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.

Asia Coming Unglued

The news out of Asia has been absolutely atrocious. Here are a few recently released gauges:

Japanese industrial output down 16.2% in November
Japanese exports down 26.7% in November
Japanese Real wages down 3.1%
Economic contraction of 1.8% in Q3 after a 3.7% decline in Q2 (estimates are for -12% in Q4)
Japanese December sales down 22% to a 34 year low

Japan is literally falling apart. Their own deflationary depression had been propped up for years by the enormous consumption bubble in the west and the massive expansion in China that resulted from it. Bernanke and other "academics" have mistakenly attributed this phenomenon to Japan's government stimulus programs in the 90's and quantitative easing starting in 1999. Now, as the US consumer bubble collapses and the China bubble goes with it, we are left to see that they had only postponed the inevitable consequences of a mania gone bad. The west doesn't even have that luxury now. There's nowhere to export to - and even if there were, there's no manufacturing capacity remaining.

Today we hear that Toyota is to halt production for 11 days.

From the article:

"Analysts say drivers are opting to hold onto their old cars for longer and making more use of public transport, while younger people are losing interest in having a car."

(emphasis mine)

From a socionomic and generational perspective, this should come as no surprise. The young Japanese have inherited an incredible amount of public debt. Going out and buying a new Lexus would only serve to associate oneself with the recklessness of the past. They'd rather take the train or ride their bike.

But the carnage is not limited to Japan:

Singapore Q4 GDP down 12.5%
Singapore non-oil exports fall 17.5%
Taiwan November exports fell 28% - exports to China fell 45%
Taiwan industrial output contracts 28.35% in November
Korean November exports down 19% in November, 17.4% in December
Korean industrial output down 14.1% year over year in November
Chinese manufacturing contracts for 3rd straight quarter in December
Chinese electrical output contracts by 9.6% in November

These are not your typical recession numbers. They are all far worse than what was seen even in the Asian economic crisis of the late 90's. Asia is entering a full-fledged depression. The decoupling theory has now turned into one of the biggest shams of the decade. It turns out that much of the growth experienced there was artificial also. The notion that they would all be able to gradually shift to domestic consumption when the west slowed was based on nothing other than wishful thinking. They don't have the infrastructure to start consuming more. And they don't have the consumerist mentality to consume more. In fact, now that many are losing their manufacturing jobs, are experiencing huge losses in the stock market, and see the unravelling going on around the world, their natural inclination is to save more and consume even less. Go figure.

To be sure, I don't put much stock into any statistic coming out of China, nor do I for any country for that matter, but especially not China. So even if these numbers look terrible, I fully expect them to be far worse in reality. Social unrest in Asia is one theme I expect to be very prevalent this year. Already we are seeing violent clashes inside the Korean Parliament. And Japanese Premier Taro Aso, who's approval rating sits at 20% is rebuffing calls for his resignation. Are political troubles in China soon to follow? Even China's state-run media seems to acknowledge that possibility.

Whatever 2009 brings, we can be reasonably certain that any relative leadership will not be forthcoming from Russia or East Asia. However, there is a good argument to be made that China and the Tigers (Korea, Taiwan, Singapore) are in a similar position to inter-war America. Regardless of how bad things get, it is a distinct possibility that some of the best long-term opportunities may be found when it appears Asia is in irreparable chaos. Now may be a good time to start preparing some wish lists among the dual listed securities we have access to.

Themes for 2009 - Part 6 (Final Thoughts)

I am often confronted by readers who feel I am too pessimistic. I am told that "things have a way of working themselves out." Instead of always looking at the glass half-empty, I should instead look at it as half-full.

My response to this is usually the same. That these people are misinterpreting my point. What I am saying, is that what we have experienced over the last 10-15 years has not been desirable. That all of the thoughtless materialism and constant obsessiveness about money were in fact destroying the very institutions that made our various cultures great. Groups of friends were separated into social classes. We became suspicious of our neighbours instead of automatically trustworthy. Families were working longer hours to "keep up with the Jones'." Bigger, faster, sexier took over from efficient, practical and natural. This is what is collapsing.

So am I a pessimist to advocate a further erosion of that? Hardly. I'd argue that I'm actually an optimist - regardless of the nasty side-effects. With that in mind, here is a summary of some major themes I expect to be prevalent in 2009. I offer it with my usual caveat: Some of it will be right, some of it will be laughably wrong. Chaos theory ensures that much. There are any number of "Black Swan Events" that could come along and render some of these themes as not only wrong, but irrelevant to more important issues.

- Government attempts to "get credit moving again" will fail. The credit contraction (deflation) will continue even as governments and central banks do everything within the law (and even some outside) to encourage hyperinflation
- Crumbling corporate earnings as consumer psychology moves away from the "gotta have it now" mentality to "it can wait until next year"
- Municipal and State bankruptcies requiring federal bailouts in the US
- Skyrocketing unemployment. Official figures to reach 9% or higher in the US.
- Worldwide social unrest or even war as currency collapses, unemployment and falling asset prices shake people's faith in their governments and scapegoats are made of traditional enemies
- Plummeting stock markets worldwide with losses of 50% or more in major indices as hype over President Obama wanes
- A wave of bankruptcies in retail, restaurants, airlines and financial services. Nationalization of the politically well-connected
- A continued strength in the US Dollar vs most other major currencies as European infighting escalates
- Declines in the price of gold but continued relative outperformance to other assets and most currencies
- Large declines for Canadian real estate, notably in bubble areas of the west and prairies
- Social "witch hunts" for those responsible for the common plight. Multiple scandals uncovered. Persecution and enormous tax increases on the extremely wealthy
- An increased focus on the family, on close friends and "time" in general

One reads a lot of "predictions" for the coming year around this time and these will probably be among the more dire that you come across. Keep in mind that I too would benefit very little if such events were to transpire. My own family and friends will be affected. No individual can come away from such a situation unscathed. Although society itself will be much healthier once all is said and done.

However, among other sets of predictions I see a striking pattern of unrelenting bullishness. The common citation for this bullishness is that there is too much negativity. I find it difficult to wrap my mind around that paradox. If everyone is so bullish, how can their reason be that everyone is bearish? Take the following anecdotal evidence. As of this writing, I am looking on Bloomberg.com and their videos section has four videos with the following titles:

Cantor's Pado sees bull market for US stocks in 2009
Jeffery Saut says, "worst has been seen" for stocks
Vitner sees "definitive bottom" for home sales in 2009
Analysts say Obama stimulus to "drive stocks higher"

The Wall Street Journal has the following article on strategist predictions for 2009. 80% of the 20 strategists surveyed see higher stock prices for 2009, many of them substantially so. This New York Times article does a better job than most in pointing out some caveats in the forecaster's methods, but still leaves the reader with optimistic conclusions. Clearly, the consensus is not for a continuation of 2008, and almost nobody is expecting an acceleration.

Another observation I have made over the last few days is the increasing use of the word "hope" by analysts and commentators on TV. They all "hope" that Obama's stimulus plan will have a positive effect. And they "hope" that corporate earnings will recover in the second half. Yet, when pressed, none of them can explain exactly how these things will happen. To me, hope is not a viable investment vehicle. I prefer to see strong balance sheets with increasing opportunities for growth when I look at buying companies. "Hope" does not often enter into the equation. It appears that these analysts, all of whom presumably own a great deal of stock, need the markets to rise in 2009 and are searching for what they think could be the catalysts for that to happen. Typically, such sophistry backfires.

Perhaps I'm wrong. Perhaps that black swan event turns out to be something revolutionary. Maybe CERN's Large Hadron Collider will teach us how to make infinite amounts of energy from nothing. Maybe we discover a miracle drug that renders sleep unnecessary. But really, do we actually want the bubble to reflate again only to come crashing down a few years later? Is that really a noble objective? I don't think so. I suppose that's where I differentiate myself between most other analysts and politicians.

Let me wish all my readers a healthy and happy New Year. Try to remember that net-worth and self-worth are not the same things. When it is all over with, even if that takes years, those who were part of the solution will be revered. Those who were part of the problem will be reviled. Keep that in mind.