THE BEAR'S LAIR The diminished incentive to save
By Martin Hutchinson
United States Federal Reserve chairman Ben Bernanke reaffirmed last week that
short-term interest rates would be kept at their current ridiculously low rates
for "an extended period". Apart from the danger of inflation this produces
there is another problem: Fed monetary policies in the past decade have done
great and possibly permanent damage to the US propensity to save. The
devastation that this will wreck on the economy is slow-moving, but potentially
ruinous.
During the 1990s (defined as 1991-2000), the average US rate of inflation was
2.67%, while the average yield on three-month US Treasury bills was 4.69%. Thus
the average real rate of return on the Treasurys, about as close as you can get
to a truly riskless
asset, was 2.02%. Historically, that's just about the normal figure. The yield
on perpetual British 2.5% "Consols" in the 19th century bottomed out at 2.2% in
the Golden Jubilee year of 1897, but Consols - being a long-term instrument -
contained substantial price and liquidity risks, even in a period when the gold
standard prevented inflation.
Readers of this column will remember that I have always maintained that
monetary policy became excessively loose not in 2002, as is commonly assumed,
but in 1995 - based on the excessive growth rate of M3 and other measures of
broad money supply from the early part of that year. However, two
countervailing factors caused real short-term interest rates to remain around
their normal 2% level during the second half of the 1990s, in spite of this
monetary sloppiness.
First, the US economy was in a period of wild speculative boom, with rapid
economic growth and huge capital investment. That would normally have tended to
increase the demand for capital, raising real interest rates far above their
normal levels. Second, in the late 1990s, there was an extrinsic deflationary
shock from adoption of the Internet and modern communications technology, and
its use to make global outsourcing of goods and some services much easier and
cheaper.
Consumer price inflation dropped sharply, to 1.7% in 1997 and 1.6% in 1998,
well below its level earlier in the decade, while interest rates were slow to
adapt to this unexpected downtick in inflation. Those two factors kept real
interest rates at around their long-term equilibrium level of 2% or so, rather
than dropping through excess money creation.
After 2000, the inflation-suppressing effect of the new technologies continued,
so inflation remained quiescent, averaging 2.55% annually in 2000-09 compared
to 2.67% in the 1990s. However, the continued rapid money growth produced a
much lower risk free interest rate. Three-month Treasury bill yields averaged
only 2.70% during the decade, so real interest rates were only 0.15% per annum.
From 2002, the effect was even more pronounced; real interest rates on
three-month T-bills in the eight years from 2002 through 2009 averaged a
negative 0.34%. Bear in mind that nominal interest receipts are taxable, and
you can see that the risk-free return to savers was substantially negative
throughout the decade.
If savers are not rewarded for saving, are even penalized for it, then it is
not surprising that they don't save. The US savings rate declined from its
already mediocre rate of 8% from the middle 1990s, falling perilously close to
zero in 2005-07. It rebounded in the 2008-09 recession, as consumption habits
finally changed, but there are now strong signs that the dolce vita of
Caribbean holidays and long weekends at casinos is recapturing those Americans
who still have jobs - only the McMansion and Hummer fetishes seem to have
diminished. The savings rate has fallen below 5% and appears likely to decline
further.
This is not surprising; the real return on Treasury bills was minus 2.65% in
2009. US savers who avoided risk were thoroughly penalized for their
accumulation. Even though savers would have made very good money by investing
in stocks in the early months of 2009, the losses they had previously suffered
on their stock portfolios since late 2007 or on their houses since 2006,
together with the difficulties in the job market, made investable funds scarce.
Jean-Paul Getty said in the 1950s, when asked how to become a billionaire
"Start as a millionaire, stay liquid, and buy in 1932." The middle part, given
the timing, is the difficult section of that assignment!
Beyond interest rates, there are other factors that have tended to depress US
saving in recent decades. Means-tested benefits such as Medicaid tend to
depress savings rates, since savers naturally realize their savings may
eliminate them from these benefits (the British system whereby nursing homes
are free for those who have used up their savings is equally damaging in this
respect).
Persistent inflation and taxes on nominal incomes make tax rates very high on
real gains in wealth or, in times when real returns are near zero, impose taxes
on income that is non-existent in real terms, merely a return of capital.
Social security and other benefits that appear to provide for old age reduce
savers' need to accumulate capital, while the elimination of money purchase
pension schemes and their replacement by generally stingy 401(k) plans has
depressed actual saving, however much it may have increased the need to save.
In summary, it is surprising that US savings rates are not in reality
substantially negative. Indeed, after a few more years of ultra-low interest
rates and rising inflation they probably will be.
It has been fashionable since the time of John Maynard Keynes to regard saving
as unimportant, even undesirable. The consumption-driven view of the economy,
by which consumers' irresponsible shopping sprees drive economic growth is,
however, on inspection fallacious. Indeed, studies of economic emergence from
poverty, both in industrialized countries and emerging markets, have shown that
savings rates, among the middle classes rather than the rich, have a crucial
impact on the speed and health of economic growth.
Countries with low savings rates either do not grow or, if they do grow, do so
sporadically with frequent debt crises and prolonged recessions. One need only
look at the economic history of the resource-endowed Argentina and compare it
with the resource-poor South Korea, or indeed to the enormous economic
successes of Japan to 1990 and China now - both countries far poorer than
Argentina in 1930.
The principal requirement for successful economic development is the
development of a middle class with adequate savings. You can see this in 18th
century Britain, which developed the Industrial Revolution primarily because it
had relatively high living standards and consequently high savings. You can see
it in the recent development of the countries of former Yugoslavia, the most
successful of which has been Slovenia, where savings could grow in Austrian
bank accounts, essentially tax-free. Conversely Serbia, far from Austria and
subject to hyperinflation, and Bosnia, where savings were expropriated by
Serbia in 1991 and never replaced, have been much less successful. Croatia and
Macedonia, whose middle-class savings were expropriated in 1991, but were
replaced by the local governments through bond schemes in 1995 and 2000, have
enjoyed at least modestly increasing affluence, far more so than the luckless
Bosnia, relatively affluent in 1985 and impoverished today.
The connection between middle-class savings and economic growth is both
economic and social. Economically, the pool of savings accumulated by the
middle classes forms the principal source of seed capital for small business,
itself the principal source of both employment and economic growth. In times
like the present, when the banking system pulls back from the small business
sector, the existence of ample middle class savings makes the difference for
most small businesses between survival and death. In countries such as China
and Japan, the banking system can restrict itself largely to infrastructure and
the larger corporations, while entrepreneurship is financed by savings. In
low-savings countries like the United States and Argentina, banking crises
become hugely damaging, because the base of middle-class savings is not there
to replace the banks.
The most extreme historical example of savings destruction happened in 1923 in
Weimar Germany. Middle-class savings were wiped out by hyperinflation, and that
destruction of middle-class virtues and living standards led directly to the
emergence of the Nazi regime a decade later.
The United States today is in the position of Weimar Germany about 1921, as I
have pointed out before and as has been elegantly illustrated in a new paper by
Societe Generale's Dylan Grice. On the surface, the economy is relatively
prosperous, having recovered well from the devastation of a few years
previously - obviously the losses caused by World War I having been far worse
than a mere banking crash.
In both 1921 Germany and 2010 America, the fiscal authorities propped up the
local economy through large budget deficits, while the monetary authorities,
Rudolf von Havenstein's Reichsbank and Ben Bernanke's Fed, have abandoned
conventional economic restrictions and pushed monetary expansion to extreme
levels in an effort to reflate the economy as rapidly as possible. In both
countries, the stock markets responded quite well - by 1921 the German stock
market had risen by over 100% in real terms from its lows. In both countries,
savings rapidly diminished in real terms, it being impossible to maintain the
value of savings other than by speculation.
We know what happened in Weimar - hyperinflation, the wipeout of savings, a few
years of unsteady prosperity and then economic and social disaster. Only after
1945, when a wiser leader with experience of both the Weimar and Nazi disasters
created a society and a Bundesbank charter in which preserving the value of
middle-class savings was paramount, did Konrad Adenauer's Germany finally
re-take the economic preeminence the country had enjoyed under Kaiser Wilhelm
II.
Von Havenstein was known as the "Money General" - a title that could well have
been applied by his admirers to Bernanke as the 2009 market and banking
recovery took hold. Our own von Havenstein has presided over a policy that has
hugely damaged the savings base of his society, and the middle-class virtues of
prudence and thrift that in a high-savings culture produce rapid economic
growth. Whether his policies will in the long run produce only anemic growth,
persistent high unemployment and a gradual decline in living standards, or like
von Havenstein's something immeasurably worse, only time will tell.
Correction: In my last column I erroneously claimed that Federal authorities
could not run around arresting grocers for using pounds as the European Union
does in Britain, because of the 1935 Schechter Poultry case. Amateur lawyering
is always a risk; a reader correctly reminds me that congress is granted in the
constitution the right to set weights and measures, and has decreed that pounds
will be used (so that a grocer selling in kilograms without a pounds equivalent
would be in trouble.) Thank you.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-2010 David W Tice & Associates.)
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
