Private savings in a post-bubble world
I caught this comment by Scott Fulwiler on a blog post a 3spoken:
the notion that firms can spend and reduce net saving in order to increase net saving of the household sector–while theoretically true and true in an accounting sense–doesn’t hold up well empirically. Across business cycles (i.e., trend as opposed to cycles), firm net saving can and has fallen while household net saving increased (and a modest govt deficit).
This is an important thing to realise. Just breaking it down for a sec, let me remind you of my post "Economics 101 on government budget deficits". Money being a medium of exchange means that money is exchanged for goods and services of equivalent money value. There is no value leakage or anything like that. So when you sum up the net deficits and surpluses of any economy, no matter how you break those sectors down, that sum will always be zero.
In practice, national accounts are broken down into a few sectors (government, private sector, external sector). So, that tells you government deficits are always exactly balanced by net imports and private savings. You can’t have net private savings without equivalent net government or capital account deficits. In plain English: if the private sector wants to net save – and that is its normal mode – you need to have net trade surpluses or government deficits or both to offset. Since the world’s aggregate external sectors also sum to zero, this tautology basically means that in aggregate net private savings is balanced exactly by government deficits. Put simply: the government’s deficit is the private sector’s surplus.
What does that mean for a post-bubble world in deleveraging mode? It means that people feel what I have labelled "debt stress", which increases the desire in the private sector to net save. Now the private sector is really three different groups in national accounts. The private sector consists of households, domestic non-financial business and financial institutions. And when you are thinking about private household net savings in a post-bubble world, unless companies are doing a serious capital investment binge or you get serious financial sector losses (net dissaving), the government must deficit spend or increased household savings can’t happen.
The reality, as Scott puts it is that "the notion that firms can spend and reduce net saving in order to increase net saving of the household sector… doesn’t hold up well empirically." Translation: if households are indebted, there is little chance that they can reduce that indebtedness because of a surge in business capital spending (net dissaving) alone because that leads to systemic fragility and the Ponzi stage of Minsky’s dictum and encourages debt accumulation by households. Likely, reduced household debt (ratios) will happen because of government deficits, default, debt forgiveness or inflation.
“government deficits, default, debt forgiveness or inflation”
So here’s my question and off the cuff answers, what do each of these mean for the real economy?
government deficits – a gradual making good or keeping bad of malinvestment with the risk of currency debasement.
default – destruction of money that should not have been created and liquidation of malinvestment for more productive use with the risk of serious financial disorder.
debt forgiveness – making good malinvestment, a one off gift from the real economy to debtors with the risk of moral hazard.
inflation – penalising savers and the general standard of living to make good malinvestment.
My hope is that there is an optimal combination of all these things that transitions us to a stable level where we then address the real cause of why we’re here – a broken private sector money creation regime.
The problem for western economies is that for countries with big asset bubbles which supplanted the needs to maintain a normal level of savings, leading to negative savings rates. That to de-leverage means that households will have to cut back spending.
For companies that need reasons to invest that significantly reduces the incentives to do so. The level of household saving needs to be even greater to both rebuild savings lost through malinvestment and to de-lever as well. With governments trying to cut back and companies having far too much economic power the ability to save and de-lever will be significantly reduced. So there will not be a major reduction in household debts unless it is through default.
Debt forgiveness is off the table, just look at Greece to see that. The worry about moral hazard of the household sector is enough to stop any easing in forgiveness and write-downs. With the financial sector, they are too important to the political classes via contributions to allow moral hazard to be a factor. So if deficits are tackled seriously then expect to see significant losses in the household sector as default becomes the only option. Long term house prices will either fall further or vacancy rates rise as investors buy up properties.
So while everything is done to reduce wage costs to improve productivity, it does not give hope for real estate prices which simply are over valued. For businesses a stagnant consumer market means that business rents are a significant problem for business, yet are rarely raised as a business concern yet regulations that stop them being under cut by those that fail to comply with regulations are regularly mentioned or are all the companies that mention it cowboy operations?