Currency and Reserve Balances

I buried one fact: banks can reduce total Fed reserve balances by withdrawing currency — physical cash — from their Fed reserve accounts. I only gestured toward this in a parenthetical and a link. It’s a trivial point for this discussion, but it raises confusion. This is the other thing (besides bonds) that the Fed issues and retires in return for reserve balances. As with bonds, it’s purely an exchange between banks and the Fed (though it’s driven by customers’ cash needs).

Banks actually have nominal control over this. The Fed has to issue currency to them (retiring reserves in exchange) when they ask for it, and they have to retire currency (issuing reserve balances) when banks send it back.

But this in no way suggests that reserve balances are money. You can withdraw currency (notes) from your bank. Does that mean that your checking account contains currency? That checking deposits are currency? No.

This issue is unimportant here because it’s essentially a mechanical function. As long as it’s working properly — ATMs dispense cash and people can deposit cash — it has no effect on things. (And cash is pretty small magnitude in the total system). Banks keep enough cash on hand to handle their customers’ needs, and the Fed accomodates that. Aside from drug dealers, etc., nobody holds much physical currency.

The only reason cash would be an important consideration would be if the Fed starting paying (significant) negative interest on reserve balances — charging the banks to to hold their reserve deposits. Banks might decide to build secure warehouses and drive cash to and from the Fed, trading it for reserve balances, when they needed to fund loans or when loans got paid off. (It’s kinda tricky to fund a $400,000 mortgage with cash…)

Otherwise it’s a nonissue for this discussion. But I should have made it clear.

Whaddaya Mean by M, Buster?

People really don’t like the idea that the Fed’s not printing “money.” MV=PY adherents especially object.

Let’s look at the standard definitions. None of the monetary aggregate definitions M0 through MZM includes reserve balances. By those definitions, reserves are not money. (Ditto the divisia measures.) So by those definitions, when the Fed issues new reserves, it’s not “printing money.”

The one exception is the “Monetary Base,” or “base money.” That definition of money includes currency, coins, and reserves. Here’s a handy chart from Wikipedia:

So fine: M in the equation of exchange means Base Money. But if you look at the data using that definition, it seems like there’s some serious explainin’ to do. Here’s the velocity of MB:

A 60+% decline since 2008? Hmm…

Cross-posted at Angry Bear.

Related posts:

1. Platinum Currency: What’s The Fed’s End Game?
2. Thinking About the Fed
3. Full-Reserve Banking Goes Mainstream
4. Full-Reserve Banking and Loanable Funds
5. Don’t Like “Money Printing”? Then Stop Borrowing. Whip Inflation Now!

There is zero correlation between the Fed printing and the money supply. Deal with it.

He points out (emphasis mine):

From 1981 to 2006 total credit assets held by US financial institutions grew by $32.3 trillion (744%). How much do you think bank reserves at the Federal Reserve grew by over that same period? They fell by $6.5 billion.

As he says:

if you are an investor, trader or economist, understanding—and I mean really understanding, not just recycling things you overheard on a trading desk or recall from econ 101—the mechanics of monetary policy should be at the top of your checklist. With the US, Japan, the UK and maybe soon Europe all with their pedals to the monetary metal, more hinges on understanding this now than ever before.

And, as we saw this week, even many of the Titans of finance and economics have it wrong.

He’s obviously been reading Manmohan Singh and Peter Stella (S&S) over at Vox EU, who cite the very same numbers and add:

In fact, total commercial bank reserves at the Federal Reserve amounted to only $18.7 billion in 2006, less than the corresponding amount, in nominal terms, held by banks in 1951.

S&S also point out (Table 1 and Figure 1) what we’ve known for decades but many seem unwilling to admit: since WWII, reserve levels have had approximately zero correlation with inflation/price levels.

They continue:

This suggests either that there is something wrong with:

• the theory of money neutrality;
• the theory of the money multiplier; or
• how money is measured.

Or, I would say, all of the above. I’d actually replace all three: there is something wrong with the (nonexistent) definition of “money.” But that’s another post.

I’m going to go even farther than Dow and say: the Fed is not printing money. (It can do that, but the result is stuff you can hold in your hand.) That’s a confusing and actually incoherent misconception. The Fed is issuing new reserves and exchanging them for bonds. Those bonds are effectively retired from the stock of assets circulating in the financial system (though perhaps only temporarily), as if they’d expired.

Reserves are not “money” in any useful sense. Or, they’re only money (whatever you mean by that word) within the Federal Reserve system. We probably just shouldn’t use the word at all here. It’s only confusing.

The key to understanding (and to avoid misunderstanding) this is to think about the banking system, not individual banks. The dynamics are totally different, because individual banks can affect their reserve positions (though under various market and regulatory constraints). The banking system can’t.

Because: Reserves only exist (can only exist) in banks’ accounts at the Federal Reserve Banks (and only members — banks plus GSEs and other large institutions like the IMF — can have accounts there). The banking system can’t remove reserves from the system by transferring them to the nonbank sector in exchange for bonds, drill presses, or toothpaste futures.

One bank can transfer reserves to the account of another entity with a Fed account, in exchange for bonds or whatever, but total reserves are (obviously) unchanged. And that exchange has no direct effect outside the Fed system. (That exchange can, does, have second-order, indirect, portfolio-rebalancing effects on the rest of the market. More below.)

And here’s the key thing: the banking system can’t lend reserves to nonbank customers by somehow transferring them to those customers’ deposit accounts (thereby reducing total reserves). They can’t “lend down” total reserves. The banking system doesn’t “take money” out of total reserves, or reduce those reserves, to fund loans.

This is why it’s so crazy to worry about those reserves eventually “flooding out into the real sector” in the form of new loans (and resultant spending), with all the hyperinflationary hysteria attached to that notion. (Equally: those reserves are not “unused cash” on the “sidelines” that the banks are “sitting on.” See Cullen Roche on this.) Reserves can’t leave the system, whether in a flood or a trickle. The banking system will lend (creating new deposits in its customers’ accounts out of thin air), if bankers think it will be profitable. But increased lending if anything forces the Fed to increase total reserves. Viz:

A bank issues a billion dollars in new loans, creating a billion dollars in deposits in its customers’ accounts. The borrowers spend the money by transferring it to sellers’ banks. When all the transactions net out at night at the Fed, the issuing bank is short on reserves that need to be transferred to the sellers’ banks (or sees that it will be short). So it borrows reserves from other banks. If reserves are tight, this pushes up the interbank lending rate. The Fed doesn’t want the interbank rate to increase, because it thinks interest rates are where they should be to fulfill its mandates. So it issues new reserves and trades them for banks’ bonds (which it retires, at least for the time being).

Short story: more lending increases total reserves. Slightly longer story: more lending forces the Fed to increase total reserves (or abandon its mandates).

In the current situation, of course, there’s no shortage of reserves. Banks are holding extraordinary quantities in excess of regulatory requirements. So the Fed instead controls the interbank lending rate within a corridor by setting the rate it pays on reserves (bottom) and the rate at which it will lend to banks (top). Read it all here from the FRBNY.

So how can the banking system reduce total reserves? Only in one significant way: by buying bonds from the Fed. Send some reserves over, and the Fed retires those, (re)issuing bonds in exchange. But of course the Fed isn’t selling these days; it’s buying.

Fed asset moves just issue and retire reserves and bonds. And those moves are purely at the discretion of the Fed (the Fed “enforces” this on the system by buying/selling at prices that individual banks will take up). So the Fed is in complete control of the level of total reserves. Again: there is no way for the banking system to turn existing reserves into deposits in its customers’ accounts. It can’t “lend down” total reserves.

When the Fed issues and retires bonds and reserves, it’s not “printing money,” so it’s not playing some kind of simplistic MV=PY game. It’s adjusting the balance of the banking system’s portfolio (“forcing” it to change exchange bonds for reserves) — and by extension, affecting the mutually interacting portfolio preferences of all market players (via interest-rate/yield-curve effects, and also, more psychologically, by imparting the optimistic notion that there’s adult supervision — that this frat party won’t turn into Animal House).

In other words, it’s a much deeper game than many monetarists would have you believe. It’s especially deep because neither the Fed nor the markets understand it properly. Certainly the Fed governors have strong disagreements about how it works. (Arguably, nobody understands, very much including me. There are many interacting understandings and reaction functions out there, many based on complete misunderstandings of the system dynamics. But I think we’re getting closer these days, with the slow but increasingly widespread and accelerating dismissal of silly notions like the money multiplier.)

Dow explains these portfolio effects and reaction functions very nicely:

…why is the Fed doing QE in the first place?

By keeping rates low well out the yield curve and providing comfort that the Fed will be there to fight the risk of recession and deflation…we start feeling better about putting our getting our money back out of the mattress and putting it back to work.

…it is the indirect psychological effects from Fed support and the low cost of capital—not the popularly imagined injection of Fed liquidity into stock markets—that have gotten investors to mobilize their idle cash from money market accounts, increase margin, and take financial risk. It is our money, not the Fed’s, that’s driving this rally. Ironically, if we all understood monetary policy better, the Fed’s policies would be working far less well. Thank God for small favors.

…

The other, more mechanical, implication is that financial sector lending is neither nourished nor constrained by base money growth. … The main determinant of credit growth, therefore, really just boils down to risk appetite: whether banks and shadow banks want to lend and whether others want to borrow. Do they feel secure in their wealth and their jobs? Do they see others around them making money? Do they see other banks gaining market share?

These questions drive money growth more than the interest rate and base money. And the fact that it is less about the price of money and more about the mental state of borrowers and lenders is something many people have a hard time wrapping their heads around—in large part because of what Econ 101 misguidedly taught us about the primacy of price, incentives and rational behavior.

I certainly make no claim to a deep understanding of those portfolio effects. (If I had such an understanding, I’d be far richer than I am.) But I do have some thoughts I’d like to share.

• When the Fed issues reserves and retires bonds, it’s 1. reducing the net flow of newly-issued (treasury and GSE-mortgage) bonds into the market, or even causing a net reduction. And if the latter is true, it’s 2. reducing the total stock of bonds available for trading in the market.

Since the flow of new bonds is obviously much smaller than the outstanding stock, you would expect flow effects of Fed actions to have much greater immediate influence on bond markets than stock effects.But it’s unclear what their long-term effects might be. A steady flow reduction, on the other hand, will eventually have cumulative effects on the total stock — again with uncertain future effects.

Jake Tepper, quoted in this post by Cullen Roche (read the comments too), gives us this:

…The fed is going to purchase $85 billion of treasuries and mortgages a month. So over 500 billion in six months…. the net issuance [by Treasury] versus refunding is a little over 100. That means we have 400 billion, 400 billion that has to be made up.

Whatever “made up” means. But Tepper’s also ignoring the Fed’s other big buys: mortgage-backed securities issued by government-sponsored enterprises (Fannie, Freddie). I would like to see as long a time series as possible of the following:

Net MBS issuance by GSEs (issuance – retirement)

Plus:

Net Treasury issuance (new issues – retirement)

Minus:

Net Fed ”retirement”

Also have to include Fed repos, I think? But maybe trivial over the long term.

In other words: net Net NET consolidated flow of new bond issuance to the private sector by Treasury, Fed, and the GSE gods.

Then: that measure as a percent of GDP? Of total Treasury/GSE bonds outstanding? Total Credit Market Debt Outstanding (TCMDO)? Other measures to compare it to?

• Contrary to what you often hear, even today when reserves and bonds are paying nearly equivalent interest rates, they are not equivalent assets. Because: bonds have expiration dates, and variable market prices/interest rates. So bonds carry market/interest-rate risk and reward for their holders — the potential for cap gains and losses. Reserves don’t.

As you can read in this must-read 2009 paper from the Bank of International Settlements, reserves are the Final Settlement Medium. They’re what it comes down to every night when all the day’s bank transactions are consolidated, netted out, transferred, and resolved. A dollar of reserves is always worth a dollar. There’s no possibility of capital gains or losses on reserve holdings. Reserves are inexorably nominal. (Even more so than $100 bills, which are worth less relative to reserves if they’re sitting in a Columbian drug-dealer’s suitcase.)

So when the Fed gives the banks reserves and retires bonds, it’s taking on market risk/reward, replacing it with absolutely nonvolatile, risk/reward-free assets (at least in nominal terms). It’s removing leverage and volatility from the banking system. (MMTers might well ask why our government system requires the injection of that volatility in the first place, when the Treasury could simply be issuing “dollar bills” with no expiration dates or interest payments, instead of treasury bills. [Or consols.] But that’s an aside.)

• I have to address notions like this one from Lee Adler, in a comment on Dow’s post:

The correlation between Fed and other central bank money printing with market behavior is clear and direct.

Yeah: while the Fed is on a bond-buying spree, it buoys bond prices and depresses yields. Especially when bond yields are historically low, market players shift their portfolio preferences from bonds to equities in a “reach for yield,” so equities go up too. (This presumably yields a wealth effect of [rich] people spending more — perhaps the only transmission mechanism to the real economy for Fed balance-sheet changes.)

This says exactly nothing about those balance-sheet moves as an impact on the stock of “money,” or inflation. It just says that while Fed asset purchases/sales are ongoing (and expected to continue), they will raise or lower the value of financial assets. It’s either orthagonal to Dow’s assertions, or  in fact demonstrates exactly what he’s saying about psychological effects.

• It doesn’t make sense to say that the Fed is “monetizing” the debt (because reserves aren’t money). If you think in terms of consolidated Treasury/Fed net issuance/retirement of government bonds, it’s retiring debt — removing bonds from the market and absorbing them into the Treasury/Fed complex. The bonds still exist, of course, and the Treasury still pays interest — to the Fed, which kicks it right back to Treasury. But as far as the markets are concerned, those bonds are essentially dead and gone (at least for now).

It seems that the Fed could simply burn a whole pile of those bonds, no? It would have no effect on flows, aside from the rather pointless interest flows back and forth between Treasury and Fed. And it would only affect the stock of “dead” bonds — ones that have been retired into the Fed. (The notion’s been discussed by people as diverse as Ron Paul and Mervyn King – Paul with the misconception that this would be “declaring bankrupcy,” and King with the misapprehension that it would be “monetizing the debt.”)

• It’s not at all clear what the flow effect would once the had Fed stopped net-buying bonds, while Treasury and the GSEs continued issuing new bonds in excess of retirements. Financial asset prices might stay at their then current levels. Who knows.

• The question, of course, is whether the Fed will ever sell all those bonds back to the market (thereby reducing reserve holdings). The average maturity of the Fed’s bond holdings is >10 years, so they’ll naturally expire and disappear, but only slowly. We’ve entered a brave new monetary world, in which central banks exert themselves not just through reserve management/interbank lending rates, but through balance-sheet expansion and contraction. (See the two “schemes” in the BIS paper linked above.) I don’t know if anyone knows what to expect in that regard. The Fed’s certainly talking about reducing its bond purchases in the future, which will affect net bond flows into/from the market, but it’s not at all clear whether it will ever shrink its balance sheet to pre-crisis levels (in absolute terms or relative to other measures), thereby reducing banks’ reserve holdings to those earlier levels.

• The $10-trillion question: If the Fed did sell off all its bond holdings in an effort to get back those halcyon days when banks didn’t hold any excess reserves — so the Fed could control the interbank rate with small open-market operations — what in the hell would happen? Whether slowly or quickly, bond prices would fall as the sales continued, yields would rise (compared to a counterfactual in which the Fed wasn’t selling off their holdings). Markets would shift their portfolio preferences from stocks to bonds, so equity prices would fall along with bond prices. Disastre?

Again, I don’t think anybody knows.

Cross-posted at Angry Bear.

Related posts:

1. Platinum Currency: What’s The Fed’s End Game?
2. More on Interest on Reserves
3. Question for Market Monetarists and MMTers: What Happens if IOR Goes to Zero?
4. Don’t Like “Money Printing”? Then Stop Borrowing. Whip Inflation Now!
5. Thinking About the Fed

Profits as a Percent of GDP: Financial Corporations vs. Nonfinancial Corporations

We saw a big decline in real businesses’ profit share in the 40s, then a slower semi-steady decline through the 70s, as wages constituted a larger share of GDP. Financial corps doubled, expanding and increasing profits, but they remained small in the big picture.

Then post-80, we saw two big moves: a dive in real business profit share below any historical norm, and the beginning of the long secular rise in financial corp profits share (quadrupling between 1980 and 2010).

How did financial corps achieve this? Simple: they’re licensed to print money, and they devoted that money to paying off the managers of real businesses to hand over those businesses’ profits. The C suite of America’s corporations went from being managers of real businesses creating real value, to being financial prestidigitators. And those individuals were handsomely rewarded for their obeisance to the financial corps.

The people who work for those real companies, of course — the vast pyramid of sub-C-suite toilers who don’t get a share of the kickbacks…haven’t gotten a share of the kickbacks.

Compensation of Employees/GDP

That 4% or 5% of GDP income flow — remember, that’s every year – was transferred from households to financial corporations, courtesy of bought-and-paid-for real-corp CEOs.

Got incentives?

Cross-posted at Angry Bear.

Related posts:

1. Why Don’t Shareholders Control Corporations?
2. Too Big to Fail? Wall Street and Main Street: How Big Are They?
3. Taxing Businesses, Encouraging Investment: Running the Numbers
4. Rents versus Profits
5. #OWS — How Wall Street Capital Destroys Capitalism

If you’re thinking that the current (overblown) hoo-ra-ra about U.S. government deficits is a result of too much spending, or that U.S. taxes are insanely high and always going up, you might want to think again (click for larger):

While the U.S. number is up from its low or 24.1% in 2009, it’s still hovering at the bottom of the OECD league table.

Got tipping points?

Cross-posted at Angry Bear.

Related posts:

1. Drowning the Baby with the Bathwater
2. More American Exceptionalism: Government Revenues
3. No, the Greeks Aren’t Lazy. The Germans Are.
4. American Exceptionalism #238: Opportunity (Not)
5. GDP and American (Non-)Exceptionalism: Again Some More

Related posts:

1. Quasi/Market Monetarists: Will You Tell Me a Story?

In brief: poorer people spend a larger share of their income/wealth than richer people. So if poorer people have more income/wealth — if the distribution is more equal — there will be higher money velocity/more spending/more production/higher GDP.

(Search for “marginal propensity” and follow Related Links to see my stabs at this.)

But Kevin — who certainly has the political inclination to make this argument — says:

This sounds pretty plausible, doesn’t it? Higher inequality should generate less consumption, which in turn produces a weaker economy. Unfortunately, the data says something else. “I wish I could sign on to this thesis,” says Paul Krugman, “and I’d be politically very comfortable if I could. But I can’t see how this works.”

Me neither. I spent a couple of months trying to write a magazine piece based on this thesis, and I finally gave up. By the time I was done, I just didn’t believe it. So I gave up and spiked the idea.

I’ve tweeted him and posted a comment, but haven’t heard: what made him give up on this? What convinced him otherwise?

And in response to a recent post where I ground this axe, Scott Sumner responded:

But you really need to give up on that MPC stuff, it was discredited decades ago. Monetary offset rulz.

This in keeping with his seeming assertion that nothing matters except monetary policy, because monetary policy will (or at least should) always offset it.

But still: Sumner, Drum, and Krugman all seem to think that the distribution/MPC/velocity argument has no legs. They’re quite categorical about this.

SRW took a stab at the subject recently, telling a story that I find quite convincing. But didn’t really explain to me why so many feel so certain that it’s not true.

Can folks (especially those who don’t believe this argument) point me to what might be considered definitive takedowns? I have notions about what they might say, but want to see the best argument(s) out there.

These takedowns should, just for instance, convincingly debunk this paper (sorry, gated), which suggests that rising income inequality ’67-’86 resulted in 12% lower consumption spending in ’86 than would have occurred if inequality had remained the same.

Cross-posted at Angry Bear.

Related posts:

1. Explaining the Fed Credibility Argument
2. The Fed Credibility Argument
3. The Central Flaw in Krugman’s Argument Against Keen
4. Bleg: Why Hasn’t Europe Caught Up?
5. Tyler Cowen’s The Great Stagnation: Government Spending Section

That may explain why, aside from a lonely Steve Randy Waldman link, I’ve seen no mention of his work out there. Just another internet econocrank?

I’m wildly unqualified to pass judgment, but Lambert’s built what strikes me as a very interesting, cogent, and coherent model of effective demand, labor share, unemployment, and capacity utilization in growing economies. And he’s extending it fast, including into optimal monetary policy. (Mark Sadowski has been challenging him on the model in comments here.)

I won’t try to summarize his modeling or poke holes — go look at it. I’ll just give you a picture and a few post titles to whet your appetite.

Here’s his UT (“Unused Total”) Index:

The regularity of its coincidence with recessions (especially the ends of recessions), at least, seems like it should raise eyebrows.

Here are some posts to peruse:

What is Effective Demand?

What Non-inclusive Growth Looks LIke

When Labor Share does not rise in the Growth Model

Effective Demand Monetary Policy: the z coefficient

AS-ED Model: Raising Labor Share of Income

Update on AS-ED model: The future has a problem

Given Scott Sumner’s recent reversion to labor share as the appropriate target for monetary policy, I’m thinking that Market Monetarists might find Lambert’s work as interesting as effective-demand-obsessed Keynesians will. MMTers and other Post-Keynesians? His results certainly comport with their political predilections.

Cross-posted at Angry Bear.

Related posts:

1. Is the Elasticity of Labor Demand at Zero?
2. Scott Sumner Goes Marxist, Proposes Targeting Labor’s Share of Income
3. Monetary or Fiscal, Discretionary or Non? Think: Automatic Stabilizers
4. Menzie Chinn Explains it All for You: Demand Inflation Now!
5. Milton Friedman Caused The Great Depression

You could flip this upside down and replace “Earning Yield” with “PE ratio.”

The data displays a remarkably regular relationship. Equity investors seem to be most optimistic about future economic (or at least earnings) growth when the inflation rate is 4.3%. (It would be interesting to see: did this relationship hold, albeit with the inevitable noise from smaller samples, in shorter sub-periods — and if so, which sub-periods? In particular curious: did it hold equally pre- and post-1971?)

Can we draw any conclusion from this? i.e.:

• Market conditions that are most conducive to economic growth are revealed by a 4.3% inflation rate.

• Equity investors display the most “irrational exuberance” when the inflation rate is 4.3%.

I’d love to hear whether Market Monetarists and MMTers think this has any useful import.

Cross-posted at Angry Bear.

Related posts:

1. Menzie Chinn Explains it All for You: Demand Inflation Now!
2. Don’t Like “Money Printing”? Then Stop Borrowing. Whip Inflation Now!
3. Demand Inflation Now! Up the Real Economy.
4. Taxes: Equity versus Efficiency? Not so Much
5. The Long Decline in Equities

Annualized change, Q1 2006 – Q4 2012:

RGDP: 1.3%
NGDP: 2.4%

But the unemployment rate fell from about 12% to 5.4%.

Lackluster GDP growth coupled with a damned impressive drop in unemployment. How do you account for that in Scott’s long-argued model, where NGDP growth drives employment growth?

As he says, he buries the lede in his first post. Here it is, from the end of the post (I’m reversing these two paras to make it flow even better; emphasis mine, correction his):

Recessions are not caused by less spending; they are caused by less income going to workers.  Usually the two go hand-in-hand, but the German miracle tells us that when they diverge, it is employer employee income that matters most.

When I started blogging I assumed wage targeting would be politically impossible, and knew that NGDP targeting was already a well-regarded concept.  So I latched on to NGDP targeting.  But in retrospect I wish I’d latched on to aggregate employee income.  Call it “income targeting.”

Did I mention admirable? Speaking of the very argument he’s been making doggedly and insistently for years, he says:

I took some shortcuts, instead of staying true to the “musical chairs model.”  In the past I’ve often argued that a fall in NGDP causes unemployment because there is less income to pay workers, and yet hourly wages are sticky.  Some workers end up sitting on the floor.  The logic of that model suggests that the real problem is not unstable NGDP, but rather instability in a component of NGDP, namely total wages and salaries.

And speaking of the school of economics based on that thinking, a school that he’s been primarily responsible for creating and popularizing, he says:

Now that market monetarism riding high, I figured it was time for a vicious internecine struggle for the soul of market monetarism.  Consider this the first shot. 

The fruit doesn’t fall far from the tree, of course; in his second post he attributes the “miracle” largely to “structural”/supply-side factors:

Germany did lots of labor market reforms, which I’ve discussed in previous posts, and this opened up lots of low wage jobs.

The basic idea: the Hartz reforms beginning in 2003 resulted in more jobs, though often with shorter hours and/or lower wages, all netting out to a larger share of GDP going to employee compensation.

This is not crazy. But it’s incomplete. And he even acknowledges that in a nod to his commenters:

Many commenters pointed to various job sharing programs, or subsidies to keep workers employed during the recession. Libetaer used the metaphor of putting 2 workers in one chair.  The one chair reflects relatively meager growth in NGDP, and the two workers represent job sharing.

The key problem I find in his thinking is his glossing over a key word in the preceding: subsidies. He only discusses job sharing, which fits neatly in his musical-chairs analogy. (How about musical benches instead? When the music “stops” — national income is weak — workers squeeze in more tightly.)

But the Hartz reforms did more than make it easier for firms to hire cheap (create more chairs/bench space); they increased subsidies for low-wage and part-time jobs. This 1) makes it easier for employers to hire lower-productivity workers for low wages, 2) gives those lower-productivity workers sufficient incentive to take those jobs, and 3) increases the share of national income going to lower-income workers.

And since those workers have a high propensity to spend their income, all things being equal that distributional shift should mean there’s a higher average velocity of money, aggregate demand, NGDP, etc., all in a virtuous cycle. (See JW Mason here and me here.)

Scott says much the same thing from a different direction:

The welfare loss to a society from a 5% RGDP shock is much greater if 5% of workers lose their jobs, as compared to all workers staying employed, but working 5% less hard.

This is a statement about absolute utility, but (hence, because spending is driven by the desire for utility) it’s also a statement about different policies’ distributional effects on spending and aggregate demand. Because subsistence has (very!) high utility, cutting some subsistence incomes (which would surely be re-spent) results in a bigger hit to aggregate demand than cutting many marginal incomes (which are less likely to get re-spent). It’s straightforward Marginal Propensity to Spend out of income thinking.

I’m here to suggest that the same logic, rather inevitably, applies to subsidies for low-wage jobs (paid for by better-off taxpayers). We redirect disposable income at the margin from higher-income folks, and flow it into the hands of lower-income folks who will spend it on. Got velocity?

Which brings me back to the axe that I’m forever grinding: the best and most feasible structural labor-policy change we could make in the U.S. to improve long-term macroeconomic performance would be to greatly expand the Earned Income Tax Credit (while streamlining its tortured administration and — to increase its “salience” — delivering the credit on weekly paychecks as we do with payroll tax deductions).

If these subsidies were sufficient to make low-wage work/workers attractive for both employers and workers (and perhaps if they subsidized hourly compensation rather than annual family income), we might even be able to do what the Germans, with their generous low-wage subsidies, have been able to do: do without minimum-wage laws.

I bet Scott would like that.

And we still haven’t talked about national compensation/income targeting by the Fed, which promises to be a very lively discussion indeed. (I can just see Ben Bernanke slapping his forehead and looking heavenward.)

Cross-posted at Angry Bear.

Related posts:

1. Leading Economists Vote on Raising the Minimum Wage
2. Does the Minimum Wage Increase Productivity?
3. Is the Elasticity of Labor Demand at Zero?
4. Minimum Wage Laws are Bad for the Poor, Right? Wrong Again.
5. Yes: Machines Are Replacing Humans

This is not new thinking. You’ll find a more sophisticated historical account, stated very clearly though in somewhat different terms, in the first few pages of this PDF. Still, despite decades of debunking, this misconception remains ubiquitous. I’d like to explain it in the simplest and clearest terms I can.

Start here:

GDP = Consumption Spending + Investment Spending

Consumption Spending = Spending on goods that will be consumed within the period.

Investment Spending = Spending on goods that will endure beyond the period.

Looking back at a period, from an accounting perspective, it’s obvious that if there’s less consumption spending, there’s more investment spending. This must be true, because that’s how we tally things up, once they’ve happened. There are two types of spending; every dollar spent last year must be one or the other. If there’s less of one, there’s more of the other.

But people conclude: if there is less consumption spending, there will be more investment spending. (So we’ll increase our stock of real stuff, and we’ll all be richer!)

They’re confusing (and confuting) a backward-looking, historical, accounting statement with a forward-looking, causal, predictive statement. Because looking back, GDP is fixed. It has to be; it’s already happened! But in that very instant of thought, people abandon that fixed, historical perspective and think: if one component is smaller, the other will be larger.

This makes no sense at all. Think about it: If people spend more on consumption goods next year, that will cause more production — including production of long-lived goods to increase production capacity. Investment won’t go down because people spend more on consumption. GDP will go up. Next year’s GDP (obviously) isn’t fixed.

Likewise, people tend to think that less consumption spending means there will be a higher proportion of investment spending (so, relatively, more real-wealth production). Wrong again. The backward-looking Y = C + I accounting identity tells us exactly nothing about why people will make their spending decisions — what causes them to choose consumption vs. investment spending. They might choose to increase or decrease either or both, for myriad reasons. One doesn’t cause the other in some kind of simple arithmetic manner.

This seems very obvious. But if you hold this firmly in your head as you peruse people’s statements out there in the world, I think that you will find that many of them do not have it fixed very firmly in their heads.

Cross-posted at Angry Bear.

Related posts:

1. I Was Wrong: There Is a Substitute for Investment (Investment)
2. “If you tax investment income what will people do? Stuff their money in the mattress?”
3. Eating the Seed Corn? Consumption in the American Economy Since 1929
4. Okay Fine, Let’s Call Investment “Saving.” Or…Not
5. Does Reduced Consumption, and Increased “Saving,” Result in “Capital” Formation?

I was really curious to talk to him about why commercial property owners don’t invest more in energy efficiency. By all accounts there’s great ROI in doing so — serious low-hanging fruit.

Why do commercial property owners leave five-dollar bills lying on the sidewalk?*

At least, it sure looks like there are five-dollar bills lying around. Here from a McKinsey report (PDF; see page 15) showing how much it costs to save (not buy/pay for) a million BTUs of energy, by instead investing in energy efficiency:

Sorry, it’s hard to see without going to the PDF. But short story: there are quadrillions of BTUs in efficiency savings available for less than $2 per million BTUs.

Now look at the cost of buying a million BTUs instead, to heat your building or power your plant (2011 figures, Energy Information Administration):

Coal: $2.39/MMBTU
Petroleum: $12.48
Natural Gas: $4.72

This is the cost to a utility company buying these fuels. The meter cost of the electricity produced (after line losses, administration, profits, etc.) — the cost for building owners — will of course be somewhat higher.

So it sure seems like there’s money to be picked up. Why don’t building owners do it? The short answer my friend and I came to? Triple-net leases — the ubiquitous standard in the commercial real-estate industry.

In these leases tenants pay per-square-foot rent, plus their pro-rata share (by square feet) of the building’s 1) taxes, 2) insurance, and 3) repairs, maintenance, and energy expenses. (Many NNN leases don’t include pro-rata energy costs, but tenants are separately metered and either pay directly or through the landlord. There are lots of variations, but landlords rarely pay all energy costs.)

Notice what is not included: the cost of improvements — for instance improvements to increase energy efficiency. So the owner gets all the costs, right up front. And the benefits go mostly or completely to the tenants, in the form of lower energy bills.

“But hey,” I asked my friend, “don’t lower energy costs for tenants mean you can charge more rent? Doesn’t it all come out in the wash?”

“Welllllhh,” he said… Most tenants are on long leases. “We just signed a ten-year lease with the anchor tenant for our mall.” My friend won’t see any dollar benefit from those energy savings for a long time, as leases turn over and are renegotiated. And it’s not at all clear how much benefit he’ll get, because tenants tend to fixate on the square-footage rental rate, which would go up. 

Imagine you’re a leasing agent for the building, trying to rent some space. You’re competing with other buildings that haven’t done the energy upgrade, so their rent/square foot is lower. You’re stuck saying “yeah yeah yeah yeah but you’ll spend less on energy!” This, if you even get the chance: Prospective tentants scanning the listings might never even call you because your rent is so high.

A building owner considering a big spend for energy efficiency really has to think thrice: would I rather have a million dollars, cash in hand, or the likely but uncertain prospect of higher profits somewhere (perhaps way) down the road? It’s easy to understand why they make the choices they do.

And all of this is true even though there’s money lying on the ground waiting to be picked up.

It’s a classic coordination problem — people acting in their own best-guess best interests, with ridiculously inefficient results — that is caused or at least greatly exacerbated by the institutional convention of triple-net leases. (The reasons the convention arose are yet another subject, about passing off risk and retaining returns.)

Obviously triple-net is not the sole villain in this very big picture. From the McKinsey report:

Got central planning?

* For those who don’t know the old joke: Two economists walking along, they see a five-dollar bill lying on the sidewalk. One of them gestures for the other to pick it up. “I’m not picking that up,” says the other. “If it were there somebody would have picked it up already!”

Cross-posted at Angry Bear.

Related posts:

1. Taxes: Equity versus Efficiency? Not so Much
2. Regulating the Ratings Agencies: Low-Hanging Fruit?
3. The Republican Energy “Plan”?
4. Gore: Subsidizing Dirty Energy?
5. The Efficiency of De Ebil Gubmint Man

Hat tip Barry Ritholtz.

Cross-posted at Angry Bear.

Related posts:

1. Banks’ “Bigger Concern”: “Republicans will no longer defend Wall Street companies.”
2. Tea Partiers and OWSers: Who Needs to Get a Job?
3. Financialization and the Stripping of the Middle Class, in Twelve Graphs
4. Stockman: How the GOP Destroyed the U.S. Economy | The Big Picture
5. Co-Founder of Reaganomics: The economic mess … is the direct consequence of too much economic freedom … the direct consequence of financial deregulation.

FRB: Press Release–Federal Reserve issues FOMC statement–May 1, 2013.

Cross-posted at Asymptosis.

Related posts:

1. Full-Reserve Banking Goes Mainstream
2. The Human and Economic Devastation of Leaded Gas: How the Visible Hand Saved the Day
3. Thinking About the Fed
4. How Money Moves
5. Does Unemployment Insurance Explain (and Cause) High Unemployment?

Fiscal austerity–or deficit cutting–is the subject of much current debate. As Europe proves, severe austerity can slow growth or lead to recession.

Despite periodic slowdowns, the US economy is on a sustainable fiscal path. The deficit is projected to drop below 2.5 percent of GDP by 2017, below its 30-year average, helped partially by the sequestration budget cuts.

Instead of pursuing short-term fiscal reform, as suggested in the president’s recently released budget, Congress should focus on working toward long-term tax and entitlement reform.

via Austerity undone – Economics – AEI.

Cross-posted at Asymptosis.

Related posts:

1. Bush/McCain Economic Advisor Sez: Raise Taxes
2. It’s The Health Care Costs, Stupid
3. The Brain-Dead 29%
4. Republican Governors: Take from the Poor, Give to the Rich, and Suck the Federal Teat
5. Tyler Cowen Ignores the Elephant

Yes, the government must pay its bills in the long run

You hear this from him a lot. And I want to ask him:

Paul, are you letting yourself be sucked into the very syndrome that you so bemoan and berate? Are you saying this because you feel the need to cast yourself as being sensible, responsible, moderate, and somewhat centrist — in short, as a Very Serious Person?

I ask because over four centuries and two centuries respectively (six hundred years combined), the U.K. and the U.S. governments have paid off their debts exactly once: the U.S. in 1836.

This happy event was followed, in 1837, by one of the most catastrophic depressions in either country’s centuries-long history. Likewise, the one other time that the U.S. got close to paying off its debt (the U.K. never has), in 1893, a disastrous depression followed immediately thereon.

Every depression in U.S. history has been preceded by a major decline in nominal Federal debt. It’s not a sufficient condition for, or reliable predictor of, depression (many declines have not been followed by depressions), but it does seem to be a necessary condition.

So we haven’t had to pay off our debt, and the one time we did (plus one time we got close), we were not happy with what ensued. From that history, how can you conclude that, now, “the government must pay its bills in the long run”?

To quote Chris Cook (HT Izabella Kaminska; emphasis mine), the national debt:

…is a national equity…

At least two-thirds … came into existence as mortgage loans, and are therefore backed by claims over the productive value of the US land and buildings which they fund. Much of the rest consists of claims over the value of US assets which fund the productive capacity of US corporations. The remainder – which provides the credit necessary to finance the circulation of goods and services in the US – is based upon the magnificent productive capacity of the US people.

Only by liquidating US Incorporated could this National Equity [read: Debt] ever be redeemed.

Such a liquidation, of course, would involve liquidating our overwhelmingly largest real asset: the ability of the American people to work. (Something your ideological opponents seem intent on doing.)

Of course you might well mean that we can’t increase deficits faster than GDP growth forever. But in today’s monetary world you have to at least question even that. Since 1971, when the U.S. stopped promising to redeem its dollar for anything besides…dollars (perhaps in some other “dollar” form, like Fed reserves), that proposition has become at least questionable. Dollars really might be like points issued by a bowling alley, and we may be able to issue a lot of them before we see problems with inflation.

I don’t think we really know; we don’t have any comparable situation to look back on (except maybe Japan, and that’s a glass, darkly). For a decade or so after the ’71 sea change, monetary authorities and markets flailed to adjust their reaction functions to the brave new world. Then those interacting functions settled down and we saw twenty years of steady inflation and steadily-declining interest rates. That may have been the inevitable emergent path for the world’s dominant economy and currency issuer, resulting inexorably from the game rules put into place in ’71/’73.

The place we are now — where Japan landed two or three decades earlier — may be the inevitable (and perhaps enduring) result.

Yes, rising globalization and the political rise of neoliberal Reaganomics may have contributed, but it seems possible that even absent those trends, we would have ended up in this place, perhaps sooner perhaps later.

So now, having arrived at this point, reaction functions are getting rejiggered again, and in a big way. (The institution of IOR was a big change, for both the Fed’s and the markets’ reaction functions.) One key element of those reaction functions is the belief that “we can’t keep running deficits forever.” But at least some parts of the market are acting as if we (and certainly Japan) can. And they may very well be right.

All of which is to say, think again. Think deeply. I’m not sure you’re thinking in your usual clear-eyed manner about a belief that may not be true. At least, given the new rules of the game, we might be a very long way — decades? centuries? — from a point where large government deficits or debt might pose any danger to our economy.

All my tentative language above should make clear that I’m not at all certain of this. I’d sure like to hear what you think.

Cross-posted at Angry Bear.

Related posts:

1. Pubs Don’t Cut Spending. They Just Refuse to Pay Their Bills. Video.
2. Public vs. Private Debt: The Long View
3. Deep and Long: Private Debt and Financial Recessions
4. Should the Government Just Keep Spending?
5. Where Did Our Debt Come From? – James Fallows – Politics – The Atlantic

Twitter / izakaminska: Why equity is a type of privately issued currency

Steve Randy Waldman has been here before, with the idea that currency issued by government (ultimately through deficit spending) is “equity” in government, or in America. But this reverses it beautifully, with the notion that private equity issuance is also currency issuance. Google stock is currency.

I won’t recap the argument here; you really need to read it. Just some thoughts:

I think different words might help make it clearer. I would say that there are many units of exchange in the world —  dollar bills, t-bills, stock shares, etc. Financial assets. They have various characteristics, a key one being limits on what they can be exchanged for. In general when we say “currency” we mean physical tokens that can be exchanged for (small quantities of) real goods. But we confuse things by not realizing that “currency” is a somewhat vaguely defined subset of “units of exchange.”

(Key distinction: the “units” I’m talking about are not measurement units like inches, degrees, or “the dollar” — units of account. Rather, in the sense of discrete units, chunks. As when a factory produces a certain number of units, which can have their value described relative to a unit of measurement/account, such as the dollar. More on the distinction between “unit” and “medium” of account/exchange here.)

You can’t buy a car or a government bond with quarters. So are quarters currency? Likewise, you can’t buy a pack of gum with a treasury bond — but you can use it to buy Fed reserves (if you’re a bank). Is the bond currency? You decide. But both quarters and bonds (and Google shares) are units of exchange. (This is why I’m still struggling with JP Konig’s “moneyness” concept: it seems to hinge on a single axis of “liquidity,” when in fact different units of exchange are differently liquid.)

We can also call these units of exchange “financial assets.”

I do not define a “bushel of apples” as a unit of exchange or a financial asset, but as a unit of commodity. Ditto an ounce of gold. Because in my definition:

1. Units of exchange/financial assets cannot be consumed by humans to produce human utility, and

2. Their creation requires no (or vanishingly little) input to production.

Returning to a previous (excessively long) post, these units of exchange/financial assets embody exchange value — money. Hence (alert: precise definition here) money is exchange value as embodied in financial assets. Money does not, cannot exist, absent such embodiment. A bushel of apples does not embody money: That bushel has exchange value, but the value is not embodied in non-consumable, only-exchangeable form.

Not sure how much this will help others, but it’s working for me.

Cross posted at Angry Bear.

Related posts:

1. All Currency is “Fiat” Currency
2. Weimar, Zimbabwe, Here We Come
3. Platinum Currency: What’s The Fed’s End Game?
4. Medium of Account vs Unit of Account: Brazil Anyone?
5. Financial Markets Are the Real Barter Economy

Try this:

John works for Debbie, and Debbie works for John.

They each start out with $100 in dollar bills, $200 total.

They pay each other in dollar bills: $100 a year, each direction.

Between them, through their labor, each year they produce $200 in real resources — things that humans can consume to derive human utility (or to produce more consumables in the future).

But: This year Debbie decides to save money, so she doesn’t hire John for as many hours, and only pays him $80. She leaves $20 sitting in her drawer; she doesn’t circulate it this year.

At the end of the year Debbie has $120, and John has $80.

Debbie has produced $100 worth of real resources, and John has produced $80 worth. $180 total, instead of $200 the year before.

Did Debbie “take those $20 in real resources ‘out of society’”? (Or was it John — lazy, feckless soul that he is — who didn’t do that $20 in resource-creation?)

We can certainly say that Debbie’s decision to leave the $20 sitting in her drawer instead of circulating (spending) it caused “society” (read: John) to produce less resources than it would have if she had circulated (spent) it.

Is Debbie a “taker”?

Cross-posted at Angry Bear.

Related posts:

1. “Saving” ≠ “Saving Resources”*
2. “You Deserve It” Part 243
3. Pro-Growth Republicans? Get Real
4. John Galt, “Genocidal Prick”
5. Pubs and Economic Opportunity: Not

Units of exchange (dollar bills, great big rocks at the bottom of the ocean) can have value merely because everyone in a community agrees that they have value. That value need not be declared, defined, or enforced by some “fiat” authority with powers of (ultimately physical) coercion — though it often or usually is.

That’s one big realization I came to from Graeber’s Debt: The First Five Thousand Years. (Though he doesn’t state it so succinctly, and I’m not sure he’d agree with it.)

Think of gold coins. If their exchange/consensus value is (enough) less than the (commodity) value of their metal content, people will melt them down and sell the metal. Arbitrage happens. Their consensus exchange value must be higher than the exchange value of their constituent metal, or they’re simply not currency any more; they’re chunks of commodity.

So why gold coins? Because the next city-state over, or the one 500 miles away, might not have the same consensus about those coins’ value as in your city-state. But there is a much wider consensus as to the value of gold. As far as they’re concerned, your ruler’s gold coins have the value of their gold content, and that’s all. But at least they have that value, because the gold-value consensus is widespread. 

So if you’re a trader looking to buy 1,000 yak skins from the remote Azbakalians, you can carry a bunch of gold coins there and trade them instead of carrying 1,000 amphoras of lima-bean oil. Yeah, you sacrifice the extra consensus value you’d have if you instead used those gold coins to buy things locally, but the cost of transporting all that oil is higher than that loss.

So is a physical one-ounce lump of gold a unit of “currency”? I’d say no. Because while the consensus value of gold might be different and might change at different times and places, there is no particular time and place where it has two different exchange values: its local consensus value and its foreign-trade commodity value. It only has its commodity value.

That differential between currencies’ consensus value and their commodity value is their very sine qua non: the thing that makes them what they are, without which they would not be currencies.

How does this work for cigarettes in a POW camp? They’re obviously used as some type of currency, as units of exchange. I’d suggest that because some people smoke and some don’t — some people value them highly for the utility their consumption can deliver, while others have no use for them — their average commodity value is lower than their average exchange/consensus value. (Also: new cigarettes are constantly being delivered and shared out in some way by the Red Cross or whoever, and they’re constantly being consumed. This is never true of coins or paper bills, which can’t be consumed.) This raises issues of distribution, power, wants, needs, and satisfactions, which I’d love to hear discussion of by my gentle readers.

Cross-posted at Angry Bear.

Related posts:

1. Currency is Equity, Equity is Currency
2. Platinum Currency: What’s The Fed’s End Game?
3. Medium of Account vs Unit of Account: Brazil Anyone?
4. The Money Confusion
5. The Problem Was Not Deregulating. The Problem Was Not Regulating.

But I want to walk back on that, or at least clarify, and give lots of credit where due. Because they did make a huge contribution, of a quality that you will not find in econoblog posts from even the best bloggers: they assembled a great data set. As I can attest — having spent hundreds of hours assembling data sets that were far less challenging than theirs — this is not a trivial task. And the value of that data set is high, assuming you throw high-quality analysis at it.

Now of course, they didn’t release the goddam data set for years. That seems unforgivable, especially given the paper’s political and policy impact. This paper wasn’t in a peer-reviewed journal (it was a “discussion paper,” which makes its impact even more eyebrow-raising), but I really wonder why those journals (in any field) would publish such papers without requiring that the data sets accompany them, for vetting by other researchers. (Yeah I know: not a new idea.)

I totally understand why this is problematic. This is the researchers’ crown jewels, upon which they can build future papers, at least. Not just the data, but the analysis methods and the coding of those methods (intellectual property?), is often included in the files. At most, you’re looking at corporate/university/personal assets, trade secrets, generally some (at least potentially) damned valuable stuff. (Throw in the issue of partial or complete government funding for the research, and it’s even more complicated.) But providing the data should be the default requirement, with some clear guidelines justifying and explaining why the data is not provided, when it isn’t.

The “damn valuable stuff” double-points to the other topic I want to mention here: the BEA’s move change the NIPAs, to count spending on R&D and the development of creative works as investment spending rather than consumption spending — as real-capital building.

“Double” because 1. the new accounting highlights the real value of this kind of data-gathering and knowledge-creation, and 2. the change itself required (and will continue to require) a huge amount of data gathering.

I was kind of wowed by this line in the Financial Times writeup on the change:

The Internet Movie Database may not seem like a natural source of data for the national accounts, but it was one of many combed by BEA researcher Rachel Soloveichik, who went through film studio records as far back as the 1920s to build a series on investment in movies.

(Another good FT post on this here.)

So when you hear me kibbitz about the structures and methods used in the national accounts, please know that I have wide-eyed respect for the diligence and skill of hundreds of accountants and economists involved in building those structures, and populating them with data from hundreds of diverse sources. (This actually sounds like one of those Google interview/hiring questions: how would you go about estimating the value of every movie made in America since the 1920s? Books? TV programs?)

That information is hugely valuable. It’s a great example of Your Tax Dollars at Work, delivering value far above the government’s cost.

Or at least, I think it is. Somebody should gather some data on that.

Cross-posted at Angry Bear.

Related posts:

1. Note to Reinhart/Rogoff (et. al): The Cause Usually Precedes the Effect
2. Full-Reserve Banking and Loanable Funds

Econ profs: I’m really curious. Do you think this post would help your intro students understand this stuff?

First: The accounting’s fine. Of course. But for some not-crazy reasons, the definition of “Saving” changes in the course of the accounting.

Thinking of the “real” sector for the moment, for simplicity and clarity. For each of the economic units at the bottom level of that sector (households and nonfinancial businesses), Saving means money saving:

(1) Saving = Income – Expenditure

But at the top, the level of “sectoral” saving, Saving means saving of real goods:

(2) Saving = Income - Consumption Expenditures

Or in words that more aptly describe what’s being depicted:

(3) Saving = Production – Consumption

(Reminder: Consumption Spending + Investment Spending = Expenditures = Income = Production)

Explanatory aside: There’s Gross or Net Saving, depending on whether Consumption just includes Consumption Spending (on goods that are bought and consumed within the period), or also includes Consumption of Fixed Assets — the very real “depreciation” of those assets. Gross is long-lived goods produced; Net is long-lived goods added, above and beyond what’s “consumed.”

Back to identities: Unlike every other measure in the national accounts, if you sum up the money Saving of all the bottom-level units, it doesn’t equal Saving for the sector. Rather:

(4) Sectoral Saving = Units’ Combined Money Saving + Investment Spending*

Investment spending, of course, causes the creation of real, long-lived goods. But this is the thing that has confused me from the get-go: Saving is (savings are) some combination of money and real goods? Aren’t financial assets supposed to be representative of, proxies for, the real assets? (Equally confusing: economists’ insistence on talking about “capital” as if it were some undifferentiated, homogeneous or vaguely contiguous lump of real and financial capital.)

Here’s what you need to know to sort that out: You know that money saving? It’s zero.

As JKH has quite rightly pointed out, if Sectoral Saving means money saving, “one stumbles upon the unhelpful conclusion that global saving…is identically zero, which is not very productive.” Income = Expenditures, right? One person’s spending is another’s income. So for the world or any closed sector (no net flow in or out), Money Saving (Income – Expenditures) must equal zero.

If you plug that zero into (4), voila, you get:

(5) Sectoral Saving = Investment Spending

This makes sense in the accepted sectoral definition; investment spending increases the stock of real, long-lived goods — Sectoral Saving. But if you don’t get confused when Spending = Saving, you’re a better soul than I.

While JKH is (identically!) correct, I completely disagree that this is “unhelpful” or not “productive.” Because in fact a money-saving approach perfectly depicts the actual situation in a way that’s easy to grasp — which is important given that so many find it so hard to grasp. If there’s no flow in from other sectors (Government and Foreign, ignoring the financial sector for the moment), the units in the real sector, in aggregate, can’t save money. You get this familiar, MMT-favorite identity:

(6) Government Deficit + Trade Surplus = Real Sector Money Saving (Net Acquisition of Financial Assets)

When you’re looking at the actual accounts, Money Saving doesn’t equal zero. Because we all know: households and businesses save money — but only, in aggregate, if there are inflows from outside (which there are). If Sectoral Saving meant money saving, as it does at the bottom, unit level, what you see at the top would be the non-zero sum of what you see at the bottom.

It’s not crazy to think about sectoral saving as money saving. Both the NIPAs and the FFAs provide a sector-level measure of Personal Saving (households), which is unequivocally money saving: Money Income – Money Expenditures. (Nobody would say that household saving is “stockpiling of real goods.”)

Unfortunately the accounts don’t have a similar measure of money saving labeled Business Saving, which would be this:

(7) Business Saving = Income – Expenditures – Distributed Profits = Undistributed Profits

(This because Distributed Profits count as Income for households, so they contribute to Household/Personal Saving, not Business Saving.)

Why no such Business Saving measure? Because this is the turning point, the crux, of the definitional legerdemain. Within the real sector in the NIPAs, businesses only do Investment Spending, and only businesses can do Investment Spending. (Households only do, only can do, Consumption Spending.) Is Investment (aka Business) Spending an Expenditure, or isn’t it? Is it Expenditure or Saving? If there were a measure here called Business Saving — money saving — then matter (real goods) would collide with antimatter (money), and the Universal Accounting Construct (perhaps the whole universe!) would explode and vanish in a fiery conflagration.

Okay, fine, hyperbole. But really: we know that businesses save money. You’ve no doubt noticed that corporate cash balances are at historic, all-time highs. It’s hard to pull that off if they’re not saving money. It would be nice to see that money saving by businesses clearly presented as such, in so many words, in the national accounts. It could then be totalled up with Household Money Saving to show Real- (nonfinancial) and Private-Sector Money Saving.

I’ve got more to say on all this, but I think I can clarify best by suggesting a different way of thinking about it, using different words/labels/definitions that might cut this conceptual Gordian knot, and help people better wrap their brains around the national (and world) accounts.

I’m going to talk in terms of the NIPAs here, and about the real sector, because the constructs are different in the FFAs, adding the financial sector makes things more complicated, and I want to be perfectly clear.

The basic problem: we’re short a word. We have more things to describe than we have words. So I’m adding one.

Whenever you see Saving in the NIPAs (except “Personal Saving”), replace in your mind with:

 Accumulation (of real goods)

 When you think about Saving, think money saving:

Household/Personal Saving (Income – Expenditures)
+ Business Saving (Income – Expenditures – Distributed Profits = Undistributed Profits) 

Adopting those labels, when you see “Investment,” think:

 Spending that adds to the Accumulation measure

Consumption?

 Spending that doesn’t add to the Accumulation measure

And here’s the crucial point:

Neither Consumption Spending nor Investment Spending adds to or subtracts from the Saving measure. Not directly.

Each of these spending flows increases Income and Expenditure simultaneously and equally, so they can’t increase Saving (which is the difference between the two). Sectoral Saving only happens if there are inflows to the sector.

If you want to talk about indirect effects (incentives, constraints, emergent properties, etc.), you’ve left the backward-looking realm of accounting, and entered the world of Economics, Psychology, Sociology, Dynamic-Systems Theory, and a whole host of other disciplines. Accounting can never tell those disciplines when they’re right. It can only, and only sometimes, tell them when they’re wrong.

In that backward-looking world, we can say that X% of spending in a period was Consumption Spending, and the rest was Investment Spending. But that tells us exactly nothing about what caused the mix. We can’t say from the accounting, for instance, that if there had been less Consumption Spending, there would have been more Investment Spending. The result might just have been less spending overall (even, perhaps, less Investment Spending), so less Income, and less Production (allowing for the buffer stock of inventories, though that looms ever smaller as our economy goes past 80% services, and produce-on-demand supply chains for physical goods get ever more efficient; the production comes after, and is caused by, the expenditure).

This last point — that spending (of either type) doesn’t reduce sectoral saving — is crucial because failure to understand it lies at the root of things like the ridiculous loanable funds model, the idea that more individual money saving (not-spending) causes more investment, the notion that consumption spending takes resources “out of society,” and many other evil and foolish economic misconceptions that I might encapsulate somewhat trivially with two words: “trickle down.”

Also realize: When you look at actual data for the real sector and think about it using these terms, Saving and Accumulation (née Saving) won’t show any kind of obvious relationship, except that they both generally grow over time with the economy.

That’s because the sector isn’t closed. There’s lending/borrowing to/from the other sectors, and loan payoffs in both directions — summing out to Net Lending/Borrowing — and crucially, trade imbalances, and government deficit-spending into the real sector, with money created ex nihilo. (The latter being the ultimate though not necessarily proximate source of real-sector money saving, a.k.a. Net Acquisition of Financial Assets.)

For the (open) real sector over the long term, Income > Expenditure. Hence: money saving.

For those who have been confused as I have been (and who admit it), this thinking and terminology might make it easier to think about important questions of (macro)economics — how personal/business saving relates to investment and production, the role of debt and equity financing and the financial industry in economic growth, the nature of “demand,” how the stock of financial assets (so-called “financial capital”) relates to the real capital stock, etc. I’d love to hear your thoughts.

Before I go, one more thought: After coming up with this “accumulation” notion/usage, Very Little Googling revealed that (no surprise) it’s hardly original. It’s right there in Volume I of Das Kapital. (I just discovered this? Hey, I’m self-taught, with the resulting predictably spotty/spotlight reading background. I’m working on it!)

And let’s not forget: It was the 1930s. Kuznets and co. were developing the national accounts, and they were devoted capitalists. They’re gonna use Marxist language, much less concepts and theory? In the National Accounts? Of The United States of America? Not gonna happen.

Just a notion. But it does make sense…

I said at the top that Saving in the national accounts is labeled the way it is for not-crazy reasons. Some who are better-versed in Marx and his (far more cogent) successors than I am, might beg to differ with me.

And I might very well agree with them.

That’s the kind of normative, rhetorical, and ultimately political insight and implication to all this seemingly mundane and purely “positive” accounting stuff that I’d like to write more about in future posts. Thanks for listening.

* For those who are thinking S = I + (S – I): right. Writing and rewriting this post (over and over and over) finally helped me internalize it.

Cross-posted at Asymptosis. 

Related posts:

1. Okay Fine, Let’s Call Investment “Saving.” Or…Not
2. Saving and “Government Saving”
3. Saving Equals … Inventory?
4. Saving, Investment, and Lending in the Real Economy (Graphs). S=I?
5. Does Reduced Consumption, and Increased “Saving,” Result in “Capital” Formation?

No need to rehash this cock-up, except to point to the utterly definitive takedown by Arindrajit Dube over at Next New Deal (hat tip: Krugman), and to point out that the takedown might just take even if you’re looking at R&R’s original, skewed data.

But a larger point: I frequently see econometrics like R&R’s, comparing Year t to Year t and suggesting — usually only implicitly or with ever so many caveats and disqualifiers — that it demonstrates some kind of causation. I.e. GDP growth in 1989 vs. debt in 1989, ’90 vs. ’90, etc.

Haven’t they heard of looking at lags, and at multiple lags and periods? It’s the most elementary and obvious method (though obviously not definitive or dispositive) for trying to tease out causation. Because cause really does almost always precede effect. Time doesn’t run backwards. (Unless you believe, like many economists, that people, populations: 1. form both confident and accurate expectations about future macro variables, 2. fully understand the present implications of those expectations, and 3. act “rationally” — as a Platonic economist would — based on that understanding.)

By this standard of propter hoc analysis, R&R’s paper shows less analytical rigor than many posts by amateur internet econocranks. (Oui, comme moi.) This is a paper by top Harvard economists, and they didn’t use the most elementary analytical techniques used by real growth econometricians, and even by rank amateurs who are doing their first tentative stabs at understanding the data out there.

Here’s one example looking at multiple periods and multiple lags, comparing European growth to U.S. growth (click for larger).

This doesn’t show the correlations between growth and various imagined causes for the periods (tax levels, debt levels, etc.) — just the difference, EU vs. US, in real GDP/capita growth. You have to do the correlations in your head, knowing, for instance, that the U.S. over this period taxed about 28% of GDP, while European countries taxed 30–50%, averaging about 40%.

But it does show the way to analyzing those correlations (and possible causalities), by looking at multiple periods and multiple lags. (I’d love to see multiple tables like this populated with correlation coefficients for different “causes.”)

Dube tackles the lag issue for the R&R sample beautifully in his analysis. In particular, he looks at both positive and negative lags. So, where do we see more correlation:

A. between last year’s growth and this year’s debt, or

B. between last year’s debt and this year’s growth?

The answer is B:

Figure 2:  Future and Past Growth Rates and Current Debt-to-GDP Ratio

(Also: if there’s any breakpoint for the growth effects of government debt, as suggested by R&R, it’s way below 90% of GDP. More like 30%.) See Dube’s addendum for a different version of these graphs, using another method to incorporate multiple lags.

Here’s what I’d really like to see: analysis like Dube’s using as its inputs many tables like the one above, each populated with correlations for a different presumed cause (“instrumental variable”). Combine that with Xavier Sala-i-Martin’s technique in his paper, “I just ran four million regressions“.

That paper looks at fifty-nine different possible causes of growth/instrumental variables (not including government debt/GDP ratio) in every possible combination, to figure out which ones might deliver robust correlations. I’m suggesting combining that with multiple periods and lags for each instrumental variable. IOW, “I just ran 4.2 billion regressions.” Not sure if we’ve got the horsepower yet, but…

Cross-posted at Angry Bear.

Related posts:

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2. Do High Marginal Tax Rates Kill Economic Growth? Again: No
3. Full Cred and Props to Reinhart & Rogoff and the BEA: They Collected the Data
4. State Taxes and Prosperity, Revisited
5. Tax the Rich! And make us all richer?

I’m comfortable changing my language in order to communicate. I have very little patience for people who aren’t similarly capable of changing their definitions.

This discussion is really about the words we use to describe different accounting constructs. Nick totally gets that as well.

So I’m ready to say, “fine, let’s call investment saving.” That’s perfectly in keeping with the very sensible understanding found in Kuznets, father of the national accounts. He characterized real capital — the actual stuff we can use to create more stuff in the future — as “the real savings of the nation.” (Capital in the American Economy, p. 391.)

So when you spend money to produce something that has long-lived (and especially productive) value, you’re “saving.”

But still, I gotta wonder: why don’t we just call it…investment?

Because this S=I business confuses the heck out of everyone. Some of the smartest econobloggers on the web have spilled hundreds of thousands of words over the last several years trying to sort out this confusion. I’ve read most of them, and I’m still confused. And I’m quite sure that all non-economists who’ve looked at this (and many or even most economists) are as well.

And that’s not a surprise. Here are a few reasons why:

1. When you invest in real assets, you’re spending. That’s why it’s called investment spending. So spending = saving. Really?

2. When you pay someone to build you a drill press, you’re saving. When you don’t eat some of this year’s corn crop, you’re saving. When you pay off some of your money debt, you’re saving. When you don’t spend some of the money in your checking account, you’re saving. Each of these is true within a given (usually implicit) balance-sheet/income-statement accounting construct. But are they anything like the same thing?

3. As I showed in my last post, f you look at the “real” domestic private sector — households and nonfinancial businesses (most people’s implicit default context) — the amount of saving (income minus expenditures) has absolutely no relationship to the amount of investment spending. Saving is always insufficient to “fund” investment. And the changes in the two measures don’t move together, either in magnitude or direction. (Aside from the long, multi-decadal growth in both as the economy grows.)

4. When you “save” by investing, you decrease the amount of money on the left-hand (asset) side of your balance sheet, while increasing the amount of real assets on that tally. Your total assets are unchanged. Have you saved?

5. When you pay someone to write a piece of software, you get a long-lived real asset. You’ve saved. But the money you gave them is income for them, so it contributes to their (money) savings as well. Do you double-count those savings, or did “the economy” get that software for free?

6. Investment means “gross investment” — all the money spent on long-lived goods, including replacement of long-lived assets that have been consumed in the period (through use, decay, and obsolescence, and — for inventory of consumer goods — actual consumption). But in KuznetsWorld, shouldn’t we be talking about net investment — the additions to our stock of long-lived assets? Gross consumption minus consumption of fixed assets (and inventory changes)? Shouldn’t we call net investment “saving”?

I know: there’s (at least apparent) confusion in some of these, but that’s rather my point. And there are answers to all of these in the context of S=I. (All of them, I think, based on the flawed [neo]classical accounting constructs embodied in the NIPAs. That’s my next post.) I’ve read them all, every which way from Sunday. But do they help anybody understand how the economy works, or…quite the contrary? If they do, why do all those econobloggers feel the need to worry at this, constantly?

I’m not sure this really solves the problem, but I’d like to suggest that saving should mean what everybody in a monetary economy means when they use the word: money saving. Monetary income minus money expenditures. In dollars, or whatever. (And while we’re about it, when you take out a loan or spend out of your savings, let’s call those “borrowing” and “spending,” not “dissaving.”)

Meanwhile investment (in economics discussions) should mean what economists mean when they use the word: “spending to create fixed assets and inventory.” (Because the national accounts only count spending on structures, equipment, software, and inventory as investment.)

And actually, that’s what it already means.

Why do we need to call it saving?

Cross-posted at Angry Bear.

Related posts:

1. “If you tax investment income what will people do? Stuff their money in the mattress?”
2. Saving Equals … Inventory?
3. Savings ≠ “Savings.” Investment ≠ “Investment.” Spending ≠ “Spending.”
4. Saving and “Government Saving”
5. Saving, Investment, and Lending in the Real Economy (Graphs). S=I?

Update: The signs were reversed for lending/borrowing. Graphs corrected and updated.

Here’s the lending/borrowing broken out for you:

This is all from the Fed FFAs. Saving is household/nonprofit net saving (after-tax/transfer income minus expenditures) + undistributed business profits (after-tax/transfer income minus expenditures and distributed profits [distributed profits are part of household income]). Details/spreadsheet on request.

I’ve actually written at least three (long) posts on this in course of building out these graphs, but now that the graphs are complete I find myself fairly flummoxed. Saving seems to always be wildly insufficient to fund investment (and no, lending/borrowing + saving has no relationship either). S=I seems to provide exactly zero illumination here.

And the post-1990 lending/borrowing swings I see don’t fit with any real-sector saving/dissaving story I’ve heard (or can remember). We see borrowing spike during the internet boom, dive following the bust, then spike again during the real-estate bust.  ?

So I’m going to leave this open to my gentle readers for the moment. What in the heck is going on here? What story (or stories) would you tell to explain what you see?

If anyone wants to see earlier periods zoomed in to get a better feel what’s going on, let me know. I’m thinking 1946-1975 (to see what seems like a period of consistency), and 1970-1990 (from the fall of Bretton Woods to the start of the internet bubble and the Clinton surplus).

Cross-posted at Angry Bear.

Related posts:

1. Okay Fine, Let’s Call Investment “Saving.” Or…Not
2. Does Saving “Fund” Investment?
3. Lending, Velocity, and Aggregate Demand
4. Identity Games: Saving ≠ Saving? Whodathunkit?
5. The Real Ponzi Scheme: Private Debt

I took him up on the challenge, and am finally writing up my thoughts because I need to reference this from another post.

Figuring I ought to go straight to the belly of the beast, I picked up a used copy of Greg Mankiw’s Principles of Microeconomics. I didn’t read every word — I’ve been poring through various econ textbooks online, plus innumerable papers and blog posts, for years, so I knew a lot of it already. But I did go through it fairly carefully (especially the diagrams), and it had some of the effect that Nick was hoping for. Some of the things that I didn’t think were (sensibly) covered in intro econ, in fact are. And not surprisingly given my autodidact’s typical spotlight (and spotty) pattern of knowledge, I learned quite a few new things.

But still, my overall impression was amazement at what is not covered, and in particular what is not covered right up front.

In place of Mankiw’s nostrums about tradeoffs, opportunity costs, margins, incentives, etc., I would expect to see discussion of the fundamentals that underpin all that:

Value. What in the heck is it? How do we measure it? This was the topic of the opening class in my one accounting class, at the NYU MBA school. Basically: accounting for non-accountants, teaching us to deconstruct balance sheets and income statements into flows of funds. A darned rigorous course, taught by a funny and cranky old guy, formerly on the Federal Accounting Standards Board, with a young assistant prof playing the straight man and the enforcer. That first class was one of the most valuable (?) I’ve ever sat through.

The phrase “theory of value” doesn’t even appear in Mankiw’s text, even though he uses the term “value” constantly, and it’s obviously a term that has some import in economics. Imagine an undergraduate who’s had zero exposure to the ideas of subjective versus objective value, or the centuries of (continuing) discussion and debate on the subject, trying to parse the following sentence, and think critically about what it really means.

…we must convert the marginal product of labor (which is measured in bushels of apples) into the value of the marginal product (which is measured in dollars).

Money. What is it? What’s its value relationship to real goods, and in particular real capital? How is it embodied in financial assets? Where did it come from? (Hint: from credit tallies and for coins, military payments of soldiers, not barter between the butcher and the baker. That’s an armchair-created fairy tale.) The phrases “medium of account” and “medium of exchange” don’t appear in the book. Since economics is all about monetary economies, this seems like a significant omission.

Utility. The most fundamental construct in economics — the demand curve — is derived from utility maps. But Mankiw doesn’t even mention the term until page 447, where it’s discussed as “an alternative way to describe prices and optimization.” Alternative? There’s no discussion of ordinal and cardinal utility, or of the troublesome doctrine of revealed preferences (which 1. is the doctrine that allows economists to avoid talking about utility, 2. constitutes a circular definition, and 3. is never mentioned in the book).

All this gives me a feeling of indoctrination into a self-validating, hermetically sealed body of beliefs floating in space, with no egress outside that bubble, into thinking about the thinking going on therein. There are huge and not-wacky bodies of thinking out there that seriously question what goes on inside, often refuting it on its very own terms, and in the words of its own most eminent practitioners.

Yes, you could argue that I’m asking too much of undergraduates, but I would suggest that you’re asking too little (or the wrong thing) of undergraduate professors.

Is Mankiw teaching his “customers” to understand – the hallmark of the North-American higher-education system, in my opinion, compared to most other countries — or is he teaching them to adopt an undeniably ideological world view (no, neoclassical economics is not purely “positive,” not even close), and to just go obediently through the motions as prescribed in the textbook? In my opinion, he’s doing the latter.

I’m tempted to suggest that this is all true because (neoclassical?) economists don’t have a coherent or non-circular theory of value, and  money, and utility. (Neither do I, but I’m working on it!) But saying that would make me sound like an internet econocrank.

Cross-posted at Angry Bear.

Related posts:

1. Mankiw Endorses Obama, Slams Palin
2. Should conservatives care about conservation? Reading Lomborg
3. Mankiw: Do Equity Analysts Create Prosperity?
4. This Time Mankiw’s Just Plain Lying. And He Knows It.
5. Mankiw: Post Friedman Ergo Propter Friedman

[Bernanke's] preferred answer is better and more system-oriented regulation. One has to ask then why regulation failed to see the crisis of 2007–2008 coming and take action to head it off. Bernanke suggests that regulators were lulled into inattention by the so-called Great Moderation. Our masters are all too eager to take the Panglossian view that a system of “free markets,” including financial markets, is self-regulating and self-stabilizing. Bernanke is surely right about this. The scholar of the 1930s has to be aware that there was similar talk about the New Era in the years before 1929. Dr. Pangloss has lots of helpers among the sharpshooters who profit most from the absence of effective oversight, and among simpleminded ideologues. They are still with us.

Cross-posted at Angry Bear.

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1. How to Avoid Regulation: Smart Regulation
2. Bernanke (Mis)Explains the Effect of the Tech and Housing Bubbles
3. Yeah, Right: Government Regulation Is the Problem
4. Regulating the Ratings Agencies: Low-Hanging Fruit?
5. Co-Founder of Reaganomics: The economic mess … is the direct consequence of too much economic freedom … the direct consequence of financial deregulation.

A fascinating item on the work of Dirk Brockmann, who’s used WheresGeorge.com to map the movement of dollar bills, and the boundaries over which they’re least likely to cross:

I have no idea what to do with this, or whether it even has any useful application. But it’s at least a fine example of the fruits of human curiosity.

Cross-posted at Angry Bear.

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1. Medicare: Government Does It Right
2. The Money Confusion
3. Full-Reserve Banking, the “Right” to Earn Interest, and “Financial Repression”
4. Don’t Like “Money Printing”? Then Stop Borrowing. Whip Inflation Now!
5. The Real Return on Treasuries Should be Zero. They’re Risk-Free.

(I’m endlessly amazed that the best econothinkers on the web — add Nick Rowe, Andy Harless, David Beckworth, Josh Mason, and many others to the list — constantly feel the need to think, re-think, and debate this fundamental economic concept. Economists haven’t figured this out yet?)

I’d like to reply to one assertion of Scott’s, because I think it cuts to the crux. This time I’ll keep it brief, at risk of obscurity. Scott:

In every case where an individual seems to be saving more and yet investment doesn’t rise, someone else is dissaving.

Scott’s far from alone in asserting this; it’s central to Krugman’s thinking.

But: This only seems right if you’re imagining an isolated private domestic nonfinancial sector, in which no new financial assets can be created. (Essentially the “loanable funds” notion.)

If you bolt on a (international) financial sector that constantly creates new/additional financial assets, and (especially) a sovereign fiat-money-issuing government sector (with the arabesques of bond issuance and OMOs), and other sovereign- (and bond-)issuing governments worldwide, and account for flows to and from those sectors, I don’t think the statement is true.

Because: “government saving” (in particular) is a meaningless concept, akin to a bowling alley “saving” points.

Cross-posted at Angry Bear.

Related posts:

1. Does Reduced Consumption, and Increased “Saving,” Result in “Capital” Formation?
2. Identity Games: Saving ≠ Saving? Whodathunkit?
3. Scott Sumner Does Not Understand that S ≠ I
4. Okay Fine, Let’s Call Investment “Saving.” Or…Not
5. Saving, Investment, and Lending in the Real Economy (Graphs). S=I?

I live (quite well) off financial investments — no need to work any more — and my taxes every year are ridiculously, embarrassingly low. Meanwhile tens, hundreds of millions of hard workers who spend all their money — enriching entrepreneurs like me, and spurring economic growth — are throttled by tax bites that far exceed mine.

This tax structure and its terrible incentives are destroying, for my children and grandchildren, the opportunities for personal fulfillment and enrichment that America provided me. I wholeheartedly support the specific initiatives of Patriotic Millionaires, but I think far more is needed to create a national tax structure that actually is progressive above $60 or $80K a year in income. Us rich folks aren’t paying nearly our share of the bill — paying for what we receive — or re-investing in the country that gave us such remarkable opportunities. Don’t we care about our kids?

Americans have told us what they want — rich and poor, tea partiers and raging liberals (the polls aren’t hard to read) — and we need to pay for it.

True conservatives pay their bills.

Cross-posted at Angry Bear.

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3. Family of Four on $11K a Year: 19 Million Americans Live On That
4. No, the Greeks Aren’t Lazy. The Germans Are.
5. Are Tea Partiers Copping a Clue? Paul Ryan Gets Booed

There are a dozen things I want to discuss on the topic, but I’d like to address the key belief underpinning much of the commentary (including Matthew’s). In my words:

If you don’t spend all your income, the unspent part is used by others to produce/purchase* “fixed” or “real” or “productive” assets. More money gets spent on investment, and less on consumption.

There are all sorts of problems with this notion, empirical and theoretical (notably the confusion of an accounting identity, “S is identical to I,” with economic incentives). I want to try and cut to the crux, with this:

A. If I transfer $100K from my bank to yours to purchase goods or labor, is there more money to produce/procure productive assets?

B. If I (or all of us) instead transfer $75K, leaving (“saving”) $25K in my bank, is there more money to produce/procure productive assets?

The answer to B is obviously “no.”

I hope not skipping too many steps here, so as to render this incomprehensible, I think Dan Kervick makes the key point in his comment on Matthew’s post:

a significant portion of monetary saving is just used to purchase government bonds

I would add, “directly or indirectly.” And: government bonds are only part of it.

This imparts the crucial understanding of aggregate, inter-sectoral balances that people lose sight of when thinking in terms of personal, individual “saving” of “money.” (Usually, implicitly, people are thinking about an isolated, domestic, private, non-financial sector — U.S. households and non-financial businesses.)

The financial system (including treasury and Fed) is constantly creating new, more, financial assets. New government bonds and currency, in particular, have no direct relationship to real investment. When you (or your bank) buy(s) a newly-issued government bond, you’re not funding/financing/incentivizing real private-sector investment in productive/useful capacity. (Though in one accounting view, you could argue that you’re “funding” government investment.)

So in a very real sense those financial assets (and arguably many [private-though-not-necessarily-"real"-sector] others) “absorb” “money” without creating new productive capacity. (This does not imply “crowding out.” Interest rates are at historic lows, and corporate cash hoards are at historic highs, even while government bond issuance has also been at historic highs.)

Funds flow from the private domestic nonfinancial sector into the the financial and government sectors (in return for an increased stock of IOUs). But absent intentional action (lending by the banks, deficit spending by government), they don’t flow back into the private domestic nonfinancial sector — and even less certainly into investment by that sector.

This is greatly simplified, and there’s much more I’d like to say, but I’m hoping to impart a straighforward (though incomplete) understanding of this view.

Here’s how I see it (this is the most important part of this post):

Production produces surplus. Output > Input.

That aggregate surplus is monetized by trade and a financial system (including treasury and fed), in a stunningly complex process that I won’t detail here. That’s why the quantity of financial assets (“money”) keeps increasing — because the surplus increases the stock of real assets, and the stock of financial assets (loosely) represents the value of those real assets.

If producers can’t sell (trade) their goods — in the process monetizing the value of the surplus created — they don’t produce them (as a successful serial entrepreneur, I’m here to tell you…), and you get less surplus. So less saving. My saving happened because people spent.

Spending causes saving. (Counterintuitive, huh?)

Though I prefer the term “accumulation.” The moral valences associated with “saving” — and the misunderstandings of its technical meaning(s?) in the national accounts — have resulted in no end of economic confusion (and confution*).

And yes: spending — and the production/trade/surplus-creation it spurs — causes monetary saving. The creation of surplus effectively forces the financial system to create new financial assets, so the producers of that surplus (workers and businesses) can monetize that surplus, and store it in their accounts. If the financial system doesn’t effectively monetize workers’ and producers’ surpluses via wages and profits, they have less incentive to work and produce, so a weak economy/slow growth results. Fed governors get replaced, politicians get voted out, and banks lose money or at least lose out to competitors who are willing to monetize the surplus.

I really have to finish this up by citing Dan Becker again, in a response to Pete Petepete at Angry Bear:

As I read your postings, it seems you are moving the discussion toward the chicken or the egg type.

But it’s not just Pete Petepete. We’re all really rehashing the old Say’s Law argument here: does production cause consumption (“demand creates its own supply”), or the reverse? The obvious answer is “Yes. Both.” But I think it’s clear which side I fall on, and I fall on that side because we have a sovereign-currency-issuing government, and a massive financial system which also constantly creates new financial assets. Say’s Law only makes sense if 1. there’s full employment***, and 2. there are no new financial assets to monetize/store/”hoard” the surplus from production and trade.

If all the “so-called” quotation marks in this post are driving you batty, my apologies. So many of the key terms in economics are used so sloppily and in so many ways, I often find it impossible to talk about the subject without constant parenthetical definitions of terms — which definitions themselves often deserve full blog posts. I hope this post will at least encourage my gentle readers to think very carefully about what I (and they) mean when using these terms.

* The produce/purchase distinction is conceptually problematic in itself (and as it’s tallied in the national accounts), as made clear by discussions among Kuznets and company back in the days when they were creating the national accounts; trade is the juncture where real surplus from production is monetized, which drops us into the thorny theoretical thickets of “value,” “capital,” and the mysteries of “money profits.”

** Yes I know that’s not a word. But it should be. Hey: good name for a new blog?!

*** Full employment is another problematic concept. Are there realistically imaginable scenarios — i.e. wage inflation without commensurate price inflation — in which large numbers of permanent non-workers would be coaxed into the work force, increasing employment without changing the percent “unemployed”? Full employment compared to what?

Cross-posted at Angry Bear.

Related posts:

1. Saving and “Government Saving”
2. Identity Games: Saving ≠ Saving? Whodathunkit?
3. Okay Fine, Let’s Call Investment “Saving.” Or…Not
4. Savings ≠ “Savings.” Investment ≠ “Investment.” Spending ≠ “Spending.”
5. Modeling the Wealth, Income, and “Saving” Effects of Redistribution: More is Better?

In this model, if you don’t eat some portion of the corn you grew this year, you’ve “saved.” You can eat it next year. Makes perfect sense.

You can see this thinking played out in Scott Sumner’s justification for consumption taxes:

I’d tax people on the basis of how many resources they consume, or take out of society, not what they produce.

He describes the opposite approach — taxing returns on financial investments or “savings” — as “morally grotesque.”

Now let’s think about this, and think about how these economists think about this. They’re assuming that if you “save” (a.k.a. don’t spend), you don’t “consume resources.” You “save” them, and don’t “take them out of society.”

This makes absolutely no sense. If you forego a massage this week, or wait a few years to get your house painted, is the labor for that massage or paint job “saved”? How about this year’s sunlight — the ultimate source of that labor power? Can you use it next week, or next year? Understand: services comprise 80% of U.S. GDP. And that’s before you even think about Apple and similar, with their just-in-time, on-demand supply chains — when you buy it, and only when you buy it, they produce it.

If you don’t buy it, it doesn’t get produced.

And if you don’t buy it, and they don’t expect you to buy it soon, they don’t invest to build the capacity needed to produce more in the future. (That investment and real-capacity building is true “national saving.” S really is I.)

That mental model, which is so widely prevalent, is a fundamental error of composition: confusing the individual with the aggregate. (And a confution of money-saving and real saving.) Sure, you’ve saved money for your (or your great-grandchildren’s) future. And when you don’t get a massage, others can sign up for that time slot, or buy a massage for a lower price. This is about competition among individuals, not how many resources we as a society produce and consume. If we all consume less, as a society we produce (and “save”) less — both for current consumption and for future production.

So in a very real (dynamic) sense, it’s the savers who are “taking resources out of society.” (And in a somewhat abstract sense, you can imagine those foregone resources being stored, hoarded, and  rendered impotent in ever-growing and largely inert Cayman-island bank accounts.)

This is not really revelatory; I know these economists understand the paradox of thrift. But they ignore and eschew it in their real-good, barter-based mental economic models. I would suggest that the explanation for this error of composition is revealed by Scott’s words: “morally grotesque.” Moralistic beliefs about how individual humans should behave make it impossible for many economists to embrace an aggregate economic reality of which they are fully cognizant.

* Yes: non-renewable natural resources are consumed when people produce, buy, and consume stuff (both goods and services). But 1. Compared to human effort, those resources constitute a small part of the inputs to GDP, and 2. this is not what economists who are subject to this thinking are talking about. All those in-ground resources are not counted as existing “capital” in the national accounts, for instance — so they can’t be depleted from those accounts — and the accounted “cost” of those resources consists almost entirely of the cost of digging them up. This is the subject for another post.

Cross-posted at Angry Bear.

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