Scott Sumner  

Saving cannot go "into" existing assets

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Every so often I need to push back against common misconceptions regarding saving and investment. The comment section of my previous post provided a few examples, starting with "pyroseed13":

In a less risk-averse and more economically free environment, savings would be flowing into new investments. But right now all that's happening is that this savings is being used to bid up prices on existing assets, mainly housing. So this asset bubble is reducing investment in other areas of the economy.
Saving does not and indeed cannot flow into existing assets, at least in net terms. You might use $X of your income to buy a certain asset, like an existing house. But that's offset by the fact that the person you buy the house from receives $X for selling the asset. In net terms, no saving has been absorbed in this transaction. In contrast, savings get absorbed when new capital goods are constructed, as when a new home is built. Because saving equals investment, we need never worry about saving being directed into non-investment uses, at least in aggregate terms.

Regarding existing assets, it's more accurate to say that money flows through markets, not into markets.

Commenter LD said the following:

Fed policies that provide cheap credit to established (or politically favored) companies that use the money to buy back (thus raising the price of) their stock, make it more difficult for smaller, newer, or politically un-favored companies to compete in capital markets. This provides an advantage to the established companies and reduces their incentive to innovate since the more innovative companies have less access to credit.
This is a good example of Paul Krugman's point about how arguments that might sound plausible using words, break down when you are forced to defend them mathematically. Actually, this argument is exactly backwards. Small firms find it easier to invest when big companies buy back their stock.

When companies earn profit, they can either re-invest those profits in new capital goods, or return the money to shareholders through stock buybacks or dividends. If they invest in new capital goods, those savings are not available for small firms to use. But if the money is returned to shareholders, then it is available to small firms via the credit markets. Just as government investment may "crowd out" private investment, the investment of big corporations may "crowd out" the investment of small firms. Hence if big firms refrain from investing, more of the savings pie is available for small firms to use.

PS. This assumes the Fed is targeting inflation. Under a different monetary regime the analysis might get more complicated, but I doubt you'd ever find small firms being hurt by the net saving of big firms. In any case, the article I was criticizing was certainly not relying on a Keynesian argument.


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CATEGORIES: Finance , Macroeconomics




COMMENTS (12 to date)
Kevin Erdmann writes:

Your first point is apropos to the argument that the "global savings glut" caused the housing "bubble". Bernanke argues that foreign capital flows were related to rising housing prices across countries. But, I argue that this is incoherent. He is correct that loose monetary policy didn't cause the housing bubble, but the savings glut story fails as a defense. Where home prices increased, this was due to supply constraints. Where there aren't constraints, capital flows into more homes at moderate prices. So, Bernanke's regression actually proves that the causation goes in the other direction, in a complex way that I won't go into here. But, as you say, capital can't flow into existing assets, so it doesn't make sense to say that there was an excess of foreign savings, and that it flowed to the places that were incapable of absorbing it. Within the US, that capital, necessarily, flowed to places like Dallas and Atlanta, where prices were moderate. Connecting those flows to rising prices doesn't make sense. If foreign savings was the cause of low rates and capital flows, the capital would have flowed into Germany and Japan, where housing markets are liberalized enough to keep prices low, not into Australia, Great Britain, and the US, where economies are characterized by constrained housing supply and rising prices.

Philo writes:

You didn't really illustrate Krugman's point, because you effectively skewered LD's argument without resorting to mathematics (at least, there were no formulas): all it took was clear thinking.

Scott Sumner writes:

Kevin, Good point about the distinction between rising prices for existing homes and new construction, often in places that did not have a big price run-up (Texas.)

Philo, That's right. But I had the math in the back of my mind.

LD Bottorff writes:

I may indeed have it backwards, but your explanation is not complete. If regulatory policies skew the availability of credit towards larger, more established companies, then yes, the smaller, riskier companies can buy the assets that the larger company didn't buy, but they do so at a disadvantage.
Then, when the smaller company seeks capital from investors, the investors must weigh the risks and rewards against the return they could get from the companies that have a credit advantage.
Of course, this is true in a free market as well. The issue is, whether or not the government regulation is providing too much advantage to the established companies.

pyroseed13 writes:

Thanks for highlighting my post. I think I misspoke. I was trying to argue something akin to what Kevin pointed out above. However, it is probably true as he notes that the proximate cause of housing price increases was a supply constraint, not low interest rates or the global savings glut.

Scott Sumner writes:

LD, I agree.

Staunch writes:

Apropos of nothing, here's an article from Bloomberg where that explicitly says that the Fed offsets fiscal stimulus

http://www.bloomberg.com/news/articles/2016-10-25/fed-inclined-to-raise-rates-if-next-president-pumps-up-budget

Effem writes:

In an accounting sense you are of course correct. However, many people are more focused on wealth effects whereas economists don't seem to care so much. The Fed certainly has the ability to push up asset values relative to income streams...thus generating a variety of economic, social, and political implications. If things end badly for the Fed, my guess is it's because they've ignored the political implications of spurring wealth inequality.

Bob Murphy writes:

Pyroseed, for what it's worth, I think you threw in the towel too early. I tried to defend your original point here. I think what happened is that Scott took you to be claiming that S was less than I because of the Fed, when I think in reality you were really saying that the Fed was distorting the composition of investment spending.

For Scott or anyone else who endorses Scott's response, I would like to know how you'd respond to my post. Thanks for any thoughts.

Bob Murphy writes:

Oops I meant Pyroseed that I think Scott took you to be saying that S was greater than I.

pyroseed13 writes:

Haha thanks Bob! That is essentially what I was trying to express.

Scott Sumner writes:

Staunch, Thanks, I did a post at MoneyIllusion.

Effem, You said:

"The Fed certainly has the ability to push up asset values relative to income streams."

I'm not so sure about that--at least not in any systematic or predictable way. (I'm assuming normal monetary policy, with T-securities. If they directly bought unconventional assets then yes.)

Bob, I'm not quite sure what you mean by "distorting". If you mean the composition of investment would be different with a different monetary policy, then I agree, although I think the effect is small.

But that's not what Pyroseed said. He spoke of saving going into existing assets rather than new investments. That's what I disagreed with.

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