Savings Is Not Just a Good Thing
The recent news that Regions Bank scored the worst of the nation's 19 largest banks on the federal government's stress tests reflected its bad loan decisions made during the economic boom. Regions' subsequent acceptance of TARP money, whether done willingly or not, meant that taxpayers would be involuntarily assuming that troubled bank's risk when a free society would have required it to internalize these self-inflicted costs.
All told, it makes for a shameful episode for Birmingham's last remaining Fortune 500 company. Nonetheless, while wondering how things got this way, I came across an article by Regions' chief economist, Bob Allsbrook, that might explain the nadir of this benighted bank. In a Birmingham News op-ed on April 26, Allsbrook wrote,
Saving — in a general sense — can be a good thing. It's something consumers should have been doing anyway. The problem today is money that is added to savings is money which is not spent. This scenario is what we economists call the "paradox of thrift." Or what is good for the individual may not be good for the entire economy.
This money that is saved is not being spent on new clothes, furniture or other noncritical goods. Or, if the money is spent, it is spent on cheaper, often lower-quality goods or services.
The decline in credit and the increase in savings are squeezing what small amount of after-tax income is available to consumers. To stretch this amount, while consumers can't always stop spending, they can become thriftier about how they spend. People still buy coffee, but they get it at McDonald's instead of Starbucks, or they make it at home. They are driving revenues at Wal-Mart, but not at department stores.
Such old-school Keynesian sentiment from a major bank's chief economist is surprising, and it makes one wonder about the quality of economic advice Regions received in the earlier part of this decade, when much of the damage was being done.
If Allsbrook believes that savings is just something that "can be a good thing," then I wonder where he thinks investment comes from. It comes from saving, and saving is essential if the economy is ever going to recover and embark on a period of sustainable economic growth.
One wonders how Allsbrook would explain the last real recession experienced in the United States. That was in the early 1980s. Like today, this was a recession that many were likening to a depression. Like today, it followed several years of unrestrained Fed-injected credit. The unemployment rate was in the double digits, as today's would be if the government measured it according to the same standards. The stock market was tanking. Again, there were news stories emphasizing the end of capitalism and the need to reinvent America.
The Paul Volcker–led Fed responded by sucking liquidity out of the banking system, and forcing an increase in interest rates — a policy that is exactly opposite to that of today, resulting in what Allsbrook would call a paradox of thrift. People certainly responded in ways expected by economists who know something about incentives. They saved, and as it turned out, this was a very good thing, resulting in a pool of real savings that lead to long-term economic growth over the following two decades.
Much of this was sustainable growth because it funded investment that produced output that people saved to purchase. This is in marked contrast with the unsustainable growth that results when the Fed simply injects money created out of thin air into the banking system. This also promotes business investment, but since such investment is not savings-induced, the resulting output is not purchased. The result is a boom followed by a bust that causes many economists — including many in the banking industry — to call for another round of new money, again created out of thin air, to start the process over again.
Such is the process of boom and bust. It explains why the dollar is constantly losing value — over a third during Alan Greenspan's reign as Fed chairman alone.
What Allsbrook calls a paradox of thrift is actually an essential liquidation process that characterizes economic corrections. This is a painful time as firms deleverage, abandon unprofitable product lines, reduce prices to sell off goods that were oversupplied during the boom, and reallocate capital from those uses not desired by consumers to those that are. This also happened in the early 1980s and had it not, that decade would be remembered today as a replay of the economically sorry one it followed.
It does not bode well for our economic future that government today has been thwarting this process, motivated by equally outmoded Keynesian sentiments. By bailing out industries, including key players in the financial industry, it needlessly prolongs the correction process, which is why I agree with Allsbrook's sense, expressed later in his op-ed, that any economic recovery we might see will be anemic at best, and not likely until the end of 2009, if then. The economy is not sounder when extramarket force causes firms to survive when market forces would have otherwise shut them down. Would the world have been a better place if a TARP-like entity allowed Enron to live to see another day?
We know better, which explains much of the public anger rightly directed at the corporate state today. But this is mercantilism, not capitalism. It is another example of the unintended consequences that follow economic planning, which in this episode centered on Congress and the Fed's manipulation of the housing and credit markets.
While Regions will survive, its directors need to understand why credit-induced growth brings more long-term damage both to the economy and to its balance sheets than savings-induced growth. The banks that understood this during this decade's unsustainable boom are in better shape today, with more secure customers, happier investors, and no socialized risk.
It is a paradox, and a better one worth pondering.