The stock-market bubble of the past few years has distorted American economic values. The wealth effect is leading Americans to think that stock prices will never go down, so there is no reason to save. Americans, whose savings rates have been declining for decades, should save more. The stock-market boom of the past few years has been fueled by over-consumption and should stop.
Are these the sentiments of some maverick Austrian economist or radical libertarian thinker? Not at all. These were recent comments and observations by America’s second most famous central banker, Paul Volcker.
“We no longer do any saving,” Volcker warned at a recent conference in New York. “We can no longer ignore this underlying problem in the U.S. economy.” Volcker noted that federal statistics show U.S. personal savings rates are now in negative territory. And while debates can rage over what is the proper way to measure savings—the government, for instance, doesn’t measure equity in a home as part of the savings equation—there is little doubt that bad fiscal and monetary policies feed a stock-market bubble that eventually leads to wild speculation.
Volcker contended that under-saving Americans have been relying on large inflows of capital to finance the boom of the last decade. This has caused a huge current accounts deficit that “cannot continue forever,” he added. Another part of the savings problem, Volcker argued, is the distorting effect of the stock market—the so-called wealth effect. Paper profits lead investors to think that they are invulnerable and that the Fed has some magic wand to keep markets going up forever.
“It takes a while for people to realize that they’re not going to get 10 percent or more every year in the stock market,” he warned.
Volcker was Federal Reserve Board chairman from the late 1970s to the late 1980s. A large part of this period was one of stagflation, marked by the coexistence of high inflation and high unemployment rates—something most economists previously had said would never happen. Some Americans feared that this unprecedented stagflation was the first step on the road to an American Weimar Republic and that hyperinflation was around the corner. Volcker said it “took time” and “a certain amount of agony” for the economy to recover from these economic diseases.
But tax, fiscal, and monetary policies have often reflected the Keynesian bias in favor of inflation, and they continue to do so. Despite the disasters of the 1970s and ‘80s, much American economic thinking of the past seventy years has been based on the influential ideas of British economist John Maynard Keynes.
In the 1930s, Keynes argued that over-saving aggravated the Great Depression. “An act of individual saving means—so to speak—a decision not to have dinner today,” Keynes wrote in his classic, The General Theory of Employment, Interest, and Money. “But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or year hence or to consume any specified thing at any specified date.”
Keynes, who was strongly influenced by the philosopher Bernard Mandeville and his “Fable of the Bees,” argued that market forces could not be relied upon to pull an economy out of a deep recession or depression. Say’s Law, that supply creates demand, was wrong, Keynes said. He argued that the markets were not self-correcting, and that loose monetary and fiscal policies should be employed to stimulate consumption. Governments, he said, should print more money, inject inflation, and run deficits to generate growth.
High tax rates on savings are an example of Keynesian thinking, which has influenced both Republican and Democratic presidential administrations since the 1930s. President Nixon ran huge deficits and declared himself a Keynesian. Milton Friedman said, “We’re all Keynesians now.” The American tax code, in a bias that would have pleased Mandeville and Keynes, has consistently encouraged consumption and discouraged saving.
Today, investors and consumers, encouraged by loose monetary and fiscal policies, buy all sorts of things on credit or margin--from more and more speculative stocks to consumer items often financed on credit--in the expectation that the stock market will bail them out.
“I don’t think there is any doubt that the economy has been primarily driven by a high level of consumption in the past decade,” Volcker said. “And consumption levels are at very high levels.” In this negation of thrift and celebration of consumption, which Volcker criticizes, one sees the triumph of the continued persistence of Keynesian thinking.
Increasingly, people are seeing little value in savings. Yet savings, with its expansion of the capital pool and lowering of the costs of capital, pushes interest rates down. Indeed, savings is the source of strong economies.
In Human Action, Ludwig von Mises wrote: “Every single performance in the ceaseless pursuit of wealth production is based upon saving and the preparatory work of earlier generations. We are the lucky heirs of our fathers and forefathers whose saving has accumulated the capital goods with the aid of which we are working today.”
When will the lack of savings start to affect the economy? Volcker predicted sometime within the next five years, unless Americans change their habits. He contended that President George W. Bush will have to offer policies to correct this “economic imbalance.”
To correct the economic imbalance, Volcker said, the proposed federal tax cut should go into effect sooner than proposed, and it should be bigger, with the biggest part of the cut coming earlier. For those who think that the Fed has outlawed the business cycle and that these problems of low savings as well as jittery markets can be solved by a brilliant central banker, Volcker has a warning: “The Federal Reserve is often not in control of things, particularly in the short run. Sometimes the markets are in control of events rather than the other way around. We only have one pill (the federal funds rate) and that is not always suitable to all circumstances.”
The answer to these issues of market bubbles and low savings rates is not that the Fed should try to pump up the market and the economy. First the Fed fuels a boom, and then a chairman such as Volcker is forced to prevent the United States from becoming another Brazil.
The answer is that the Fed and its economic allies should stop intervening in the economy. The government should stop trying to stimulate economically “acceptable” behavior and should discontinue its wholesale campaign of social engineering.
Do Americans need to save more? Yes, so the Fed and the government should get out of the way and let people save if they wish. What would be the effect of not taxing savings? Or of not taking away a third or a fifth of each taxpayer’s capital gains? Or of letting thrifty people enjoy all the benefits of their income? The nation would not only obtain more savings, it would see a boom in investment capital. Then it would no longer have to suffer lectures from former economic czars.
