When S != I
As Brad DeLong has noted, Tim Geithner believes it is time for “the economy has now recovered sufficiently for government to begin to make way for private business investment.” In short, he expects “the private sector” to do the heavy lifting in these joyous times of economic recovery.
Cynics among us—why, yes, that might well include me—would note that the private sector has had to do much of the heavy lifting for the past several quarters, in the face of what is varyingly described as “a precipitous decline in Aggregate Demand” or “a rise in unemployment.” (You say overextended credit, I say bankrupt.) And that its performance has been, not to put too fine a point on it, exemplary in the face of the constraints presented.
Yes, I’m praising the efforts of the private sector. Not just because small businesses especially are trying to sustain current levels of production and services in the face of tightened credit and the aforementioned AD decline, but also because they, as LBJ once observed in another context, have been put into the position of trying to run a race when the shackles are just being removed from their ankles.
I blame the banks.
Now you know it’s me. The problem is, the evidence is on my side. Recall that the alleged reason we needed to “save” the banks is that they are Financial Intermediaries, taking a slice out of the matching between Investors (Savers, in most economics models) and Capitalists, who borrow to recombine Capital (K) and Labor (L) into a new product that presents a better return than the old one.
Call it “creative destruction.” Call it “capitalism.” Call it “economic growth.”
Let us ignore—though it Abides, like Earth or a steaming pile of elephant dung—that the “intermediaries” were making somewhere between 30 and 40% of the total profits in the U.S. for the past decade. We can (1) pretend that those were all payday lenders, (2) be a “first-best economist” and claim that is the way things should be, or (3) realize it’s a problem and leave addressing it for another time.*
But let us not ignore that capital supply is essential to growth possibilities. With labor abundantly available, the limitation on creating new product is essentially The Big K, and it’s “Main Street” proxy, money.
As noted above, in most models of economic growth, we treat Savings as being equal to Investment. This makes sense: even when the Financial Intermediaries were making $3 or $4 of every $10, they were reinvesting in better systems, better technology, better analysis, and better methods. Low Latency leads to High-Frequency Trading (HFT) which leads to…well, let’s be nice and just say “greater firm profits.” Even if only 50% of those profits are being directly reinvested, they are being reinvested, while the rest produces at worst greater paper investments and at best a higher velocity of money and/or a multiplier (“trickle-down”) effect from increased spending.**
Put your money in a Mutual Fund, it’s Invested. Buy a stock, it’s invested. Put it in a Demand Deposit Account (what used to be a “Savings” or “Checking” account), and it’s invested (“swept”) by the Financial Intermediary, who gives you a share of the profits in the form of interest.
Not to sound like a broken record, but Excess Reserves put a spanner in that last one. Don’t believe me, ask economists Bruce Bartlett or Joe Gagnon. Or just look at a graphic of M2 and what I’m calling “Intermediary Private Investment” (M2 minus the Excess Reserves maintained by Financial Intermediaries).
As Excess Reserves are not Seasonally Adjusted, I used the NSA version of M2. As noted in my previous post, up until September of 2008, the Fed did not pay interest on Excess Reserves (or Reserves, for that matter), so that excess reserves were essentially a rounding error—funds kept because of the asymmetric risk-reward of a miscalculation, or “precautionary savings.” They tended to total about $1-2 Billion on average, rather minor in the context of $7-8 Trillion.***
But once you hit September of 2008, the growth in M2 is more than negated by the growth in Excess Reserves. Indeed, the horizontal line on the graphic above is the level of Intermediary Private Investment in August of 2008—nine months into the “Great Recession.”—isn’t exactly reaching for the skies. But it’s also significantly higher than the current I, as opposed to S.
(Note that the NSA trend is also downward since the alleged beginning-of-recovery months of June-July, 2009. That the performance has been as good as it has been in such a context is amazing.)
When Savings=Investment, there is potential for growth. When savings go into mattresses—for good reason, especially in the pre-FDIC days—intermediaries cannot do their job so efficiently as the models presume.
What are we to call it when Intermediary Private Investment is significantly less than Savings—when not the people, but the intermediaries themselves, are stuffing money into their own, interest-bearing mattress?
I would suggest “bad economics,” but that term seems too applicable to more general conceits.
*I would rather lose what is left of my eyesight and hearing than take the second position; others, from Scott Sumner explicitly to Brad DeLong implicitly, have significantly variant mileages, which is why there’s a horserace for describing economic policies in the past decade or so. They are winning, while I received several decent paychecks over the time.
**It is left as an exercise whether the “trickle-down” effect is positive or significant.
***Another sign of improved technology is that the growth in reserves decelerates—funds are used more efficiently by the intermediaries—after ca. 1990/1991; the trend moves slightly upward in the Oughts, though that is both relatively minor and possibly due to complications related to the expansion of products offered.
you seem to be saying that excess reserve growth is a cause not a symptom of something?
likely there are excess reserves because of one of the following (1) the banks are (stupidly) getting paid by the fed for excess reserves, so they keep them, (2) at least some banks are capital and not reserve constrained, (3) some banks are still afraid of a run or a FDIC action if there is another crisis and so are hoarding reserves in response, (4) lending is demand-constrained and not supply-constrained, like in most recessions, or (5) banks see the current level of reserves as temporary.
Zuckerman and the neocons are correct for the wrong reasons when they blame “policy”.
The US needs to build new capacity with the excess reserves.
US policy does nothing for the capacity side of the “too little demand” issue.
The US has excess capacity for war materiels which do nothing for the production of consumer and personal properties in the economy.
It has 75% of the war production in the world. It has almost zero capacity is shoes, finsihed clothing and a large shortfall in capacity for auto and energy productions.
US policy has been to off shore consumer production (like the Sovietes) and maintain a socialized welfare state for about 8% of the economy between war machines and other discretionary spending.
Excess reserves should be used to create consumer and industrial equipment capacity.
Policies to avoid the appearance of protecting industries need to be changed.
The US will not survive as a republic with a Rome-like Equestrain class and a huge under class of poor.
Not to go all Ex post on you, but Sept. ’08 is exactly when the M1 multiplier plummeted from an anemic 1.6 to 0.8. Probably just a coincidence.
By the way, money laid down in a mutual fund or a stock purchase is NOT invested. That took place at the IPO. The secondary market is just speculative asset shuffling.
Cheers!
JzB
Ken,
You stated:
“But let us not ignore that capital supply is essential to growth possibilities.”
Well only sometimes and in some economies, it not always essential and not even needed right now for the us economy. Let us also not ignore the fact that the US economy is a well developed late stage market economy that is well capitalized and has all the productive capacity it will need, at least in existing industries, for a decade or more.
I would posit that without consumptive demand our economy will ground to a halt. My complex econometric representatino of this entails one to look out the window and see what state our economy is in. What we need is the government to start new industries and employ people to creat real organic growth. The supply siders argument is ony useful and predictive in an immature undercapitalized economy. the supply of credit is not destiny.
“Let us ignore—though it Abides, like Earth or a steaming pile of elephant dung—that the “intermediaries” were making somewhere between 30 and 40% of the total profits in the U.S. for the past decade. “
Actually, the BEA’s corporate profit numbers do not merely reflect corporate profits IN the U.S. They reflect profits made by “U.S.” companies everywhere in the world. Thus, the BEA corporate profit numbers for U.S. companies are a multiple of actual corporate income reported to the IRS. By selling fake “assets” like CDOs, banks have full control over where the sale occurs (like the Cayman Islands) and can avoid U.S. tax treatment and thus artificially boost their profits. Still, your are correct that there’s something not right about the banks’ share of corporate profits.
“Put your money in a Mutual Fund, it’s Invested. Buy a stock, it’s invested. Put it in a Demand Deposit Account (what used to be a “Savings” or “Checking” account), and it’s invested (“swept”) by the Financial Intermediary, who gives you a share of the profits in the form of interest.”
The inclusion of demand deposit accounts makes this a very expansive view of the term “investment.” I’m starting to come to the conclusion that none of these things is really investment in the strict sense. The first two examples are actually speculation, and the third is savings.
I really like your “Intermediary Private Investment” metric, by the way.
In terms of who to blame, the Fed, the Treasury and the banks have all been complicit. It was the Fed, after all, who dumped all those reserves on the banks’ balance sheet. While I’m sure Paulson and Bernanke sold Bush and the Congress on the idea that handing this money to the banks would kick start the credit engine, I’m sure at least Bernanke never believed that. The purpose of those reserves was to keep the banks solvent and provide liquidity, and now those reserves are being used to reflate the bank balance sheets. In other words, the entire purpose of the bailout that resulted in these huge reserves was to give free money to the banks to stuff in their mattresses.
You are correct that as an accounting identity S=I always but there is a big question as to the direction of flow. Many think that it is savings which leads to investment, I would like to suggest that the flow is the other direction. Savings is the end result of investment. IOW without investment there can be no savings. When investment stops savings disappears, when it rises savings rises as well. I think this is an important distinction. Heres an article which discusses this quite well
http://blog.andyharless.com/2009/11/investment-makes-saving-possible.html
And this from Warren Moslers “Soft Currency Economics”
Savings and Investment:
How the Government Spends and Borrows As Much As It Does Without Causing Hyperinflation
Most people are accustomed to viewing savings from their own individual point of view. It can be difficult to think of savings on the national level. Putting part of one’s salary into a savings account means only that an individual has not spent all of his income. The effect of not spending as such is to reduce the demand for consumption below what would have been if the income which is saved had been spent. The act of saving will reduce effective demand for current production without necessarily bringing about any compensating increase in the demand for investment. In fact, a decrease in effective demand most likely reduces employment and income. Attempts to increase individual savings may actually cause a decrease in national income, a reduction in investment, and a decrease in total national savings. One person’s savings can become another’s pay cut. Savings equals investment. If investment doesn’t change, one person’s savings will necessarily be matched by another’s’ dissavings. Every credit has an offsetting debit. As one firm’s expenses are another person’s income, spending equal to a firm’s expenses is necessary to purchase it’s output. A shortfall of consumption results in an increase of unsold inventories. When business inventories accumulate because of poor sales: 1) businesses may lower their production and employment and 2) business may invest in less new capital. Businesses often invest in order to increase their productive capacity and meet greater demand for their goods. Chronically low demand for consumer goods and services may depress investment and leaves businesses with over capacity and reduce investment expenditures. Low spending can put the economy in the doldrums: low sales, low income, low investment, and low savings. When demand is strong and sales are high businesses normally respond by increasing output. They may also invest in additional capital equipment. Investment in new capacity is automatically an increase in savings. Savings rises because workers are paid to produce capital goods they cannot buy and consume. The only other choice left is for individuals to “invest” in capital goods, either directly or through an intermediary. An increase in investment for whatever reason is an increase in savings; a decrease in individual spending, however, does not cause an increase in overall investment. Savings equals investment, but the act of investment must occur to have real savings. The relationship between individual spending decisions and national income is illustrated by assuming the flow of money is through the banking system. The money businesses pay their workers may either be used to buy their output or deposited in a bank. If the money is deposited in a bank, the bank has two basic lending options. The money can be loaned to: 1)someone else who wishes to purchase the output (including the government), or 2) to businesses who paid the individuals in the first place for the purpose of […]
I agree the banks have been making things worse, making up their previous losses on increased spreads, but the real problem is interest rates need to be negative, that is, we need higher inflation to make the rates we have reasonable and investment worthwhile. That is the central bank’s problem.
Maybe we are seeing that people with money to invest won’t invest it here in anything that employs people. The easy way to make money is to lend it out and collect interest on consumer debt. Tried and true relatively low risk up until now. Now, the country needs jobs and no one with money is willing to risk investing in anything as messy and hard to manage as manufacturing, power production, transportation and the like. Even energy production has its downside, it appears, when conducted in/near a developed country.
There are several kinds of cottage industries (that is, small companies) that we could develop all of which would create jobs. You know, we could have shoe and textile factories for domestic consumption, for example. Same thing with off-grid power production through solar, thermal, wind, etc. But, all that stuff takes money. If private money isn’t there, then the federal govt has to step in. Otherwise, this stuff they call “structural unemployment” becomes a permanently impoverished citizenry and we become Panama. Nancy O.
I lifted this comment from those at econbrowser by commenter Steve. He said:
“When people, such as myself, who have always paid their bills, run and owned business’s and met their obligations, can not even get a sniff of business capital from banks with 20 year relationships, there is a problem. I went from being able to borrow on my word, to being denied very viable loans. It is as if the banks have had a higher power, I believe the U.S. Government, tell them they will not be lending any money. It really looks from this vantage point that all future capital for private, small business will be raised not from banks, but from private pockets. It has taken me two years to handle having been cut off at the knees financially and to begin to raise my own savings level to fund my future projects. I will however, not form any companies nor seek to employ others until Barak Obama has been removed from office along with the current Congress. It is quite accurate to say the middle class is hunkered down, paying off debt, forming it’s own pools of capital and that it fully understands the rules have changed. If this causes deflation, so be it. The middle class has suffered a holocaust and is chanting “NEVER AGAIN”. Oh, and we will get our pound of flesh at the ballot box.”
I have heard similar stories for the past year+ from other small business owners.
“ It is as if the banks have had a higher power, I believe the U.S. Government, tell them they will not be lending any money. It really looks from this vantage point that all future capital for private, small business will be raised not from banks, but from private pockets”
First off…..HA HA HA HA HA HA HA HA HA HA HA …. You take this perspective seriously????
Its AS IF??? The govt is telling the banks not to lend?? What a load of crap.
I got a message for the guy….. banks ARE private pockets.
The banks arent lending him money because they are not sure he will have any customers and be able to pay his loan back.
Thanks for posting the paranoid rants of small business owners afflicted with O D S.
“I will however, not form any companies nor seek to employ others until Barak Obama has been removed from office along with the current Congress”
Good, we dont need YOU employing others, someone will as soon as the opportunities are there. Once there is money to be made someone will take it. Go ahead and cut your nose off to spite your face. Whenever you let politics interfere with your business your a fucking idiot.