Saving Ourselves
By Daniel O'Connor of Integral Ventures, LLC
The Economist recently published an article on the shift away from thrift:
IT MAY be a virtue, but in much of the rich world thrift has become unfashionable. Household saving rates in many OECD countries have fallen sharply in recent years. Anglo-Saxon countries—America, Canada, Britain, Australia and New Zealand—have the lowest rates of household saving. Americans on average, save less than 1% of their after-tax income today compared with 7% at the beginning of the 1990s. In Australia and New Zealand personal saving rates are negative as people borrow to consume more than they earn.
Other countries with rapidly greying populations—especially Japan and Italy—have also seen their personal saving rates plummet, though from a higher level. The Japanese today save 5% of their household income, compared with 15% in the early 1990s. A few rich countries, notably France and Germany, have bucked the trend away from thrift. Germans saved around 11% of their after-tax income in 2004, up slightly from the mid-1980s.
These shifts raise important questions. Are people saving too little? What are the consequences of falling saving rates? Should governments try to encourage people to save more, and if so, how?
What's interesting about these questions and the many answers floated by The Economist is the way they skirt the essential question of why people are saving so little. Granted, attributing causality to selected factors within a complex dynamic system of interrelated factors is always difficult and controversial. Depending upon where we begin our chain of logic, it often seems as though one factor's cause is but another factor's effect, with no clear driving forces within the overall web of mutual causality. Such is the market economy.
Nevertheless, as I have argued and as common sense confirms, we do not live in a pure market economy. Not even close. Moreover, even though self-organizing markets can generate clear trends that reflect the gradual evolution of the value functions of market participants, I think the best place to start the inquiry into such trends as the saving decline is with the state's deliberate attempts to promote the appearance of economic growth. Cutting to the chase, I think we can look to our central banks and their profligate monetary policies for much of the answer to the essential question of why people are saving so little.
Generally speaking, as central banks use the policy techniques at their disposal--setting discount rates for central bank lending to banks, setting reserve requirements for banks' lending to households and businesses, engaging in open market purchases of government bonds, and shaping people's perceptions of monetary policy and economic performance--to promote economic growth, they create new alignments of key economic factors that would not otherwise exist and cannot be sustained forever.
For example, in recent years, the Federal Reserve's inflationary monetary policy of lower short-term interest rates has been met by similarly inflationary policies of some other central banks who, in order to support their respective export sectors, have attempted to stem the dollar's natural depreciation in relation to their own currencies by aggressively purchasing US Treasury securities. The combination of these two opposing state interventions has produced lower-than-market interest rates which, in turn, have created valuable incentives for households to save less and consume more. To the extent that the value functions among householders have remained relatively stable, we can be sure that these people have indeed saved less and consumed more than they would have if the central banks had maintained policy neutrality.
At the same time, the central banks' inflationary monetary policies have resulted in lower-than-market costs of capital for businesses, which have therefore tended to invest more in capital goods than they otherwise would have invested. We might also add home construction to this category of capital goods, whose production certainly seems to have increased as a result of the lower-than-market mortgage rates offered to builders and homeowners. These lower-than-market costs of capital have resulted in higher-than-market rates of appreciation in the prices of many assets--e.g., stocks, bonds, houses--which are often touted as the increasing savings balances that more than offset any downside associated with the decreasing saving rates.
Overall, with more consumption and more investment, we saw rates of US economic growth that were higher than what they would have been absent the monetary policy interventions. Furthermore, US economic growth appeared to increase all the more so because of the growth in deficit-spending by the state, which has been fueled by lower interest rates for its own debt obligations as well as the seamless monetization of its budget deficits as a critical component of the Federal Reserve's inflationary monetary policy.
Such is the basic argument for the use of monetary and fiscal policies--increases in the supply of money and increases in deficit-financed government spending--to drive economic growth, particularly in the midst of recession. So much the better if the US government can get foreign central banks to play along with them.
The critical weakness in this policy, it seems to me, is that it relies on the distortion of market prices--the observable, measureable results of our past market decisions--in order to incent market participants to make future market decisions that they would not have made if they could have based these decisions on valid market prices. Thus, as the diagram suggests, state interventions in the market can, through the distortion of market prices, undermine market participants' efforts to make reasonable decisions consistent with their value functions and to learn from their market experiences in order to make even better decisions in the future.
How does this dysfunctional tug-of-war between State Learning and Market Learning manifest in the economy?
In a mountain of debt, growing faster than the economy itself.
Why debt?
Because when central banks bid interest rates down below their market levels, encouraging excess consumption, discouraging necessary saving, and encouraging excess investment, they create a shortage in the supply of funds relative to the demand for funds that can only be bridged through the extension of credit and concurrent creation of money. This extension of credit and the accumulation of debt over time is the process by which central banks create the appearance of economic growth greater than, and different from, what would have occurred absent the inflationary monetary policy.
So what?
Well, if we do not fundamentally alter our value functions--our preferences, expectations, biases, and heuristics, our values and assumptions about what is true, good, and beautiful in this life--to conform to this perverse alignment of factors whereby we seem to be able to consume our cake and save it too, then it is only a matter of time before our real value functions more fully manifest in the prices throughout the market. What will be for some an intentional re-alignment of values, actions, and results will be for others a series of interrelated financial crises of unknown origin and uncertain outcome. The process will be far from enjoyable for most, but in learning again how to save ourselves, we can move toward a path of more sustainable economic development.
© 2005 by Daniel J. O'Connor. All Rights Reserved.
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