Intro: The U.S.’ long-term productivity decline has its roots in its declining savings rate, which is a partly a result of fiscal and monetary policy decisions. Any reduction in foreign investor demand for dollars would require the U.S. to raise its savings rate or encounter an investment collapse in order to run a current account surplus. While fiscal deficits and money printing may increase private sector nominal savings, they actually undermine real savings, to the detriment of future growth.
With the Federal Reserve creating money out of thin air at will, the distinction between money and real savings can is often muddied in the minds of mainstream economists and investors. In this article we attempt to explain the concept of economy-wide savings rates and how the Fed and Treasury’s stimulus measures are undermining the U.S. economy’s already-low real savings rate to the detriment of future growth.
First we need to define the terms…
Saving: All production that is not consumed.
Investment: All goods produced for the purpose of producing other goods and services.
Depreciation: The wear and tear of investment goods over time.
All Investment Must First Come From Savings
The best way to understand savings in the economic sense is to consider that all goods that are produced are either produced for consumption (consumer goods) or to be used in the production of other goods (investment goods). This means that all the goods that are produced and not consumed now are used for investment. It should be clear therefore that all investment must come from savings.
Source: Bloomberg, Federal Reserve
In 2019 the U.S. economy produced just under USD22trn worth of goods and services at current price levels. However, total consumption of goods and services amounted to just under USD18trn while consumption of fixed capital (depreciation) amounted to roughly USD3.5trn. This means that total savings in the economy amounted to just USD340bn, or 1.5% of GDP.
The decline in the U.S.’ national savings rate reflects a number of policy decisions and cultural dynamics, but perhaps the two most important have been the rise in government transfer payments and the decline in real interest rates. Both of these policies have undermined the desire of individuals to save.
Saving Is Not A Drag On Growth
If all investment comes from savings then it should be clear that higher savings levels are positive for economic growth. The more savings available in an economy, the greater the potential for businesses to find profitable opportunities for any given amount of labor. The more infrastructure, factories, machinery and equipment etc. that exist, the more productive labor will become.
This idea seems to be lost on the financial media and mainstream economists which see saving as some kind of a drag on growth; a leakage from the economic system. The misunderstanding likely comes from the fact that the majority of final sales in an economy are on consumer goods and services and so any increase in household savings rates can hurt consumption. In the near term, consumption and investment are often substitutes: in order to invest more we have to consume less. However, in the long term they are compliments: the more we invest, the more we ultimately are able to consume as productive capacity increases.
Even in the short term, an increase in consumer savings rates do not necessarily imply a slump in growth. If consumers in an economy decide to save more, this gradually frees up resources to be used to produce investment goods. Profitability in the consumer-focused industries will be reduced, but profitability in investment focused industries will concomitantly increase. Unless the rise in the savings rate is particularly sharp due to some economic shock, growth need not be negatively impacted, even in the short term. What is lost in terms of consumer goods production is made up for in terms of investment goods production.
In terms of the C+I+G+NX framework, while C will fall, I or NX will rise, offsetting the decline. From a longer-term perspective, the higher the level of investment, the stronger growth is likely to be in the future, raising the overall level of consumption.
As we argued in ‘Brace For Sub-1% Long-Term Growth‘ the decline in the savings rate since the 1960s has been a major factor in the decline in labour productivity over this time and points to an even greater decline in the years ahead. The impact of saving rates on real GDP growth is crucial and perhaps best summed up by Warren Buffett as explained in his 2019 shareholder letter:
Remember, earlier in this letter, how I described retained earnings as having been the key to Berkshire’s prosperity? So it has been with America. In the nation’s accounting, the comparable item is labelled “savings.” And save we have. If our forefathers had instead consumed all they produced, there would have been no investment, no productivity gains and no leap in living standards.
Buffet’s understanding of the importance of savings in driving economic growth seems to run contrary to his ‘Never Bet Against America‘ philosophy.
Current Account Deficits Reflect Borrowed Savings
Total U.S. investment last year, net of depreciation, amounted to roughly USD1.0trn, or 4% of GDP. The difference between saving and investment reflected the fact that the U.S. effectively borrowed roughly 2.5% of GDP worth of goods and services from overseas in the form of a current account deficit. An individual country can invest more than it saves but this investment must come from an exactly equal amount of savings from overseas.
While the U.S. current account deficit reflects the fact that country’s domestic investment requirements exceeded domestic savings, domestic investment and saving decisions do not happen in isolation. Over the past 40 years the desire of foreign investors and central banks to lend to the U.S. in excess of U.S. investors’ desires to lend to other countries has dictated that the U.S. run a current account deficit.
There is no guarantee, however, that foreign investors will continue to want to lend to the U.S., particularly with the Treasury and Fed issuing and monetizing records amounts of debt. This creates a huge potential economic threat given that the U.S. economy has racked up net external liabilities equivalent to 50% of GDP. Should foreign investors reduce their net lending to the U.S., requiring the country to run a current account surplus, one or two things will have to happen. The U.S. will have to sharply increase its domestic savings rate or see a devastating collapse in domestic investment.
Fiscal Deficits Do Not Increase Real Private Savings
Of all the misunderstandings surrounding the concept of savings, perhaps the most egregious is the idea that fiscal deficits boost private sector savings. When the government runs a fiscal deficit it effectively buys more from the private sector than it takes from it in taxes and in exchange it gives the private sector a Treasury bond. Nominal private sector financial assets therefore rise, but this is not the same thing as private sector savings rising in real terms.
From an accounting perspective, the payment of stimulus checks does add to private savings while reducing public sector savings (or increasing public sector dissavings) to an offsetting amount in the form of larger deficits. However, all savings come from the private sector as governments do not create wealth, only redistribute it. By issuing debt and giving money to citizens, private consumption will tend to rise while overall production remains unchanged, leading to a rise in consumption as a share of GDP and a reduction in real savings. We can see from data across OECD countries that those with stronger fiscal positions tend to have higher overall savings rates.
Source; World Bank (2019 Data)
New Money Creation Does Not Increase Real Savings
The concept above is perhaps easier to understand if we think about stimulus checks coming from direct Fed money creation rather than fiscal deficits (which is pretty much the case anyway given that the Fed simply monetizes the Treasury’s bond issuance). Here the difference between money and real savings should become clear.
If every individual in the economy receives USD1200 in freshly printing money from the Fed, the monetary savings of the private sector will increase by this amount. However, creating money out of thin air does not increase the availability of real savings in the economy. The amount of infrastructure, factories, machinery and equipment remain unchanged. This means that if and when people decide to spend their stimulus checks on real goods and services, their money’s purchasing power will decline in direct proportion to the amount of additional money they have. The only people who are made better off are those that spend the money first before prices rise undermining the money’s purchasing power. Whether this money comes directly from the Fed or indirectly from the government issuing Treasuries makes no difference at all. No real savings have been created.
Low Interest Rates Do Not Reflect Abundant Savings
If interest rates were set by the free market they would be set at the level which balanced the availability of savings and the demand for investment across the economy. The greater the willingness of individuals to save, the lower interest rates would tend to be as there would be an abundance of goods available to be used for investment. A lack of savings, on the other hand, would tend to cause high interest rates for any given level of investment demand.
Of course, central banks determine interest rates in modern economies but keeping interest rates negative in real terms does not alter the fact that real savings are needed for investment. It certainly doesn’t suggest, as Ben Bernanke claimed in 2005, that there is a savings glut. In fact, the greater the difference between the natural rate of interest and prevailing interest rates, the greater the potential for scarce savings to be misallocated and speculative bubbles to be formed, as we see today.