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According to the
latest government data, the personal saving rate has eased to 4.6% in June
from 6.2% in the month before. Despite the fall in the personal saving rate
from May to June, the saving rate of 4.6% must be contrasted with the rate of
0.4% in June of just last year. In terms of the dollar, personal saving
climbed from an annual $46 billion in June 2008 to $505 billion in June of
this year. This means that since June last year savings have been in visible
increase. But
is this really the case?
Figure 1
According to the
National Income and Product Accounts (NIPA), the saving rate is established
as the ratio of personal saving to disposable income. Disposable income
is defined as the summation of all personal money income, less tax and
non-tax money payments to the government. Personal income includes
wages and salaries, transfer payments, income from interest and dividends,
and rental income.
Once we deduct
personal monetary outlays from disposable money income, we get personal
saving. Personal saving, then, is determined as a residual.
But is it valid
to add all incomes in an economy in order to establish the so-called
"national income?" Does the summation of money incomes equate with
the true national income? Let us explore this point.
Why Government
Data on Saving is Misleading
The nature of the
market economy is such that it allows various individuals to specialize. Some
individuals engage in the production of final consumer goods, while other
individuals engage in the maintenance and enhancement of the production
structure that permits the production of final consumer goods.
We suggest that
it is the producers of final consumer goods that fund — that is,
sustain — the producers in the intermediary stages of production.
Individuals who are employed in the intermediary stages are paid from the
present output of consumer goods. The present effort of these individuals is
likely to contribute to the future flow of consumer goods. Their present
effort however, does not make any contribution to the present flow of the
production of these goods.
The amount of
consumer goods that an individual earns is his income. The earned consumer
goods, or income, supports the individual's life and well being.
Observe that it
is the producers of final consumer goods that pay the intermediary producers
out of the existing production of final consumer goods. Hence, the income
that intermediary producers receive shouldn't be counted as part of overall
national income — the only relevant income here is that which is
produced by the producers of final consumer goods.
For instance,
John the baker has produced ten loaves of bread and consumes two loaves. The
income in this case is ten loaves of bread, and his savings are eight loaves.
Now, he exchanges eight loaves of bread for the products of a toolmaker. John
pays with his real savings — eight loaves of bread — for the
products of the toolmaker.
One may be
tempted to conclude that the overall income is the ten loaves that were
produced by the baker, plus the eight loaves that were earned by the
toolmaker. In reality, however, only ten loaves of bread were produced
— and this is the total income.
The eight loaves
are the savings of the baker, which were transferred to the toolmaker in
return for the tools. Or, we can say that the baker has invested the
eight loaves of bread. The tools, in turn, will assist at some point in the
future to expand the production of bread. These tools, however, have nothing
to do with the current stock of bread.
While the
producers of final consumer goods determine the present flow of savings,
other producers could have a say with respect to the use of real savings. For
instance, the toolmaker can decide to consume only six loaves of bread and
use the other two loaves to purchase some materials from material producers.
This additional
exchange, however, will not alter the fact that the total income is still ten
loaves of bread and the total savings are still eight loaves. These eight
loaves support the toolmaker (six loaves) and the producer of materials (two
loaves). Note that the decision of the toolmaker to allocate the two loaves
of bread towards the purchase of materials is likely to have a positive
contribution toward the production of future consumer goods.
The introduction
of money will not alter what we have said. For instance, the baker exchanges
his eight saved loaves of bread for eight dollars (under the assumption that
the price of a loaf of bread is one dollar).
Now, the baker
decides to exchange eight dollars for tools. This means that the baker
transfers his eight dollars to the toolmaker. Again, what we have here is an
investment in tools by the baker, which at some point in the future will
contribute toward the production of bread. The eight dollars that the
toolmaker receives are on account of the baker's decision to make an
investment in tools.
Note once more
that the tools the toolmaker sold to the baker didn't make any contribution
toward the present income — that is, the production of the
present ten loaves of bread. Likewise, there is no contribution to the total
present income if the toolmaker exchanges two dollars for the materials of
some other producer. All that we have here is another transfer of money to
the producer of materials.
Obviously, then,
counting the amount of dollars received by intermediary producers as part of
the total national income provides a misleading picture as far as total
income is concerned.
Yet this if
precisely what the NIPA framework does. Consequently, savings data as
calculated by the NIPA is highly questionable.
The NIPA Follows
the Keynesian Model
The NIPA
framework is based on the Keynesian view that spending by one individual
becomes part of the earnings of another individual. Each payment transaction
thus has two aspects: the spending of the purchaser is the income of the
seller. From this it follows that spending equals income.
So, if people
maintain their spending, they keep income levels from falling. And this is
why consumer spending is viewed as the motor of an economy.
The total amount
of money spent is driven by increases in the supply of money. The more money
that is created out of thin air, the more of it will be spent — and
therefore, the greater the NIPA's national income will measure (see Figure
2). Thus, an increase in the money supply on account of central bank policies
and fractional-reserve banking makes the entire calculation of the total
income even more questionable.
Since this money
was created out of thin air, it is not backed by any real goods; income in
terms of dollars cannot reflect the true income. In fact, the more a central
bank pumps additional money into the economy, the more damage is inflicted on
the real income. As a result, money income rises while real income shrinks.
Figure 2
Do People Save
Money?
Is it true that
individuals are saving a portion of their money income? Do people save money?
Out of a given
money income, an individual can do the following: he can exchange part of the
money for consumer goods; he can invest; he can lend out the money (i.e.,
transfer his money to another party in return for interest); he can also keep
some of the money (i.e., exercise a demand for money).
At no stage,
however, do individuals actually save money.
In its capacity
as the medium of exchange, money facilitates the flow of real savings. The
baker can now exchange his saved bread for money and then exchange the money
for final or intermediary goods and services.
What is commonly
called "saving" is nothing more than exercising demand for the
medium of exchange (i.e., money). This means that people don't actually save
money but rather exercise demand for it. And, when an individual likewise
exchanges his real savings for money, he in fact only increases demand for
money. The money he receives is not income; it is a medium of exchange that
enables the individual to secure goods. In the absence of final consumer
goods, all of the money in the world would be of little help to anyone.
Consider the
so-called helicopter money case: the Fed sends every individual a check for
one thousand dollars. According to the NIPA accounting, this would be
classified as a tremendous increase in personal income. It is commonly held
that, for a given consumption expenditure, this would also increase personal
savings.
However, we
maintain that this has nothing to do with real income and thus with saving.
The new money didn't increase total real income.
What the new
money has done is set in motion the diversion of real income from wealth
generators to the holders of new money. The new money that the Fed has
created out of thin air prompts exchanges of nothing for something.
Consequently, wealth generators have less real wealth at their disposal
— which means that the process of real wealth and savings formation has
weakened.
In the helicopter
example we have a situation in which, for a given pool of real savings, an
increase in nonproductive consumption took place. (By nonproductive
consumption we mean consumption that is not backed up by the production
of real wealth.) This means that the real savings of wealth generators,
rather than being employed in wealth generation, is now being squandered by
nonproductive consumption.
From this, we can
also infer that the policies aimed at boosting consumer spending do not
produce real economic growth, but in fact weaken the bottom line of the
economy.
In the NIPA
framework, which is designed according to Keynesian economics, the more money
people spend, all else being equal, the greater total income will be.
Conversely, the less money is spent (which is labeled as savings), the lower
the income is going to be. This means that savings is bad news for an
economy.
We have, however,
seen that it is precisely real savings that pays — i.e., that which supports
the production of real wealth. Hence, the greater the real savings in an
economy, the more are the activities that can be supported.
What keeps the
real economic growth going, then, is not merely more money, but wealth
generators — those who invest a part of their wealth in the expansion
and the maintenance of the production structure. It is this that permits the
increase in the production of consumer goods, which in turn makes it possible
to increase the consumption of these goods.
Only out of a
greater production can more be consumed.
Can the State of
Savings be Quantified?
What matters for
economic growth is the amount of total real savings. However, it is not
possible to quantify this total.
To calculate a total,
several data sets must be added together. This requires that the data sets
have some unit in common. There is no unit of measurement common to
refrigerators, cars, and shirts that makes it possible to derive a unified
"total output."
The statisticians'
technique of employing total monetary expenditure adjusted for prices simply
won't do. Why not? To answer this, we must ask: what is a price? A price
is the amount of money asked per unit of a given good.
Suppose two
transactions were conducted. In the first transaction, one TV set is
exchanged for $1,000. In the second transaction, one shirt is exchanged for
$40. The price, or the rate of exchange, in the first transaction is
$1,000 per TV set. The price in the second transaction is $40 per shirt. In order
to calculate the average price, we must add these two ratios and divide them
by 2. However, it is conceptually meaningless to add $1,000 per TV set to $40
per shirt. The thought experiment fails.
The Real Culprit
Rather than
attempting the impossible, as far as calculating real savings is concerned,
one should instead focus on the factors that undermine real savings. We
suggest that the key damaging factors are central bank's and government's
loose monetary and fiscal policies.
These policies
are instrumental in the weakening of the process of real savings formation
through the diversion of real savings from wealth generators to
non-wealth-generating activities.
The US economy
has been subjected to massive monetary pumping since early 1980 via the introduction
of financial deregulations. The ratio of our monetary measure AMS to its
trend jumped from 1.17 in January 1980 to 3.5 in July 2009. (The trend values
were calculated by a regression model, which was estimated for the period
1959 to 1979, the period prior the onset of financial deregulations).
Likewise, the US
economy was subjected to massive government spending. For the fiscal year
2009, US federal government outlays are expected to stand at $3.5 trillion.
The
outlays-to-trend ratio (the trend was estimated for the period 1955 to 1979)
jumped to 4.1 in 2009, up from 3.5 in 2008 and 1.45 in 1980.
Figure 3
 
The
ever-expanding government outlays are also depicted by the federal debt,
which stands at $11.6 trillion thus far into 2009. Against the background of
massive monetary pumping and ever expanding government, we suggest that this
raises the likelihood that the pool of real savings could be in serious
trouble.
That this could
be the case is also suggested by the private sector debt-to-its-trend ratio.
This ratio stood at 5.8 in first quarter, against a similar figure from the
previous quarter. The ever-rising ratio raises the likelihood that the
increase in the private sector debt is on account of nonproductive debt. Real
savings, instead of funding wealth generating activities, have been
supporting non-wealth-generating activities. This weakens the ability of
wealth-generating activities to grow the economy.
Figure 4
We can conclude
that, given prolonged reckless fiscal and monetary policies, there is a
growing likelihood that the pool of real savings is in trouble. If our
assessment is valid, this means that US real economy is likely to struggle in
the quarters ahead.
In addition, if
the pool of real savings is under pressure, none of the government and
central-bank policies to lift the economy is going to work. Note that as long
as the pool of real savings is holding its ground, such policies appear to be
effective. In reality, though, it is the expanding pool of real savings that
drives the economy — and not various stimulus policies.
Conclusions
According to
latest US government data, the personal saving rate jumped to 4.6% in June
this year after settling at 0.4% in June last year. We suggest that on
account of an erroneous methodology, the so-called "saving rate"
that the government presents has nothing to do with true savings.
Since early
1980s, the ever-rising money supply and government outlays have severely
undermined the process of real savings formation. As a result, it will not
surprise us if the US pool of real savings is in serious trouble. If what we
are saying is valid then it will be very hard for the US economy to grow, for
it is a growing pool of real savings that makes economic growth possible.
Furthermore, the
growing pool of real savings is the reason that loose monetary and fiscal
policies appear to be working. In reality, however, all that these loose
policies achieve is a further depletion of the pool of real savings —
thus reducing prospects for a genuine economic recovery.
Frank Shostak
Frank Shostak is a former professor of
economics and M. F. Global's chief
economist.
Also
by Frank Shostak
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