Daniel O'Connor | Integral Ventures, LLC
We finally did it. This past year, for the first time since the pit of the Great Depression, we in the United States managed to drive our annual personal saving rate below zero. What this basically means, on the surface, is that all of us together, as a group, spent every dollar of household income we had leftover after taxes, plus another half a cent that we must have borrowed. Of course, some of us did manage to save something last year. But all of this saving was more than offset by all the dissaving the rest of us did. Of course, this wasn't a great surprise. The trend has been clear for a good many years and I've even discussed it in some previous essays, like Saving Ourselves and Saving Themselves?
What does it mean on a deeper level?
To answer this question, let's review some just-in-time theory. The personal saving rate is a derivative of the fundamental trade-off for every household--consumption versus saving--and it reflects householders' preferences for allocating their scarce resources over time. Given a flow of after-tax income, householders can either use the money for current consumption or save it for future consumption.
This temporal trade-off is known as time preference because it expresses a preferential relationship between a particular good in the present versus that same good in the future. It is considered by economists of the Austrian School to be the subjective origin of the interest rate, because the greater our valuation of a good in the present relative to our valuation of the same good in the future--i.e., the higher our time preference--the greater the implied interest rate in our value function and the greater the interest rate must be to induce us to defer enjoyment of this good through saving.
Time preference may also have a neurological connection, as I proposed in The Neuroeconomics of Time. According to recent research into the idea of time inconsistency, people use completely different parts of their brains to process decisions in the present versus the distant future. When it comes to making decisions about the distant future, people do so in a relatively rational way using the prefrontal cortex. But when making decisions about the present that entail a choice of whether to consume something now or later, the emotional limbic system takes over and prefers immediate gratification. Whether this neurological time inconsistency causes psychological time preference or the other way around is uncertain, so perhaps we can just think of them as mutual causal.
So how can these ideas help us interpret the negative personal saving rate?
When we see householders as a group choosing to save none of their current income, preferring instead to use it all for current consumption, we can infer that they do not value the future enough to save for it. Perhaps they imagine that they do not need to save for the future because they already have enough savings in the form of assets (like home equity) or because someone else is doing it for them (like a government or corporate pension). Perhaps they have carefully planned to save for the future using their prefrontal cortexes, but then when they must make their monthly decisions to consume now or save for later, their limbic systems undermine their long-term plans. Either way, it's pretty much the same implication: no saving implies no future.
When people lower their valuation of the future or the goods they might buy in the future, they are expressing what is known as higher time preference, which is consistent with the higher interest rate that is required to induce them to save enough to satisfy investors' demand for funds. To see what I mean, just think of how we compute the present value of a future cash flow by applying a discount rate. The higher the discount rate we apply, the lower the present value of the future cash flow. Thus, the lower our present valuation of our collective economic future, the higher is the implied interest rate that should prevail in the markets for money, credit, savings, and investment. This is how markets work, like a dynamic system seeking a reasonable balance. In this case, the balance being sought is that between the supply of funds and the demand for funds being saved by households.
But if there is one thing to which we've all grown accustomed in the past several years, it is lower interest rates. According to the theory of time preference, lower interest rates imply lower time preference and therefore a relatively higher valuation of the future in relation to the present. A lower discount rate applied to the future cash flow in our example will generate a higher present value of that future cash flow. So the relatively low interest rates in recent years would seem to be an indication that we householders value our collective economic future rather highly--as if we are saving a great deal more than we really are.
Thus, we have a sort of temporal conundrum.
On one hand, the trend in personal saving suggests that we place so little value on our economic future that we'd rather just consume everything we possibly can in the present, without regard for future consequences. On the other hand, the trend in interest rates suggests that we value the future rather highly and therefore save a significant portion of our income so that businesses can invest in the creation of the economic product that we expect to enjoy in the future.
How can we resolve this temporal conundrum?
By recognizing that the monetary policies of our own central bank and the central banks of our trading partners have been distorting market interest rates to such an extent that we householders are literally behaving as if we can consume all our income today, while simultaneously saving enough for the future we value--consuming our cake and saving it too.
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 (e.g., China) 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 dollar-denominated Treasury securities. By increasing the demand for US Treasury bonds, notes, and bills, these foreign central banks have bid US interest rates down to levels that would not have existed in the absence of the policy interventions.
This multi-lateral strategy of competitive currency devaluation has produced lower-than-market interest rates all along the yield curve, from short-term rates to long-term rates, which, in turn, have created valuable incentives for households to save less, borrow more, and consume more. These lower-than-market interest rates have resulted in higher-than-market rates of borrowing throughout the economy and higher-than-market rates of appreciation in the prices of many assets--stocks, bonds, houses--which are often touted by government-paid economists as the increasing savings balances that more than offset any downside associated with the decreasing saving rates. To the extent that the value functions among householders have remained relatively stable, we can be sure that we have all saved less, borrowed more, and consumed more than we would have if the central banks had maintained policy neutrality.
Therefore, the inflationary monetary policies of the Fed and other central banks have induced progressively higher time preferences among US householders, who have responded with a predictably emotional rationalization that appreciating stocks, bonds, and houses, even in the absence of any saving from year to year, can somehow compensate for excessive borrowing and spending in the present.
But why hasn't this increasing time preference triggered the balancing mechanism of increasing interest rates in order to induce the higher saving needed to balance the market?
Because the demand for funds is still being met, not through the traditional source of household saving but through the extension of additional credit via the fractional reserve banking system. In other words, the banking system, as an extension of the Federal Reserve, fulfills the inflationary monetary policy by systematically increasing the supply of credit to compensate for the decreasing supply of household saving. This allows the Fed to effect its policy objectives, which include households saving less, borrowing more, and consuming more, all the while rationalizing that their appreciating stocks, bonds, and houses will secure for them a comfortable future.
So what?
The wider consequences of these policy-driven distortions in the temporal dimension of our market economy extend well beyond the seemingly mundane world of household finances, contributing to such challenges as:
- the ominous debt trap,which is rooted in the design of our monetary system;
- the recurring business cycle, which is rooted in the debt-filled gap between decreasing saving and increasing investment; and
- the depletion of natural capital, which is exacerbated because excessive consumption in the present over-uses today's relatively inefficient, resource-intensive technological capital base.
The deeper implications of this temporal conundrum are more difficult to articulate. It is as if we are all contributing to a self-fulfilling prophesy that is, ironically, contrary to the conscious visions of a better future that most of us are actually trying to create in our own ways. It is difficult for me to see a way out of these self-fulfilling, self-justifying, self-contradicting, and self-destructive dynamics without a significant transformation in the way we choose to participate in our market economy.
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