Following Ben Bernanke, the chairman of the Council of Economic Advisers, in his testimony to the Congress on July 20,2005, Fed Chairman Alan Greenspan said that it is quite likely that we are currently experiencing a global savings glut. Agreeing with Bernanke, the Fed chairman views this glut as one of the factors behind the so-called interest rate conundrum, i.e., long-term rates have been falling despite the tight interest rate stance of the Fed.
This savings glut, according to many commentators, has been instrumental in the very low mortgage interest rates, which have pushed the housing market to new highs. The housing boom in turn has lifted consumers’ wealth and in turn boosted their expenditure and thereby kept the US economy going.
Indeed the International Monetary Fund (IMF) seems to support the Fed chairman’s view. According to the IMF the World is flooded with savings. The IMF has estimated that world savings as a percentage of world GDP stood at 25.4% in 2005, which translates into US$11.8 trillion—nearly the size of the US economy.
Most economists are in agreement that in order to grow an economy saving is a must. It is saving that funds investment in capital goods like computers tools and machinery, which in turn makes the economy more productive. However, it is argued that whilst saving plays an important role in growing an economy sometimes too much saving can actually be a bad thing.
For instance, it is held that if consumer demand is weak then more savings will only undermine consumer expenditure and in turn weaken economic growth. After all, it is held the motor of the economy is consumer expenditure and saving is the opposite of consumption. According to this way of thinking if people decide on saving a large proportion of their income, then only a small quantity of output will find a market. Output will have to be low because there will be no demand for larger quantities of production.
Also, it is held that while saving may pave the road to riches for an individual, if the nation as a whole decides to save more, the result may be poverty for all.
Since mainstream thinking views an excess of saving, or too much of it, as bad news for economic activity, obviously what Greenspan also had in mind in his speech was that world economies may be under threat due to a glut of savings. Indeed many economists are of the view that too much saving could destabilize the world economy.
However, does all this make much sense? It seems that most experts including Greenspan have fallen into the trap of confusing money with saving.
What is saving?
Saving as such has nothing to do with money. For example, if John the baker produces ten loaves of bread and consumes two loaves his saving is eight loaves of bread. In other words, the baker’s saving is his production of bread minus the amount of bread that he consumed. The baker’s saving now permits him to secure other goods and services. For instance, he can now exchange his saved bread for other consumer goods or he can exchange it for oven parts and tools.
By exchanging his bread for other consumer goods the baker can expand the variety of final goods that he can consume at present. The exchange of his saved bread for oven parts and tools, all other things being equal, will enable the baker to enhance the oven, which in turn will make it possible for him to raise the quality and the quantity of the production of bread.
Note that it is the bakers’ decision that determines how much of his stock of saved bread will be allocated for his personal consumption and how much towards the buying of oven parts and tools. Also, note that by exchanging his saved bread for oven parts and tools the baker transfers his saved bread to the producers of parts and tools. The bread, coupled with other final consumer goods, maintains these producers’ lives and well being and allows them to continue in their production activities.
Observe that saving here supports the consumption of the baker and the producers of parts and tools. Also, note that when the baker exchanges his saving for final consumer goods and for tools and parts he pays for them with his saving. In short, his means of payments are saved loaves of bread.
Furthermore, we are here dealing with the productive consumption of savings. The consumption is productive because both the baker directly and the producers of tools and parts, indirectly, are engaged in the production of bread, i.e., real wealth. Nonproductive consumption refers to the transfer of real savings to various activities that do not make any contribution to the flow of production of final consumer goods. For instance, expanding the size of the government will fall into this category. Or digging ditches in order to raise employment—in accordance with the Keynesian framework of thinking—is part of nonproductive consumption.
Can there be such thing as too much saving? It is like asking can we have too much real wealth. The greater the pool of saved final consumer goods, the better the quality and the quantity of tools and machinery that can be made, which in turn gives rise to a greater production of final consumer goods, i.e., an increase in living standards.
In other words, saving can never be bad for economic growth. Furthermore, as we have seen saving is entirely absorbed in the consumption of the producers of final consumer goods and the producers of tools and machinery, i.e., capital goods producers. In other words by supporting productive consumption saving in fact only promotes economic growth.
So if saving is the key for wealth generation then obviously it is absurd to suggest that it may be good for individuals but not necessarily good for the nation as a whole. Since a nation without individuals doesn’t exist, obviously if saving is good for individuals it must be also good for the nation.
What about the commonly accepted view that the driving force of an economy is consumer demand for goods and services? In other words, in this way of thinking what poses a threat to economic activity is the scarcity of demand. There is however, never a problem with demand. What always matters is having enough means to support demand.
However, as we have seen the baker can exercise his demand for various final consumer goods because he has produced bread that the producers of other final consumer goods are ready to accept in exchange for their goods. This means that the limiting factor here is not the baker’s demand for consumer goods but his ability to pay for them. His ability to pay in turn is dictated by his ability to produce bread. Consequently, as more means of payments become available greater demand can be accommodated.
According to James Mill,
When goods are carried to market what is wanted is somebody to buy. But to buy, one must have wherewithal to pay. It is obviously therefore the collective means of payment which exist in the whole nation constitute the entire market of the nation. But wherein consist the collective means of payment of the whole nation? Do they not consist in its annual produce, in the annual revenue of the general mass of inhabitants? But if a nation’s power of purchasing is exactly measured by its annual produce, as it undoubtedly is; the more you increase the annual produce, the more by that very act you extend the national market, the power of purchasing and the actual purchases of the nation. . . . Thus it appears that the demand of a nation is always equal to the produce of a nation. This indeed must be so; for what is the demand of a nation? The demand of a nation is exactly its power of purchasing. But what is its power of purchasing? The extent undoubtedly of its annual produce. The extent of its demand therefore and the extent of its supply are always exactly commensurate.1
Relation between saving and money
Now in a barter economy people will have difficulty engaging in trade. For instance, a baker may want to buy shoes for his bread. However the shoemaker has no interest in his bread. Hence no exchange will take place and John the baker will not be able to accommodate his needs. Money—the medium of the exchange—resolves these difficulties. John can now exchange his saved bread for money. Once he has the money he can exchange it for the goods and services he requires. Money therefore enables the goods of one specialist to be exchanged for the goods of another specialist. By means of money people can channel real saved final consumer goods, which in turn permits the widening of the process of wealth generation.
The existence of money also resolves the difficulty of saving perishable goods. Rather than trying to save by storing the bread the baker can now exchange his unconsumed bread for money and avoid the need of storing the bread. Needless to say that the storing of the bread runs the risk that in a few days time it will become an unwanted good. The unconsumed production of bread is now “stored” so to speak in money.
Money can be seen as a receipt, as it were, given to the producers of final goods and services that are ready for human consumption. When a baker exchanges his money for apples the baker has already paid for them with the bread produced and saved prior to this exchange. Money therefore is the baker’s claim so to speak on real savings. It is not, however, savings. Money only provides the ‘facility’ for the baker to pay for various goods and services he wants with his produced and saved bread. Likewise other producers by means of money can now secure the final goods and services they desire.
So if we do not save money as such what then are various savings deposits and other savings schemes? Don’t we save money by placing them in various saving deposits? No. What we are doing here is lending money to financial intermediaries, which means that we are transferring claims on real savings to financial intermediaries. Financial intermediaries in turn lend the money out to various individuals, i.e., transferring claims on real savings to the borrowers.
Let us now examine the effect of monetary expansion on the pool of real savings. The expanded money supply was never earned, i.e., goods and services do not back it up, so to speak—it was created out of “thin air.” When such money is exchanged for goods it in fact amounts to consumption that is not supported by production. (As a rule it leads to nonproductive consumption).
Consequently, a holder of honest money, i.e. an individual who has produced real wealth that wants to exercise his claim over goods, discovers that he cannot get back all the goods he previously produced and exchanged for money. In short, he discovers that the purchasing power of his money has fallen—he has in fact been robbed by means of loose monetary policy. The printing of money therefore undermines wealth generators and thereby weakens the pool of real savings over time.
The fiction of the world glut of savings
The notion of the supposed world glut of savings is based on the premise that saving is the amount of money left after monetary income was used for consumer outlays, which implies that saving is synonymous with money. For a given amount of monetary expenditure on consumer goods an increase in money income implies more monetary saving.
However, what matters for economic growth is not monetary saving but rather the stock of real savings. This stock, however, cannot be quantitatively ascertained because of the heterogeneous nature of final goods and services. We cannot arithmetically add up potatoes and bread into a meaningful total. The employment of various price deflators to extract out of monetary income real income and in turn real saving will not do the trick since it contradicts the fact that potatoes and tomatoes can’t be added up to a meaningful total. One thing we can be assured is that monetary pumping can never be good for the pool of real savings.
Most so-called savings countries have actually been engaged in strong monetary pumping over the past six years. So it is quite likely that on account of loose monetary policies the strong monetary saving in fact is not that strong in real terms. For instance, between January 99 to June 2005 China’s money M1 increased by 153%. Malaysian money M1 increased during this period by 107%, the Thailand’s money M1 rose by 93% while money M0 in Russia increased by 828%.
To be sure, qualitatively one can suggest that countries like China and the former Soviet Union are generating more real wealth than in previous times on account of the introduction of a freer market economy. This, we suggest, has given an important support to the US economy. Because the US dollar is an internationally accepted medium of exchange, through monetary expansion Americans can divert real savings from other countries, i.e., they can engage in an exchange of nothing for something. This ability to divert world real savings to the US doesn’t mean that there is abundance of real savings in the world.
Additionally, it is questionable to establish so-called world liquidity (as the IMF does), which is labelled as savings by averaging the various monetary savings of the world. In the US the only accepted medium of the exchange is dollars. So it is of no consequence whether China’s or European monetary saving is growing. These moneys cannot have any effect on prices of goods quoted in American dollars.
Hence if China, Europe, or any other country is having a glut of money this cannot do much for the prices of American assets. The investors from other countries to the US must acquire US dollars for their money before they can buy American assets. The amount of these dollars however is dictated by the Fed’s monetary policies and the US fractional reserve banking. It is obvious then that Greenspan’s and Bernake’s assertions that the glut of foreign liquidity is having a powerful effect on American asset prices is dubious.
Summary and conclusions
According to Greenspan it is quite likely that we are currently experiencing global saving glut. This glut, according to the Fed chairman and most economists, has not only distorted relationships between long-term and short-term interest rates but has also contributed to the housing boom. Consequently, many experts fear that this has introduced an element of instability into the world economy.
In short, too much saving can be bad for your health, so it is held. However, what generates instability is not too much savings but too much money out of “thin air.” Furthermore, what matters for economic growth is not monetary saving but rather the stock of real savings. This stock, however, cannot be established quantitatively.
Most savings countries may not have generated so much real savings as various experts are saying. In fact many of these countries have been engaged in reckless monetary pumping, which we suggest has undermined the pool of real savings. Also, we have shown that it is not valid to look at so-called world global liquidity as the driving force behind the boom in US financial and real estate markets. The US financial bubble is entirely the result of the Fed’s monetary policies and has nothing to do with the mythical glut of world savings.
- 1James Mill, On the overproduction and underconsumption fallacies. Edited by George Reisman, a publication of The Jefferson School of Philosophy, Economics, and Psychology – 2000.
