Does Saving "Fund" Investment?
If Asymptosis has any tiny claim to any important influence, it might be that anonymous and magisterial commenter JKH used the comments section here to first bruit his insight (both tautological and profound) that S = I + (S – I).
He revisited that construct and concept again recently, and I’ll leave it to you to explore his very interesting thinking.
But I do want to address a central issue in that discussion: the notion of “funding.”
JKH quite properly uses standard flow-of-funds accounting terminology to explain that private-sector “saving” “funds” both its “investment” (buying/creating drill-presses and such), and its acquisition of newly created financial assets.
Quite properly, but: it’s important to understand what that key accounting verb (“funds”) actually means. It describes an after-the-fact and arguably largely arbitrary accounting allocation of income streams to outflow streams.
Imagine 2011, a year in the life of BFC Corp.:
INFLOWS
Profits (revenues – expenses): $100,000
Net Borrowing (borrowing – loan payoffs): $100,000
OUTFLOWS
Investment (spending on drill presses and such): $100,000
Dividends paid to shareholders: $100,000
Looking back: Of the $200K in inflows, which part “funded” the investment spending on drill presses? What funded the dividend payout? The accountant’s allocation decision, absent any other information, is after-the-fact and completely arbitrary. Funds are fungible — especially when viewed in retrospect.
Before-the-fact conditions and restrictions might well give justification for a given after-the-fact accounting allocation decision. If BFC decided in 2010 to spend X% of profits on drill presses in 2011, and that X% came to $100,000, an accountant after the fact might quite reasonably say that the drill-press purchases were “funded” by that year’sprofits.
Alternately: Imagine BFC “set aside” $100,000 from 2010 profits for future drill-press purchases by “funding” a drill-press holding account on their books, debiting their 2010 profits to “fund” that holding account. (Maybe it even created an actual external bank account to hold and segregate those funds, though that’s not actually material to this discussion.) It then spent down that holding account in 2011 to buy drill presses. Were those purchases “funded” by 2011 profits or borrowing? The proper accounting answer here is “neither.” Looking backwards you might/could/would say that they were funded, ultimately if somewhat arbitrarilly, from 2010 profits, or from the holding account. Either is accurate, depending on how you telescope your “funding” pipeline, in both time and account-space. (This is all rather like discussions of the Social Security Trust Fund.)
When we say, in a backward-looking flow-of-funds statement, that “X funded Y,” that is an ex-post description that is informed, and arguably justified — but not fully or authoritatively determined — by knowledge of before-the-fact intentions.
So when we say that “…the marginal dollar borrowed by a nonfinancial business [post-’85] was simply handed on to shareholders, without funding any productive expenditure at all,” we are making a statement about what “funds” what. We’re saying that all the borrowing went to payouts, and all the profits went to investment. The reverse could be equally accurate, given that shareholders from ’04 to ’08 were paid about $200 billion more than their companies earned in profits.
Let’s try this on the level of national/international accounts, and sectoral flows. Here’s mythical 2011 accounting for Bandalaria:
Assume (purely for simplicity in explaining the “funding” concept) that:
1. There is no net trade surplus or deficit, and the country’s capital account balance sheet remains unchanged.
2. The central bank does not increase or decrease its holdings on net.
3. The financial system does not increase or decrease its loan book to the private sector.
That leaves two sectors, with (looking back) no accounting impact from the above:
• Federal government (Treasury)
• The nonfinancial private sector (nonfinancial firms and households)
What do Bandalaria’s net money flows look like?
From Treasury -> Private
Deficit (purchases minus taxes): $100 million
From Private -> Treasury
Treasury bond purchases : $100 million
Looking back, how would you describe these flows? Are are the bond purchases “funding” the deficit, or is the deficit spending “funding” the bond purchases?
The correct answer is “Yes.”
Likewise: when JKH says (my words actually) that saving (income – expenditure) by the private domestic nonfinancial sector “funds” both its investment spending and its net acquisition of new financial assets (including government bonds), his description is perfectly correct.
But he would equally correct if he said that government deficits (less trade deficits) “fund” some of the investment, or (all of) the acquisition of new financial assets (notably government bonds), by the private domestic nonfinancial sector (or some of each).
Obviously, the two accounting-based descriptions, both accurate, have very different rhetorical implications.
This just reiterates the point I made in the post to which JKH responded with his revelatory identity: accounting tells us nothing about economics, except that it often tells us when economic thinking doesn’t make any logical/arithmetic sense.
I guess my main point here, perhaps obvious to many, is that accounting descriptions — choices about how to describe the past in accounting-speak, especially regarding “saving” and “funding” — are, inevitably, rhetorical hence normative. Or at least, those choices of descriptions have inevitable rhetorical hence normative implications.
Or to put it simply: accounting is normative.
My impression is that many economic discussions and disagreements, especially in the “MM” worlds, are at their root disagreements about what “funds” what (frequently compounded by imprecise sector definitions with different parties using different implicit definitions), and the rhetorical hence normative implications of those competing descriptions.
Cross-posted at Asymptosis.
How about “savings refunds investment” then?
i am not sure i would agree. it may be that the funds are fungible.
but there is a narrative in the mind of the owner or “investor” that goes something like this:
I need a new drill press that costs 100,000$. I can borrow a 100,000$ to pay for that (and “pay” for it out of it’s future contribution to earnings).
That leaves me with a 100,000$ “profit” of revenues over (current) expenses this year, which i choose to use to pay dividends to shareholders.
you can argue that the money is fungible, but the “thinking” is almost certainly not.
We may be looking at the gap between economics and accounting. From an accounting point of view, the “thinking” is important, but from an economic point of view, the “thinking” is irrelevant. Money is money.
It’s like the New York Power Authority, a utility with no generation, transmission or distribution facilities. It buys chunks of power for the state, various cities, hospitals and other such organizations, and arranges for that power to get to its users. From an accounting point of view, you could analyze the oomph on the electrons in each branch of the transmission system and assign a portion to the NYPA and the remainder to other parties, but, from the point of view of the electrons, the distinction is meaningless.
Kaleberg
the reason i don’t trust this reasoning is that for some time we have been hearing that “money is fungible” and “therefore” Social Security “really” does add to the deficit.
Of course it does not. People pay for their Social Security into a legally separate entity where it is used to pay for benefits or held in a “Trust Fund,” from which it is lent to the government
which accounts the borrowed money as “revenue” without, apparently, any mental reservation that it has to be paid back
so that when it is paid back, that money is counted as “expense” without any admission that is is “payment of debt.”
that kind of thinking can be very helpful to a confidence man. not so helpful to honest people who like to keep track of where the money came from, and why, and when and to whom it needs to be paid, and for what.
from an “economics point of view” it doesn’t matter if dad spends moms income on groceries for the kids or heroin for his arm.
as far as electrons go
if they care about anything at all, i suspect they do care about who pays… that determines where they go, and ultimately, whether they go.
Why is S=I+(S-I) “profound”?
S=I+(S-I) is just the basic sectoral balances equation, as described in any number of texts on the subject.
As the MMT Wiki says (courtesy of Bill Mitchell):
“The sectoral balances equation says that total private savings (S) minus private investment (I) has to equal the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)), where net exports represent the net savings of non-residents.
Another way of saying this is that total private savings (S) is equal to private investment (I) plus the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)), where net exports represent the net savings of non-residents.”
In other words:
S=I+(G-T)+(X-M)
or:
S=I+(S-I)
(S-I) simply denotes domestic private sector net saving.
So we can re-state S=I+(S-I) as:
private sector saving (S) = private sector investment (I) + private sector net saving (S-I).
(S-I) equals (G-T) + (X-M)
Mitchell continues:
“All these relationships (equations) hold as a matter of accounting and not matters of opinion.
Thus, when an external deficit (X – M < 0) and public surplus (G - T < 0) coincide, there must be a private deficit. While private spending can persist for a time under these conditions using the net savings of the external sector, the private sector becomes increasingly indebted in the process."