suppression of domestic wage growth and on consumption growth in order to boost corporate profits and increase asset prices.
In fact, the Federal Reserve’s low interest rates discourages household sector savings and promotes the accumulation of debt. The government may expand in order to induce an increase in net private sector savings, but fiscal expansion is a blunt instrument. The government cannot (in the short-term) determine where capital account or private sector surplus is directed or held. Right now, government deficit spending is increasing business savings and not household savings.
Moreover, having low nominal rates skews investment toward payoffs with long lead times (think telecom infrastructure or tech in the 1990s and property in the 2000s). Longer-term, much of this shows up as malinvestment. You can’t expect an adequate long-term return on capital when average nominal rates across the business cycle are low.
What will happen instead is that firms like pension companies that have actuarial assumptions that are pegged to higher nominal returns will reach for return creating a misallocation of investment capital to riskier enterprises. Much of this will turn out to be a dead weight loss to the economy. You see this already with the returns in high yield bonds and the prevalence of payment-in-kind securities in leveraged finance deals to boost returns.
This is just an asset-based economic model predicated on ever-increasing asset prices. There is certainly something "unhealthy" going on here. Low rates are no panacea for slow economic growth. Nor is deficit spending in the absence of a purge of accumulated malinvestment. Trying to increase demand to meet excess supply simply doesn’t work, especially in an aging population. Just ask the Japanese.
A reader tipped me off to a recent FT article by former Daiwa Securities Chief Economist Tadashi Nakamae, "How Japan could lead the way back to durable growth," which points to excess capacity as a reason for Japan’s continued malaise. He makes good points that I have made about malinvestment previously. I especially like it when Nakamae says:
demand-side fiscal and monetary policies have served only to delay the much-needed elimination of excess capacity.
That is exactly what I have been saying. However, I do have concerns that his ‘solution’ of firing people en masse as he suggests leads to a deflationary spiral. More likely, it is better to allow marginal firms to fail.
As Wilder correctly states at the end of her piece, it is an increase in household income which will truly increase demand – sustainably. Wilder gives one example of how to increase income via a jobs program, something I have also broached and called unemployment insurance for the 21st century. See The consumption response to income changes from Vox for another take.
Also see Nakamae’s prescient remarks from January 2008 on the reluctance to write down debt in the banking crisis in the FT’s Japan’s salutary tale in banking crises.
The saving rate paradox – Rebecca Wilder