Power & Market
Economists Are Still Hooked on the Myth that Saving Is Bad for the Economy
According to new data from the US Bureau of Economic Analysis, the personal saving rate in the US in September 2019 was 8.3 percent. That puts it near a six-year high, and comparable to the saving rate we saw during the early 1990s.
Indeed, the personal saving rate has been heading upward steadily for the past eighteen months. And that's a bit of an unusual thing. For at least the past fifty years, the saving rate has tended to increase when the economy is doing poorly, and decrease when the economy is doing well.
We saw this in the last 1970 and earl eighties during the age of stagflation and the 1982 recession. We certainly saw it in the wake of the 2008 financial crisis, when the saving rate quickly rose from a near-low of 3.8 percent in August 2008, more than doubling to 8.2 percent during may of 2009.
But if the BEA's numbers are correct, that pattern appears to be over, and Americans appear to be more willing to save even when job growth continues to head upward.
This change could be a result of several factors. It could be Americans are less confident about their prospects for future earnings, even if the current job situation appears bright. Many could be less confident that the assets they do have will provide a cushion in case of crisis. For example, many Americans may have learned their lesson about the myth that "housing prices always go up."
The fact that these numbers are averages makes it especially hard to guess. After all, surveys suggests a very large numbers of Americans are saving very little.
For example, CNBC reported in January that "Just 40 percent of Americans are able to cover an unexpected $1,000 expense, such as an emergency room visit or car repair, with their savings..."
A separate survey "found that 58 percent of respondents had less than $1,000 saved."
Regardless of who is doing it, however, increased saving can be a good thing for the economy overall. For instance, even if only the rich are the ones saving more, their saving increases the amount of loanable funds, decreasing the interest rate, and making lenders more likely to lend to riskier borrowers. That's good for farmers and small business owners.
Moreover, as the wealthy refrain from spending, they increase the value of cash held and spent by people at all income levels. For example, if the rich are spending less on restaurant meals and pickup trucks, this means the prices for those items are not being bid up as much. When the rich save, that means fewer dollars chasing goods and services, which can lead to more stable, or even falling prices. That can be good for many people at lower income levels.
Nonetheless, many mainstream economists continue to get hung up on the idea that saving "too much" hampers economic growth. For example, in a recent article at the Wall Street Journal titled "Americans Are Saving More, and That Isn’t Necessarily Good" Paul Kiernan writes:
if saving outstrips investment opportunities for a long time, some economists say, it can hold down interest rates, inflation and economic growth. Such “secular stagnation” may leave less room to cut interest rates, making it harder for the Federal Reserve to boost growth during downturns.
“Rather than being a virtue, saving becomes a vice,” said Gauti Eggertsson, an economist at Brown University.
This is an old story we've been hearing for years, and the idea that there is too much saving certainly received its share of promotion during the 2001-2002 recession, and during the 2007-2009 recession.
Economists do recognize that more saving helps increase loanable funds — and thus puts downward pressure on interests rates — and reduces inflation. But more saving does not, as they think, reduce real economic growth.
True, it might reduce economic growth as measured by government stats which mostly just add up money transactions . But properly understood, economic growth increases with saving, because the capital stock is increasing, making it easier for entrepreneurs to deliver new goods and services — and more goods and services — to consumers. As Frank Shostak explains, we need more saving to create more and better goods:
What limits the production growth of goods and services is the introduction of better tools and machinery (i.e., capital goods), which raises worker productivity. Tools and machinery are not readily available; they must be made. In order to make them, people must allocate consumer goods and services that will sustain those individuals engaged in the production of tools and machinery.
This allocation of consumer goods and services is what savings is all about. Note that savings become possible once some individuals have agreed to transfer some of their present goods to individuals that are engaged in the production of tools and machinery. Obviously, they do not transfer these goods for free, but in return for a greater quantity of goods in the future. According to Mises, "Production of goods ready for consumption requires the use of capital goods, that is, of tools and of half-finished material. Capital comes into existence by saving, i.e., temporary abstention from consumption."
The common view among many economists today, however, is that it's better for economic growth to make sure more people spend every last dime on trinkets at the discount store. Those who have been around long enough to remember previous business cycles will remember that this idea manifests itself during times of recession as pundits insist it's our patriotic duty to spend more, in order to create economic growth.
In truth, in a time like today, the best thing people can do is save more. We live in a time of multiple economic bubbles and non-productive sectors of the economy fueled by inflationary monetary policy. When recession finally does come, vast amounts of debt will never get paid back and immense numbers of "assets" held on balance sheets will evaporate. The result will be a lot of lost jobs and a lot of failed businesses. The only real cushion will be real savings which will be badly needed in a time of recession.
A Note on Asset Prices, Wealth, and Inequality
Warren and Sanders et al. are misled by the government’s inflation of the money supply into believing that the stagnation and decline of our economic system in recent decades is the result of growing economic inequality.
The truth is that both the appearance of increasing wealth of the rich and the reality of declining actual wealth are the result of the government’s pouring new and additional money into the stock and real estate markets, where the effect is to raise prices.
Since the rich own far more stock and real estate than the average person, the effect of this rise in prices is that economic inequality appears to increase. (Somehow the sharp declines in apparent economic inequality that necessarily accompany market busts, are not reported.)
While the rich appear to gain because of the rise in the prices of their assets, in reality they lose.
This is because the taxation of their profits on the sale of stocks and real estate prevents the funds accruing to them from keeping pace with the rise in prices. Their funds grow only to the extent of what remains after the payment of taxes.
For example, imagine that the infusion of new and additional money into the stock and real estate markets increases prices there by 10%. Originally, one had an asset worth $1 million. Now it can be sold for $1.1 million.
But if the capital gains tax is 25%, the seller ends up with only $1.075 million, a 7.5% gain, while the prices of the assets available for him to purchase have increased by 10% on average.
This is a major way in which inflation — the government’s expansion of the money supply — destroys an economic system. It creates the appearance of business prosperity along with the fact of general impoverishment, which results in blaming poverty on business and profits.
The Problem with the Wealth Tax
One "solution" to inequality — put forth by Elizabeth Warren — is the wealth tax. Warren advocates a wealth tax that every year would take away 2% of the wealth of everyone worth more than $50 million, and 3% of the wealth of everyone worth more than $1 billion. This taxing away of capital means less means of production and thus less production and higher prices. At the same time, it means less demand for labor and thus lower wages. Elizabeth Warren’s program is a call for mass impoverishment. And the same is true of the essentially similar programs of her fellow haters of the rich, such as Bernie Sanders and Ocasio-Cortez.
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Austrian Perspectives on Entrepreneurship, Strategy, and Organization, by Foss, Klein, and McCaffrey, Available Free for a Limited Time
We are happy to announce a new book by Nicolai J. Foss, Peter G. Klein, and Matthew McCaffrey, Austrian perspectives on Entrepreneurship, Strategy, and Organization, now available from Cambridge University Press. This short volume is a concise introduction to the work that's been done over the past few decades applying and extending the ideas of Austrian economics in the management disciplines. It's well-known that Austrian economics places entrepreneurship at the heart of economic theory, but Austrian work, especially the ideas of writers like Mises, also has a lot to offer scholars in disciplines like strategy and organization studies. The table of contents is as follows:
- Introduction
- What is Austrian Economics?
- Entrepreneurship
- Extensions of Entrepreneurship Theory
- Strategy in an Entrepreneurial Perspective
- The Entrepreneurial Nature of the Firm
- The Future of Austrian Economics in Management Research
Most important, the book is available free of charge until November 18th, so be sure to check it out!
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The Fed Looks Increasingly Concerned About Liquidity and Growth — Even If it Says Otherwise
The Federal Reserve lowered its benchmark interest rate on Wednesday, cutting the target federal funds rate by 0.25 percent to a range of 0.5 to 0.75 percent.
The Fed's rate-setting committee, the FOMC, has now cut rates three times this year. The committee's rhetoric around the rate cut was the usual routine. The committee's statement indicated that " labor market remains strong and that economic activity has been rising at a moderate rate." But the official statement says something similar nearly every time the committee meets. So, there is no information here to suggests why the committee is cutting now versus all the other times the labor market is "strong" and economic strength is "moderate."
Two members of the committee voted against the cut: Esther L. George and Eric S. Rosengren.
Rosengren voted against the measure because he wanted a bigger ate cut. George, like her predecessor Thomas Hoenig at the Kansas City Fed, is relatively hawkish — although not the extent Hoenig was.
Thus, George noted in response to the rate cut: “While weakness in manufacturing and business investment is evident, it is not clear that monetary policy is the appropriate tool to offset the risks faced by businesses in those sectors when weighted against the costs that could be associated with such action.”
In other words, George recognizes that, yes, there are downsides to expansionary monetary policy.
Although the Fed statements offer no insights, the fact the Fed continues to cut rates suggests it is working from a position of fear about the true strength of the economy. Although jobs data continues to point to expansion, a number of other indicators look less rosy. The Case-Shiller index, for example, has fallen to 2-percent growth, and appears to be headed toward zero. We have seen a similar dynamic since 2006. Moreover, new housing permit growth has been negative (year-over-year) in six of the last ten months. Tax receipt data has also been weak, with seven out of the last ten reported periods showing negative year-over-year growth.
It's true that other indicators point to strength, but if things are going so well, why cut rates?
After all, the target rate is already remarkably low even by the standards of the most recent expansion, when the Fed Funds rate was allowed to rise to over five percent.
The Fed has justified this ultra-low-rate policy with theories about the natural interest rate, and about the alleged need to keep prices at or above two-percent inflation.
The problem is that the Fed cannot actually observe the natural interest rate and the two-percent inflation standard is a completely arbitrary standard invented in recent years.
Nonetheless, the Fed continues to look relatively restrained compared to other central banks, to which its policies are in part a reaction. Other central banks have set a very low bar, to be sure, but the Fred nonetheless looks almost hawkish compared to the ECB and the Bank of Japan. Both are pursuing a negative-interest-rate policy, and even with the latest rate cut, the Fed's target rate also remains above that of the Bank of England, and equal with the Bank of Canada.
But the target rate is, of course, not the Fed's only policy tool. To address liquidity problems observed during the recent repo crisis, the Fed has stepped up purchases and added to its balance sheet.
And then there is the interest the Fed pays on reserves. On Wednesday, the FOMC also announced a cut to the interest rate "paid on required and excess reserve balances," dropping the rate from 1.8 percent to 1.55 percent, mirroring the drop in the fed funds rate.
This keeps the interest paid on reserves at 0.2 percent below the fed funds rate. That's the biggest gap we've seen since 2008, and it suggests the Fed wants more lending in the real economy, even though it's also apparently concerned about liquidity for banks.
This makes sense if we're in a late phase of the boom which brings increased demand for loans, but without sufficient savings and earnings at the street level to assure liquidity for banks through the marketplace. This is only a problem one encounters in an economy built on central-bank credit expansion. Central bankers no doubt are sure they can navigate these waters, but its unclear how long they can keep the current boom going.
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Bitcoin's Past Accomplishments and Future Challenges
Oct. 31 marks the 11th anniversary of the release of the famous bitcoin whitepaper. It is worthwhile to take stock of the first crypto-currency’s impressive achievements to date, while also warning of the future perils it faces.
Bitcoin has defied the critics repeatedly, being declared “dead” many times over. (In this respect it’s appropriate that it was born on Halloween.) Although its price has been volatile, it’s currently trading at a market cap of $170 billion — more than McDonald’s, and comparable to CitiGroup.
Along the way, internecine battles led to a “hard fork” and the creation of “Bitcoin cash” (in August 2017), but the cryptocurrency community emerged wiser. As for the future, ironically a piece of otherwise good news — faster computing power — may pose serious problems if the promise of “quantum supremacy” should be fulfilled.
An estimated 5 percent of Americans hold bitcoin, and the global number of users is probably around 25 million. More impressive (and precise) details concern the financials: as of this writing, some 18 million bitcoins have been “mined” — the metaphorical term describing the procedure by which a new bitcoin becomes recognized as belonging to someone’s address on the blockchain — and a single bitcoin currently fetches a market price of about $9,450. For something that critics derided as a tech fad that would soon evaporate, that’s a rather impressive accomplishment.
Read more at The Hill
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Why Income Is an Important Concept in Economics
At his entertaining blog, John Cochrane has a good thought experiment showing the flaws with conventional measures of income inequality. However, after making his great point, Cochrane summarizes by writing:
"Income" is really a fairly meaningless concept. We do not live in the Ancien Regime, or a Jane Austen novel in which people are described for life by the annual income they receive. Income varies a lot over a lifetime, and ebbs and flows for many. And "capital income" is not the same as earned income. The broad consensus theory of taxation states that capital income -- the rate of return you get to induce you to save some income for future consumption rather than to blow it all right away -- should not be taxed at all. It really isn't "income" in any meaningful sense. [Cochrane, bold added.]
I am amazed when economists, frustrated with arguments over inequality, conclude that the very concept of “income” itself is meaningless. Long-time readers may remember that I wrote a long article at Mises.org on the issue when Scott Sumner wrote an entire post arguing that “income” was a “meaningless, misleading, and pernicious concept.” (What is it with the Chicago School that makes economists jettison the very concept of income?)
Contra Cochrane and Sumner, income is actually a critical concept. As Hayek explained in his Pure Theory of Capital, income can be defined as how much one can consume without depleting capital. All of these accounting relationships are of course integral to economic calculation, upon which—as Mises showed—civilization itself depends.
In this short blog post I won’t give a full rebuttal and explanation of what income is, and how it relates to lifetime consumption (which Cochrane and Sumner do think is a meaningful concept—thank goodness). Interested readers can refer to my earlier piece. For our purposes here, let me just use an analogy to show why Cochrane and Sumner are overreacting. Imagine a PhD nutritionist surveying all the fad diet crazes and exclaiming:
"Weight" is really a fairly meaningless concept. We don’t all have the same body types, and can’t be described by a single number. Weight varies a lot over a lifetime, and ebbs and flows for many. And "fat weight" is not the same as “muscle weight.” The broad consensus theory of health states that gaining muscle weight shouldn’t be penalized at all. It really isn't "weight" in any meaningful sense.
Would the above make any sense at all? Would we excuse it by saying, “Oh, that nutritionist is just lashing out at the nonsense in the supermarket tabloids”? Of course not; we would just insist that the experts chide the novices for superficial discussions, and ask them for more nuanced analyses.
Likewise, just because politicians try to justify higher taxes through ludicrous abuses of statistics, doesn’t mean the very concept of “income” is meaningless.
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Dave Smith One-on-One with Jeff Deist
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Cantillon and Me
As many of you know, I have been researching and writing about the economics of Irish economist and banker Richard Cantillon for over 20 years. He was the first to write a book about economic theory, circa 1730, coined the modern term entrepreneur, and the first to provide a supply and demand analysis of prices, as well as the basics of Austrian Business Cycle theory, along with many of the fundamental aspects of economic theory and beyond. In 2010, Chantal Saucier and I published a translation of his Essai into modern English.
I had a DNA done by Ancestry.com last year and it came back exactly as expected with the vast majority being "Irish or Scottish" and tiny amounts of western Europe and the Iberian peninsula. Today I received an update from Ancestry.com with a more refined analysis and it turns out that the majority of my DNA comes from the same place where Cantillon was born in the County Kerry area! Ancestry.com describes the area as a "perfect place for rebels and outlaws who sought refuge from British authority"!
Very satisfied with this Ancestry.com thing!
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California Has Tried Warrenomics. It's Been a Disaster.
California is suffering a slow but steady decline.
Bad economic policy has made the Golden State less attractive for entrepreneurs, investors, and business owners.
Punitive tax laws deserve much of the blame, particularly the 2012 decision to impose a top tax rate of 13.3 percent.
I’ve already shared some anecdotal evidence that this tax increase backfired.
But now we have some scholarly evidence from two Stanford Professors. Here’s what they investigated.
In this paper we study the question of the elasticity of the tax base with respect to taxation using microdata from the California Franchise Tax Board on the universe of California taxpayers around the implementation of Proposition 30 in 2012. This ballot initiative increased marginal income tax rates… These increases came on top of the 9.3% rate that applied to income over $48,942 for singles and $97,884 for married couples, and also in addition to the 1% mental health tax that since 2004 had applied to incomes of over $1 million. The reform therefore brought the top marginal tax rate in California to 13.3% for incomes of over $1 million.
For those not familiar with economic jargon, “elasticity” is simply a term to describe how sensitive taxpayers are when there are changes in tax policy.
A high measure of elasticity means a large “deadweight loss” since taxpayers are choosing to earn and/or report less income.
And that’s what the two scholars discovered.
Some high-income taxpayers responded to the big tax increase by moving.
We first study the extensive margin response to taxation, and document a substantial one-time outflow of high-earning taxpayers from California in response to Proposition 30. Defining a departure as a taxpayer who went from resident to non-resident filing status, the rate of departures in 2013 over 2012 spiked from 1.5% after the 2011 tax year to 2.125% for those primary taxpayers earning over $5 million in 2012, with a similar effect among taxpayers earning $2-5 million in 2012.
By the way, you won’t be surprised to learn that California taxpayers increasingly opted to move to states with no income tax, such as Florida, Nevada, and Texas.
Read More: People Love to Move to States Paul Krugman Hates Most
Other taxpayers stayed in California but they chose to earn and/or report less income.
We combine these results on the extensive margin behavioral response with conclusions of analysis of the intensive margin response to Proposition 30. …we use a differences-in-differences design in which we compare upper-income California resident taxpayers to a matched sample of non-resident California filers, for which there is relatively rich data… Our estimates show a substantial intensive margin response to Proposition 30, which appears in 2012 and persists… We find that California top-earners on average report $522,000 less in taxable income than their counterfactuals in 2012, $357,000 less in 2013, and $599,000 less in 2014; this is relative to a baseline mean income of $4.15 million amongst our defined group of California top-earners in 2011. …the estimates imply an elasticity of taxable income with respect to the marginal net of tax rate of 2.5-3.3.
In the world of public finance, that’s a very high measure of elasticity.
Wonky readers may be interested in these charts showing changes in income.
By the way, guess what happens when taxpayers move, or when they decide to earn less income?
The obvious answer is that politicians don’t collect as much revenue. Which is exactly what the study discovered.
A back of the envelope calculation based on our econometric estimates finds that the intensive and extensive margin responses to taxation combined to undo 45.2% of the revenue gains from taxation that otherwise would have accrued to California in the absence of behavioral responses. The intensive margin accounts for the majority of this effect, but the extensive margin comprises a non-trivial 9.5% of this total response.
We can call this the revenge of the Laffer Curve.
By the way, it’s quite likely that there has been a resurgence of both the “extensive” and “intensive” responses to California’s punitive tax regime because the 2017 tax reform restricted the deductibility of state and local taxes. This means that the federal government – for all intents and purposes – is no longer subsidizing California’s backwards fiscal system.
P.S. Makes me wonder if California politicians will turn Walter Williams’ joke into reality.
Originally published at International Liberty
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Remembering The Road to Serfdom: Individualism and Markets
While much of Friedrich Hayek’s The Road to Serfdom focused on correcting erroneous ideas and sloppy thinking that misled (and still mislead) many to support socialistic expansions of government power, that is not all it did. It also reiterated the case for individualism and its economic manifestation—free markets. Since convincing careful thinkers requires such an affirmative case as well as defensive debunking, the book’s diamond 75th anniversary is a propitious time for Americans to remember what only individualism provides, so that we will not continue to follow a path of “replacing what works with what sounds good,” as Thomas Sowell described it.
- The essential features of…individualism…are the respect for the individual man qua man…the recognition of his own views and tastes as supreme in his own sphere…and the belief that it is desirable that men should develop their own individual gifts and bents.
- The attitude of the liberal toward society is like that of the gardener who tends a plant and, in order to create the conditions most favorable to its growth, must know as much as possible about its structure and the way it functions.
- The holder of coercive power should confine himself in general to creating conditions under which the knowledge and initiative of individuals are given the best scope so that they can plan most successfully.
- The successful use of competition as the principle of social organization precludes certain types of coercive interference with economic life.
- Planning and competition can be combined only by planning for competition but not…planning which is to be substituted for competition.
- It is the very complexity of the division of labor under modern conditions which makes competition the only method by which such coordination can be adequately brought about.
- Nobody can consciously balance all the considerations bearing on the decisions of so many individuals…coordination can clearly be effective only by… arrangements which convey to each agent the information he must possess in order effectively to adjust his decisions to those of others…This is precisely what the price system does under competition and what no other system even promises to accomplish.
- The economist…His plea is for a method which effects such co-ordination without the need for an omniscient dictator.
- The various kinds of collectivism…[refuse] to recognize autonomous spheres in which the ends of the individuals are supreme.
- Recognition of the individual as the ultimate judge of his ends…that as far as possible his own views ought to govern his actions…forms the essence of the individualist position.
- What are called “social ends” are…merely identical ends of many individuals…to the achievement of which individuals are willing to contribute…Common action is thus limited to the fields where people agree on common ends.
- The clash between planning and democracy arises simply from the fact that the latter is an obstacle to the suppression of freedom which the direction of economic activity requires.
- The more the state “plans,” the more difficult planning becomes for the individual.
- The important question is whether the individual can foresee the action of the state…that the individual knows precisely how far he will be protected against interference from others, or whether the state is in a position to frustrate individual efforts.
- In a planned society the Rule of Law cannot hold…the use of the government’s coercive powers will no longer be limited and determined by pre-established rules.
- Economic control is not merely control of a sector of human life…it is the control of the means for all our ends.
- To believe that the power which is thus conferred on the state is merely transferred to it from others is erroneous. It is a power which is newly created and which in a competitive society nobody possesses. So long as property is divided among many owners, none of them acting independently has exclusive power to determine the income and position of particular people.
- The power which a multiple millionaire…has over me is very much less than that which the smallest fonctionnaire possesses who wields the coercive power of the state on…whether and how I am to be allowed to live or to work.
- Contrast…two types of security: the limited one, which can be achieved for all, and which is therefore no privilege but a legitimate object of desire; and absolute security, which…if it is provided for some, it becomes a privilege at the expense of others.
- Individualism is thus an attitude of humility…the exact opposite of that intellectual hubris which is at the root of the demand for comprehensive direction of the social process.
- It was men’s submission to the impersonal forces of the market that…has made possible the growth of a civilization without which this could not have developed; it is by thus submitting that we are every day helping to build something that is greater than any one of us can fully comprehend.
- If the democracies themselves abandon the supreme ideal of the freedom and the happiness of the individual…they implicitly admit that their civilization is not worth preserving.
- It is more important to clear away the obstacles with which human folly has encumbered our path and to release the creative energy of individuals than to devise further machinery for “guiding” and “directing” them—to create conditions favorable to progress rather than to “plan progress.”
Friedrich Hayek’s The Road to Serfdom defended the individual—the only ultimate locus of choice, responsibility and morality—as the appropriate focus of efforts toward human improvement, at a time when failing to keep that focus threatened the entire world. That is a lesson we need to remember now as well, when many do not remember the horrors that can lead to, and so support constantly expanding government powers over its citizens, which is in precisely the opposite direction of what once created America as a unique beacon of hope for the world.
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