Asymptosis

The misconceptions embodied in this post’s headline sow more confusion in economic discussions than any others.

“Saving” and “Savings” seem like simple concepts, but they’re not. They have many different meanings, and their different usages (often implicit or unconscious) make coherent understanding and discussion impossible — even, often, in writings by those who have otherwise clear understandings of the workings of financial systems.

In short: if you disagree with this post’s headline, you are thinking (perhaps unconsciously) in the “Loanable Funds” model. And the loanable funds model is complete, incoherent bunk. (I’m not even going to bother citing the hundreds of supporting links here, including unequivocal papers from central bank research departments worldwide; Google them.) 

Think this through with me:

Your employer transfers $100K from their bank account to yours to pay you for your work. You’ve saved.

But is there more savings in the banks? More money to lend? Obviously not.

You buy $50K in goods from your employer, transferring the money from your account to theirs. They’ve saved. You’ve dissaved (spent).

But is there more or less savings in the banks? More or less money to lend? Obviously not.

You transfer $50K from your bank to your employer’s, in exchange for $50K in Apple stock or government bonds.

Did you just “save” again? Is there more savings? More money to lend? Obviously not.

When people save up money, they do not add to the stock of monetary savings — the mythical stock of “loanable funds.” Monetary saving does not increase monetary savings.

And since saving up money doesn’t increase the stock (supply) of money, it doesn’t lower the cost (interest rate) of money. On the aggregate level, saving doesn’t “fund” lending. (Banks lend by creating new money ex nihilo if they think they’ll make a profit; that’s what they’re licensed/chartered to do.)

This error and misunderstanding exists partially because there are two ways to “save,” which are widely confuted, conflated, and confused:

Pay people to create real assets — drill presses, houses, ideas, skills, etc. — that you own or have a claim on. Paradoxically, in this case you save by spending.

Increase holdings of financial assets (net of debt) — from dollars to debt securities to Dell stock to CDOs. (It’s much easier to think about this coherently if both dollar bills and deeds are viewed as financial assets: legal constructs designating particular rights or claims on real assets.)

The confution of these two, of course, was all hashed out many decades ago in the Cambridge Capital Controversy — when the MIT/classical Cambridgeans admitted defeat at the hands of the Cambridge Cambridgeans, including acknowledging their central point. (The classicals have proceeded to ignore the whole thing ever since, acting and thinking just as they did before, as if it never happened.)

…the measurement of the “amount of capital” involves adding up quite incomparable physical objects – adding the number of trucks to the number of lasers, for example. That is, just as one cannot add heterogeneous “apples and oranges,” we cannot simply add up simple units of “capital.” As Robinson argued, there is no such thing as “leets,” an inherent element of each capital good that can be added up independent of the prices of those goods.

(This also explains why the the Q in MV=PQ is utterly incoherent: the only unit that can be used to measure Q — dollars — varies with P. It’s like measuring a rubber band using a ruler whose inches vary in length with the changing length of the rubber band.)

People get confused about this partially because “saving” in the national accounts encompasses both real capital created (measured by dollars spent to create it), and net acquisition of financial assets. It’s not what people think it is: a simple sum of everybody’s money saving (income minus expenditures) — not even close.

Here’s how monetary saving happens — aggregate increases in people’s net holdings of financial assets:

People spend money (some of it borrowed from the financial sector), paying people to create real assets. (Purchases of existing real assets can spur creation of new ones — a second-order effect — but the creation’s the thing.)

The market decides that the financial assets that are claims on those assets are worth more than was paid to create the real assets. (Sometimes the market overestimates; this is a problem.)

The people’s debt is unchanged, but their financial assets are worth more. Their net worth has increased. They’ve saved up money. (When the market optimistically bids up financial assets, there’s suddenly, magically, more money.)

Saving (not-spending) money doesn’t increase monetary savings. We saw that obvious reality at the top of this post. Spending (partially enabled by new money creation via bank lending and government deficit spending), coupled with market re-pricing of financial assets, increases monetary savings. This is how the financial system monetizes the accumulated surplus from production.

Since saving money is not-spending, more saving results in there being less savings (relative to the counterfactual of more spending). Or if you must call them this, less loanable funds.

Spending increases savings.

There’s more I’d like to say, but I’ll leave this with a question for my gentle readers:

The IS/LM model seems to be inescapably based on the misconception detailed above — that more saving results in more savings hence, because of supply and demand for loanable funds, lower interest rates.

But: if Krugman’s constantly repeated assertions are correct, that model seems to perform very well.

Why is this true? What am I not understanding?

Cross-posted at Angry Bear.

I was having a discussion with a conservative friend recently, and challenged him to write up a budget for a decent life for a responsible, hard-working American:

Living in Shoreline, a relatively inexpensive area north of Seattle.

Divorced, two kids.

Not very smart or capable, but has worked hard their whole adult life.

He has so far demurred to do so. Said:

Ahhhhh. “Decent.” Sadly the scarcity red herring rears its head again.

I replied:

This is why I want you to do a budget. Because I think your baseline minimum — “not starving or freezing in the streets” — is Dickensian, cruel, utopian in a very dystopian way, and wildly unrealistic.

With very good reasons, none of us wants a large portion of our population living on that edge. I think you included.

We’re all worse off at that dystopian baseline.

Is there a scarcity of money in America? If that means “not enough for everyone to live a decent life,” no. (Though of course there’s competition for money. Not the same thing.)

I don’t think you understand what you’re really saying:

If income/wealth were less concentrated, inflation would be rampant because demand would be banging against scarce supply of real resources.

But that’s a fundamental misunderstanding of monetary economics, and of scarcity and resources in a modern economy.

In an 80% service economy where many physical goods are produced on demand (basically a service itself):

• The totally dominant “resource” is human effort/work hours/labor. (You know that your theories are are only true in a full-employment economy, right?)

• More spending causes more production (quantity). Close to 1:1. Think massages, and iPhones. If you don’t buy it, it doesn’t get produced. The primary adjustment mechanism is not via price. (The real market is not like the financial markets that way.) It’s via quantity.

IOW, in a market with huge untapped labor resources (limited “scarcity” of “resources”), the quantity elasticity of labor (“resources”) is high.

More spending (demand) causes more production (supply).

Another way to think about it: as the demand curve shifts up, it pulls the supply curve right. Quantity adjusts (mainly), not price.

Higher GDP (and GDP/capita), not higher inflation.

This is not, of course, an argument for perfect equality (don’t try that straw man). We know that would be a dystopia too. Other (i.e. incentive) effects are at play. Lots of moving parts.

But bottom line: in the high-productivity American services economy as it exists, Say’s law is pretty much 180 degrees wrong.

And we haven’t even bolted on lending/borrowing/debt/credit yet, much less fiat money or central banks.

The fundamental notion of scarcity is not the simplistic real-goods/barter-economy thing you think it is.

The policies you promote would result in a return to a more Dickensian society. Exactly what we see in countries with high inequality and small governments. Not a country you want to live in.

Truly, taking America back.

Show me a realistic budget for a decent life for the responsible, hard-working American I’ve described.

And tell me why — if we can have a country where everyone can have that decent baseline, while huge upsides still exist for smart stivers — we shouldn’t do so.

Since you’re so fond of pooh-poohing “fairness” arguments, a reason beyond “It’s not fair to confiscate my money!”

Cross-posted at Angry Bear.

I’m hoping my gentle accounting-dweeby readers can help me.

I’m very interested in looking at economic measures (i.e. debt/lending/borrowing) for the U.S. “real” sector: households plus nonfinancial business.

My problem: with some exceptions, various national accounts (NIPA, FOFA, IMA) don’t provide tables for this “sector.”

I don’t think I can simply sum up household and nonfinancial business, because some of the lending/borrowing is between these two sectors. Is it possible to net that out based on published tables?

I’d really like to see a sectoral balance chart (really a “balance of flows”) displaying the following sectors:

Domestic Real
Domestic Financial
Government
Rest of World

I’d really love to see the lending/borrowing flows from each sector, to each other sector. Sized arrows between each. Is this possible?

That sectoral breakout is tricky, of course, because firms —  especially financial firms — are heavily engaged in ROW. Is it even possible to realistically estimate the financial sector as a purely domestic entity?

Any thoughts and suggestions are welcome. Thanks.

Update: A further condundrum: at least in the FOFAs, hedge funds are tallied under Households. This is presumably because like households but unlike commercial banks, they’re not licensed/chartered to print new money for lending (at least nominally, technically…). To the extent that “hedge funds” includes the whole goddam shadow-banking industry (?), it seems like this would (wildly?) distort numbers for the household hence the real sector. Also: Several  banks and holding companies, i.e. Goldman Sachs, magically transformed themselves into commercial banks during the financial crisis, so they could tap bailout funds. How did national accountants deal with that? How would it affect time series of debt/lending/borrowing for the financial and real sectors?

 

 

I don’t think there’s anything eye-popping or revolutionary this post, but it’s thinking that I’ve been finding useful.

Long before Larry Summers bruited his recent ideas about secular stagnation and the need for bubbles, I came up against this great line from Nick Rowe (April 2011):

The economy wants a Ponzi scheme.

I’ve been pondering that line ever since. (As usual with Nick, read the whole post.) Pretty quickly, I came to an even more radical belief:

The economy is a Ponzi scheme.

Economies are exercises in log-rolling, but with magical logs that expand when more people climb aboard and run faster, and and contract when people slow down or fall off. People can fall off because there’s not enough room on the log, because they can’t run fast enough, or because they try to stand still or run too slowly. (Sorry to torture the metaphor so.)

To put it another way:

Economies are confidence games.

When people are confidently optimistic (the two are not synonymous), more people jump on the log and run harder, because they think there will be personal profit in it.

But where does that confidence come from? I would suggest that most people form their expectations for the future based on the present and recent past. (A very reasonable Bayesian stance.) How much money do I have? How much is coming in? How do those compare to the recent past? (Market monetarists: Idle guesses, surmises, and predictions about the Fed’s future policy stance seem wan, weak, and feckless compared to those very tangible and tally-able present indicators.)

Which bring me back to a current favorite graphic, showing that every recession since 1960 was preceded by a decline in the inflation-adjusted (“real”) value of household assets:

There are only two instances (since 1960) where this measure fell below zero and there was not a recession: 2002 and 2011. Both look like aftershocks/carry-ons from the preceding recession. (Or: Maybe these times are different?? Think: massively higher household debt.)

The confidence story I’m telling here: people give huge weight to their current wealth/assets/net worth, and recent changes in those measures, when forming expectations for future growth — far more weight than they give, for instance, to their predictions of Fed behavior (the huge mass of people have no such predictions). This may be foolish or it may not be, but it’s what people do. (They undoubtedly also give big weight to current income and recent changes in income. I’ll let somebody else graph that.)

Or you could say: declines in household assets means there’s less money. (All financial assets embody money.) And at that point you can invoke a straightforward monetarist explanation — with a Minskyish self-perpetuating component added — for recessions.

The key point: the decline in real household assets always precedes the recession. It’s at least a leading indicator of real production declines, and at most a cause. When people feel poorer, they act poorer. (I told you this post wasn’t revolutionary thinking.) They spend less. So there’s less production. (In an 80% service economy with just-in-time production of many physical goods, if spending doesn’t happen, production doesn’t happen.) So there’s less (demand for) labor. The log shrinks and slows down. GDP and employment (growth) slow or decline.

Okay, yeah, Wealth Effect, blah blah blah. But the assertion I’m making is that people don’t just spend more when they feel wealthy or wealthier. They raise their expectations of future wealth, and consume/invest according to that. You get a positive or negative self-perpetuating feedback effect.

Going abstruse with this: Given the widespread belief that quantitative easing only really achieves any effect by buoying financial-asset prices (I include deeds in that class of assets), is it reasonable to suggest that the Fed is actually (and unconsciously, and arguably incompetently) engaged in Real Household Asset-Value Targeting (RHHAVT)? Can they limit the feedback effects? Should they shift to level targeting (RHHAVLT)?

Cross-posted at Angry Bear.

I’m rather devastated to find (thanks to Tom Brown at Pragmatic Capitalism!) a discussion  I missed at Winterspeak’s place from mid-December, with some of my favorite commenters going after the underconsumption argument that I’ve been going on about.

It starts by citing Mark Sadowski’s comment from Interfluidity “clarifying the difference between wealth and income.”

I found that rather puzzling at first because the first-blush, obvious difference between the two is that one’s a flow and one’s a stock. Duh. But I figured out that he’s actually distinguishing between income and capital gains, making the well-known point that in the language of national accounts, capital gains aren’t income.

I’d like to address two points here:

1. I think JKH would say that this is all as it must be — that it’s conceptually incoherent to think of capital gains as income. I understand why he would say that. But I’d like to push back on that.

Imagine a company in two counterfactuals — a simplified, stylized representation.

Scenario A: All earnings/profits are paid to shareholders as dividends every year. Book value remains unchanged.

Scenario B: All earnings are retained. Book value increases 1:1 with earnings.

Now: a shareholder holds shares for thirty years, then sells at book value. (Assuming the paid-out dividends and the retained earnings are “invested” identically — say in physical cash that earns no interest, to keep things simple.)

At the end of the period, the shareholder has received all those earnings in each scenario, and has identical wealth in each scenario.

Is it conceptually coherent to say that in scenario B, the shareholder had zero income?

Within the linguistic and logical constructs of the national accounts, yes. But in any reasonable economic construct, it’s crazy. The shareholder accrued those earnings every year; they were just “unrealized” via sale. Just because those earnings were tallied up on the corporation’s books, instead of the individual’s (and eventually transferred to the individual’s), can we reasonably say that the shareholder’s share of corporate earnings were not accrued income?

See JW Mason’s comments at Winterspeak for more on this, expressed more authoritatively than I can achieve.

2. Sadowski says “In underconsumption theory recessions and stagnation arise due to inadequate consumer demand relative to the production of new goods and services.”

That may be true. But I would suggest that underconsumption theory is not nearly so standardized — that in fact it’s wildly un(der)theorized. (I do wish [liberal] economists would get on this hobby horse…)

In my bruited notion of underconsumption, stagnation arise[s] due to inadequate consumer demand (“spending”) relative to wealth — which I define somewhat roughly as the total stock of financial assets. (Claims on real assets, or future production, which have a rough equivalence that I won’t discuss further here.*)

It’s a straightforward monetarist(ic)  velocity argument, but with “money” defined as “the exchange value embodied in financial assets.” (In this construct, all financial assets embody money, including those things like currency that have traditionally, in the vernacular, been called “money.”) So the “money stock” is the market value of all financial assets, from dollars to deeds (yes, deeds) to CDOs.

Because of declining marginal propensity to spend relative to wealth (which I think no one will contest), increased concentrations of wealth, arithmetically and inexorably, result in lower money velocity, ceteris paribus.

I posted two graphics to demonstrate this velocity/stagnation situation over the decades. (You can argue with the specific economic measures used here, but they’re reasonably representative of the big picture.)

Personal Consumption Expenditures as a percent of Household Financial Assets:

(Personal Consumption Expenditures + Business Investment Spending) / (Household Total Assets + Business Total Assets)

Now these are showing ratios, and it’s possible that an increased denominator (assets) is where the big secular change occurred: arguably many more of the country’s real assets were financialized/monetized/capitalized over the decades shown. (Think: student loans monetizing/present-value-capitalizing those student’s human capital and future earnings.)

But if we’re just surmising, we can say it’s equally possible that the declines here are numerator-driven — resulting from declining spending out of wealth due to wildly increased wealth and income concentrations. I’d expect that both are true.

Somewhat as an aside, I also made a straightforward “money-supply” assertion about recessions, again using my preferred definition of “money.” I’ll share it in the concise language that Twitter requires and encourages so admirably:

Every recession since ’60 preceded by decline in infl adj value of HH assets. Two false (?) positives: 02 and 11.

— Steve Roth (@asymptosis) January 10, 2014

This is getting long so I’ll stop here, with one final assertion:

Any aggregate consumption function (viz: Keynes’) that doesn’t incorporate some measure(s) of wealth, that doesn’t incorporate some measure(s) of wealth and income distribution, and that doesn’t include (distinct and probably interdependent) functions for declining marginal propensity to spend out of wealth and out of income, is useless.

* I have to toss in one more pet peeve here: financial assets (often called financial “capital”) are not capital! They’re claims on capital. And contrary to much sloppy and often implicit thinking and discussion that you see out there from professionals and amateurs alike, they’re not an “input to production.” 

Cross-posted at Angry Bear.