Is There A Savings Glut?

Following Ben Bernanke, the chairman of the Council of Economic Advisers, in his testimony to the Congress on July 20, 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, boosting their expenditure and keeping the US economy afloat.

And 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 global savings as a percentage of global GDP stood at 25.4% in 2005, which translates into US$11.8 trillion nearly the size of the US economy.

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Most economists agree that in order to grow an economy, saving is a must. Savings fund investment in capital goods like computers tools and machinery, which in turn make the economy more productive. However, it is also argued that 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 spending and weaken economic growth. After all, saving is the opposite of consumption. According to this way of thinking, if people opt to save a large part of their income, then only a small quantity of output will find a market. Output will therefore have to be low, because there will be no demand for larger quantities of production.

Also, 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 too much saving as bad news for economic activity, obviously what Greenspan was concerned about 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, his saving is eight loaves. In other words, the baker's saving is his production of bread, minus the amount he consumes. The baker can now secure other goods and services with these savings. For example, he can exchange his saved bread for other consumer goods or 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. He can also exchange his saved bread for oven parts and tools which will enable him to enhance his oven, enabling him to raise the quality and the quantity of bread production.

When the baker exchanges his saved bread for oven parts and tools the baker transfers his savings to the producers of those parts and tools. The bread, coupled with other final consumer goods, maintains these producers' lives and well-being and allows them to continue their production activities.

This is 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.

Non-productive 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 example, expanding the size of the government falls into this category. Or digging ditches in order to raise employment in accordance with the Keynesian framework of thinking is part of non-productive consumption.

Is there such a thing as too much saving? It is like asking if we can 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, 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 promotes economic growth.

So if saving is the key to wealth generation, then 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, 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? This way of thinking suggests that the key threat to economic activity is scarcity of demand. But there is never a problem with demand - what matters is having enough means to support demand.

For example, the baker can exercise his demand for various consumer goods because he has produced bread that other producers are ready to accept in exchange for their products. So the limiting factor is not the baker's demand for consumer goods, but his ability to pay for them. His ability to pay is in turn dictated by his ability to produce bread. Consequently, as more means of payments loaves of bread, in this case - become available, greater demand can be accommodated i.e., he can afford to consume more.

The relationship between saving and money

In a barter economy, people will have difficulty engaging in trade. For example, John the baker may want to buy shoes for his bread but the shoemaker has no interest in his bread. So no exchange will take place and John will not be able to accommodate his needs.

Money the medium of the exchange solves these problems. John can now exchange his saved bread for money. Once he has the money he can exchange it for the goods and services he needs. Money enables the goods of one specialist to be exchanged for the goods of another specialist. Using 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 for storing the bread. Obviously, storing 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" in money.

Money can be seen as a receipt 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 the exchange. Money therefore is the baker's claim on real savings. It is not in itself, however, the savings. Money only provides the facility' for the baker to pay for the goods and services he wants with his produced and saved bread. Likewise, other producers can use money to secure the final goods and services they desire.

But don't we save money by placing it in various savings 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. they transfer claims on real savings to the borrowers.

Let us now look at the effect of monetary expansion on the pool of real savings. The expanded money supply was never earned in other words, goods and services do not back it up. 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.

This means that an individual who has produced real wealth, who wants to exercise his claim over goods, discovers that he cannot get back all the goods he previously produced and exchanged for money. In other words, 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 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 is used for consumer spending, 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 wide nature of final goods and services. We cannot add up potatoes and bread into a meaningful total. Using various price deflators to take real income out of monetary income, and in turn calculate 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 of 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 loose monetary policies mean that the strong monetary saving is not that strong in real terms. For instance, between January 1999 to June 2005, China's money M1 increased by 153%. Malaysian money M1 increased during this period by 107%, Thailand's money M1 rose by 93% while money M0 in Russia increased by 828%.

To be sure, 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 in other words, they can exchange nothing for something. This ability to divert world real savings to the US doesn't mean that there is an abundance of real savings in the world.

Also, it is questionable to establish so-called world liquidity (as the IMF does), which is then labelled as savings, by averaging the various monetary savings of the world. In the US the only accepted medium of exchange is dollars. So it does not matter whether Chinese or European monetary saving is growing. This money cannot have any effect on prices of goods quoted in American dollars.

So if China, Europe, or any other country has a glut of money this cannot do much for the prices of American assets. Foreign investors must acquire US dollars before they can buy American assets. The amount of 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.

Loose monetary policy is the problem

According to Greenspan it is quite likely that we are currently experiencing a global savings 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 this has introduced an element of instability into the world economy.

In short, too much saving can be bad for your health. However, what really generates instability is not too much saving but too much money created out of "thin air." And what matters for economic growth is not monetary saving but rather the stock of real savings. This stock, however, cannot be established quantitatively.

Most countries with high levels of saving may not have generated as much real saving as various experts are saying. In fact, many have engaged in reckless monetary pumping, which has undermined the pool of real savings. Also 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.

By Frank Shostak, an adjunct scholar of the Ludwig von Mises Institute.

For more from the Ludwig von Mises Institute, go to https://www.mises.org/