Thursday, January 8, 2009

There Is No "Paradox" In Saving

Considerable ink has been spilled over a recent article in the Wall Street Journal titled, "Hard-Hit Families Finally Start Saving, Aggravating Nation's Economic Woes." And for good reason. The article, as it's title implies, seeks to perpetuate the myth that saving is a bad thing and if everybody just kept on spending like crazy, the economy would recover nicely and we'd all live happily ever after.

This, of course, is absurd.

To be fair, the article is a good one and well worth reading. However, the offending paragraph and the note on which the article ends, leaves me either wanting to bang my head against a wall or whine about it for all to see. Having chosen the latter, I offer the offending paragraphs:

Usually, frugality is good for individuals and for the economy. Savings serve as a reservoir of capital that can be used to finance investment, which helps raise a nation's standard of living. But in a recession, increased saving -- or its flip side, decreased spending -- can exacerbate the economy's woes. It's what economists call the "paradox of thrift."

This is not what economists call the "paradox of thrift." This is what Keynesian economists call the "paradox of thrift." Until journalists begin to point out the difference, I will continue doing it for them.

Keynesians believe that the future is made up of a whole bunch of short-terms. According to them, as long as we ensure that everything is hunky-dory in the short-term, nothing can ever go wrong. The arguments against this kind of swiss-cheese logic should be self-evident, however they are not. Not to the vast majority of economists that have infected our universities and governments.

To them, cumulative imbalances are strange and inexplicable phenomena. They come out of the blue, like monsters hiding in the closet. What's more, any explanations of the imbalance citing past missteps or oversights are quickly disregarded as it would pose a threat to their current legitimacy.

The article goes on to accurately describe how normal, middle-class families are cutting back on expenditures to compensate for falling net worths in real estate and the stock market. In order to leave a lasting impression of sinfulness in any reader who may be experiencing a similar situation, the writer finishes with:

This year, Mrs. Capp and her husband are resolved not to touch the $2,600 they have in savings, and to augment as soon as possible. "You look around, you see the closing stores, and you know someone needs to spend," Mr. Capp said. "Just not us."

The insinuation in all of this is that saving is wrong. That if one were a true patriot, he/she would spend everything they had to support the economy. Unfortunately, even a child could figure out how this is counterproductive. Once all the savings are spent, spending would eventually fall anyway. Eventually is now. We have been pushing off saving, and trying to spend our way out of recessions for decades now. So much so, that the savings rate actually dropped below zero - just as home prices in the US were peaking.

Mike Shedlock had a few words on the article in Families Start Saving; Does This Aggravate the Nations Woes? Here is what he had to say:

...In Austrian economics terms, saving is what is left over (not consumed) from production.

Keynesian theory suggests you can have something today and tomorrow which is of course as preposterous as having your cake and eating it too. In simple terms one cannot consume what one does not produce, at least not forever.

Spending now will only borrow from future production. The United States has been doing that for decades and all we have to show for it is an exodus of manufacturing jobs from the United States to China, and a housing bubble of epic proportion.

There is no paradox. The United States has borrowed itself into oblivion. Consumers have finally seen the light and are attempting to save in spite of horrible economic policy encouraging them to do otherwise.

Indeed. Politicians of all mainstream colours have been instructing people to do the exact opposite of what is in their best interest. Conservatives, Republicans, Liberals, Democrats, Socialists. They all have the same solution: Hair of the dog.

Kevin Depew also took issue with the same paragraph in From Generation Boom to Generation Save-a-Lot:

... While this part in the Journal article - "savings serve as a reservoir of capital that can be used to finance investment, which helps raise a nation's standard of living" - certainly is true, the real problem is blissfully glossed over into the next sentence on the "flip side" of savings, where "decreased spending... can exacerbate the economy's woes."

See, while decreased spending exacerbates economic woes, that's not the real issue. The real issue is related to first half of the equation; a reservoir of savings. We haven't had a "reservoir of savings" in this country in nearly two decades. Indeed, the central bank, by disguising that lack of savings with artificially low interest rates, is the reason this necessary step to repair consumer balance sheets and restore saving sis going to be so very painful.

The bottom line? Consumers are now saving and repairing balance sheets. This is a secular trend, not a temporary aberration, that will crush consumption for far longer than even the most bearish economists expect.

Meanwhile, even as asset price (stocks, junk bonds, etc.) deflation temporarily stalls, guess what is happening to the labor market and wages? They are deflating at a near-record pace. moreover, this is not just happening in the U.S., but globally. You do not get inflation from this kind of structural deflationary debt unwind, at least not for many, many years.

So, those who today are selling Treasuries, buying risk assets and hoarding gold in anticipation of "The Coming Great Inflation" will, ironically, be among those contributing to the elements of structural deflation in the not-so-distant future.

Depew hits this one out of the park. The savings rate has been below average for a long time. Now, as we return to the mean level of savings, and likely beyond (as mean reversion typically operates) the victims will be all sorts of trinket salesmen, doggy daycare operators, nail salons, and numerous other nonsensical businesses that only functioned due to society's unwillingness to save a penny.

If we are going to have a legitimate recovery, it is going to come from private savings. Trying to prop up asset prices as a means to encourage people to spend more is as intellectually fallacious as it is undesirable. Asset prices need to fall to a level commensurate with the level of true capital. Not capital "backed" by credit derivatives. Not capital "backed" by government guarantees. That is not capital. That is a liability masquerading as capital. Now the masquerade is over. Savings come from labour. From production.

We are going to have to work harder, consume less and save more. Lower wages are something we're going to have to expect. Once we have done this for long enough, and enough of the aforementioned nonsensical businesses have gone to business heaven, then we can get back to entrepreneurial people providing value-added goods and services to the population. Until prices fall enough for such a start-up to make economic sense, it simply won't happen. A butcher who gets his meat from a local farmer, thus providing a superior product, cannot pay $2,200 in monthly rent. Drop the rent to $900 and it might make sense. A copper mining company cannot pay $40/hour in wages and benefits to their miners. Not with Copper at $1.50/lb. Drop the wage to $15/hour and it might make sense.

This is what it is going to take in order for us to recover. There is no "reservoir of savings" to fall back on. Prices need to fall and savings need to rise. Everything our politicians and their economic advisers are doing is a direct attempt to prevent that.

Judging by their record, are you going to listen to them? I highly doubt many will. And that is precisely why hyperinflation is impossible now or any time soon.


Anonymous said...

Hi Matt,

Your blog is inspiring. I am a third year university student in economics. I am also very interested in investments.


Gil said...

Every dollar saved is one less dollar that can by multiplied x10 by that magical, mythical, fractional, fiat thingy, esp one stuffed into a mattress.

"We saved too much!" Wasn't that a GD quote?

Hording cash may become illegal...

I was in the hyperinflation camp but have since moved into the deflation side.

Money isn't gold, silver, paper. Money is whatever people accept in the transaction of their goods. Seashells, cows, party hats.

Lesson really sunk in when I sold my silver. 1 oz generic rounds sell for less then SAE or Maples. Who thought that not all silver bullion is created equal.

But the main thing I learned was people had more faith/desire/prefered for US silver coins.

US dollars are money long as people accept/prefer it.

Not sure what is going to happen but I'm 50-50 US dollar & gold.

Bankers hold both. Bankers run the world. I'll switch once the bankers switch.

Thanks for the blog! You are helping to clear my mind. I'm suffering from much info, too little time.

Matt Stiles said...


I used to often say, "gold is money."

The correct phrase is "gold is often money." I'm fairly certain it will become money again in my lifetime. I just don't know when. But I think the "sound money" crowd would do better to just push for a competitive currency system. That way people can determine themselves.

Of course, this would also require the abolishment of the income tax.

Thanks for the comments.

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