Why America’s new love affair with saving is not great economic news

This data from Gallup shows that the 2008 recession transformed America’s relationship with money. In 2006, before the recession, 55 percent of Americans saw themselves are savers, and 45 percent saw themselves as spenders. By 2010, 62 percent saw themselves as savers, and only 35 percent saw themselves as spenders, a pattern which holds up today:

This tallies with data showing that the total level of money Americans are sitting on has soared since the recession. This is not great news.

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Hey, Pope Francis: Markets are the solution, not the problem

Pope Francis continues to make waves as the new head of the Catholic Church, offering a blistering critique this week of free markets and capitalism in his first apostolic exhortation:

[S]ome people continue to defend trickle-down theories which assume that economic growth, encouraged by a free market, will inevitably succeed in bringing about greater justice and inclusiveness in the world. This opinion, which has never been confirmed by the facts, expresses a crude and naïve trust in the goodness of those wielding economic power and in the sacralized workings of the prevailing economic system. Meanwhile, the excluded are still waiting. [vatican.va]

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Bitcoin: The opportunity costs of mining for money

Everything we do and every choice we make has an opportunity cost. In a world of scarce time and resources each choice necessarily means rejecting many other possible opportunities. One of the best illustrations of this concept was made by President Eisenhower in a 1953 speech. Eisenhower criticized the use of scarce resources for military purposes because of the opportunity cost:

The cost of one modern heavy bomber is this: A modern brick school in more than 30 cities. It is two electric power plants, each serving a town of 60,000 population. It is two fine, fully equipped hospitals. It is some fifty miles of concrete pavement. We pay for a single fighter with a half-million bushels of wheat. We pay for a single destroyer with new homes that could have housed more than 8,000 people. [The Chance For Peace]

These kinds of choices are just as difficult as they were for Eisenhower in 1953. How much time, resources, and effort should be dedicated to military activities? It’s still a contentious argument, and opinions greatly differ.

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How saving endangers the economy — and what to do about it

An impressive video featuring former Treasury Secretary Larry Summers has been making the rounds.

Summers makes the case that the United States and other Western nations may have reached a state of permanent stagnation in growth and employment. In Japan, per capita incomes grew strongly until the 1990s, and since then they have been growing very weakly and intermittently. Summers cites Japan as an early example of what might occur elsewhere.

Japan’s stagnation is shocking — today, the Japanese economy is only half the size economists in the 1990s predicted it would be if it had continued on its pre-1990s growth trend. As Summers notes, in the U.S., growth is also well below its pre-crisis trend, and unemployment remains persistently high. More than 12 million people who want work and are actively looking cannot find it. That’s a very ugly situation.

Under normal conditions, central banks can lower interest rates on lending to banks as a way to encourage activity and fight unemployment. Lower rates make business projects easier to afford, and more business projects should mean more jobs. If an economic shock pushes the unemployment rate up, central banks can lower lending rates to ease conditions. And conversely, if economic conditions are overheating and inflation is pushing up above the Federal Reserve’s target of 2 percent, interest rates can be hiked to encourage saving and discourage spending.

Yet in the current slump, unemployment has remained elevated even while interest rates have been at close to zero for four years while inflation has remained contained. This suggests that the interest rate level required to bring employment down significantly is actually below zero. Summers agrees:

Suppose that the short-term real interest rate that was consistent with full employment had fallen to negative 2 percent or negative 3 percent sometime in the middle of the last decade.

But central banks can’t lower interest rates below zero percent because people can just hold cash instead. Why invest if you’re going to lose money doing so?

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The London Real Estate Bubble


In October, London real estate asking prices jumped 10%. In my view is kind of parabolic-looking jump has developed out of quite a silly situation, and one I think is a good exhibit of just how irrational and weird markets can sometimes be.  London real estate prices have been rising strongly for a long while, and a large quantity — over half for houses above £1 million — of the demand for London real estate is coming from overseas buyers most of whom are buying for investment purposes. It is comprehensible that London is a desirable place to live, and that demand for housing in London might be higher than elsewhere in the UK. It is a diverse and rich place culturally and socially, boasting a huge variety of shopping, parks, art galleries, creative communities, restaurants, monuments and landmarks, theatres and venues, financial service providers, lawyers, think tanks, technology startups, universities, scientific institutions, sports clubs and infrastructure. Britain’s legal framework and its straightforward tax structure for wealthy foreign residents has proven highly attractive to the global super rich. With London real estate proving perennially popular, and with the global low-interest rate environment that has made borrowing for speculation cheap and easy, it is highly unsurprising that prices and rents have pushed upward and upward as the global super rich — alongside pension funds and hedge funds — sitting on large piles of cash have sought to achieve higher yields than cash or bonds by speculating in real estate. In some senses, London real estate (and real estate in other globally-desirable cities) has become a new reserve currency. And while this has occurred, price rises have proven increasingly cyclical as both London residents and speculators have sought to buy. The higher prices go, the more London residents become desperate to get their feet on the property ladder in fear they won’t ever be able to do so, and the more speculators are drawn in, seeing London real estate as an asset that just keeps going up and up.

Yet the bigger the bubble, the bigger the bust. And I think what we are seeing in London is a large psychological bubble, a mass delusion built on other delusions. Chief among these delusions is that real estate should be seen as a productive investment, as an implicit pension fund, or as a guaranteed source of real yield. While investors can look at real estate however they like, there is no getting away from the fact that real estate is a deteriorating asset. Sitting on a deteriorating asset and hoping for a real price gain — or even to preserve your purchasing power — is a speculation, not a productive investment. For commercial enterprises buying as a premises for business, or for residents buying as a place to live this is not in itself problematic. But as an investment this can be hugely problematic. It is just gambling on a deteriorating asset under the guise of buying a “safe” asset.

Of course, in the UK where housing has been treated by many successive governments as an investment, and as a haven for savings and pensions, real estate owners have done particularly well. Governments have been willing to prop up the market with liquidity via schemes like Help To Buy and via restrictive planning laws to rig the market to restrict supply. This may make investors feel particularly secure, but governments can be forced — not least by demographics — to swing in another direction. An important side-effect of continually rising prices and a restricted supply of housing is that many people will not be able to afford to buy a home. With the house prices-to-wages ratio sitting far above the long-term average, the next UK government will come under severe pressure within the next few years to allow — and probably subsidise — much more housebuilding to bring down housing costs for the population. The past-trend of government-protected gains may have inspired a false sense of security in investors.

But such a reversal of policy would not in itself crash the London real estate market. After all, London is a unique place in Britain, and the majority of the new housebuilding may take place away from London. More likely, the bubble will simply collapse under the weight of its own growth. Sooner or later, even with liquidity cheap and plentiful, the number of speculators seeking to cash out will exceed the number of speculators seeking to cash in, and confidence will dip. Sometimes, this simply equates to a small correction in the context of a large upward trend, but sometimes — especially when it can be negatively rationalised — it manifests into a deeper malaise.

When this occurs, one probable rationalisation is as follows.  Domestically, many of the relatively low-income artists, designers, technologists, musicians, students, artisans, academics, service workers and professionals (etc) who make London London are priced out, then they will go and contribute to communities elsewhere where rents and housing costs are lower — Birmingham, Manchester, Glasgow, Paris, Berlin, out into the sprawl of the home counties, and deeper into the English countryside, to places where a four bedroom house costs the same as a studio apartment in central London. Where once this would have been culturally, professionally and socially prohibitive, fast, ubiquitous internet allows for people to live a culturally and socially connected life without necessarily living in a big city like London. Internationally, other cheaper cities and jurisdictions will simply catch up with London in terms of amenities and desirability to the global super class. Competition for global capital  is huge, and while London as an Old World metropolis has done well since 2008, it may suffer in the wake of renewed competition from newer, cheaper, faster-growing Eastern metropolises.

When the bubble begins to burst — something that I think could occur endogenously within the next five years, especially if the fast increases continue — speculators, and especially speculators who are heavily leveraged may face severe problems, resulting in a worsened liquidation and contraction, and possibly threatening the liquidity of heavily-invested lenders. As many people at the table are sitting on big gains, they may prove desperate to cash out. Just as many presently feel pressured to get in to avoid being priced out of London forever, a downward turn could be severely worsened as many who are heavily invested in the bubble and scared of losing gains on which they hoped to fund retirements (etc) feel pressured to get out. Such an accelerated liquidation could easily lead to another recession. While I doubt that London prices will fall below the UK average, prices may see a very sharp correction. The psychological bubble is composed of multiple fallacies — that housing is a safe place to put savings and not a speculation, that deteriorating real estate should yield higher returns than productive business investments, that the UK government will continue to protect real estate speculators, that large flows of capital from overseas speculators will continue into London. A bursting of any of these fallacies could begin to bring the whole thing into question, even in the context of continued provision of liquidity from the Bank of England.

On Depressions, the Structure of Production & Fiscal Policy

I came into economics and finance blogging in 2011 a very different economic thinker than I am today. I was convinced (and remain convinced) that we were going through a once-in a generation economic transformation, or more accurately an industrial revolution the shape of which remained uncertain. These ongoing industrial revolutions, of course, cause great upheavals. As Joseph Stiglitz has noted, the Great Depression of the 1930s can be seen as a great displacement of labour in agriculture thanks to technological improvement. Stiglitz, like myself, sees a parallel between today’s slump and that of the 1930s; in the 1930s we were transitioning out of agriculture. We are also in a transitional period today. Since the advent of globalisation, and the growth in automation in the 1970s and 1980s society had begun suffering from falling real wages, and had had to lever up on debt in order to sustain lifestyles and spending habits. The financial sector had taken advantage of this, offering cheapish debt and — morally hazardously — securitising these debts and selling it a greater fool. This was a bomb waiting to explode — because lenders did not have to take responsibility for the fruits of their lending, they could lend to any NINJA, pay the credit rating agencies to grade highly speculative debt as AAA-grade, and sell it to another bank, or a pension fund, or a hedge fund. When the financial crisis blew up, I desired very, very strongly to see the entire corrupt market liquidated. This was an entirely Darwinian wish; financial firms had acted irresponsibly, creating a monstrous system that nobody really understood and they should pay the consequences for their irresponsibility. In liquidation, people would learn a harsh lesson and the economy would be forced to adapt to the new reality. In Hayekian terms, I thought that the structure of production ought to be left alone to adjust.

So I was furious to see the financial sector bailed out and rescued, and I strongly suspected that such medicine would have very harsh negative side effects as the speculators had been rescued instead of learning their lesson the hard way. Maybe the bankers and financiers who got bailed out — and the regulators who were found to be asleep at the wheel — have not learned a lesson. We shall see. Yet, when push came to shove, governments and central banks chose to save the system instead of watching it burn to the ground and given the complexity of the system, and the danger of good businesses being destroyed alongside the speculators and shysters, that is an entirely understandable decision. Certainly, it was also a morally questionable decision — after all, while bankers and financiers get bailed out in an emergency, help for the much poorer fringes of society is much less forthcoming. Yet this is the world in which we live in.

Of course, the world goes on. Banks may not have been disciplined, but the structure of production still must adjust to the new world, albeit in a less brutal and immediate fashion. This has been far from simple. Even though the financial system was saved, economies around the world remained in a depression. In fact, I would define an economic depression in these terms — a depression as opposed to a transitory recession, which relatively quickly self-corrects is a situation in which the structure of production cannot adjust itself back into a pattern of growth, and economic activity becomes permanently lowered. In Britain and the Eurozone we are so far behind our pre-crisis trend that we still as of October 2013 have not grown our way out of the trough yet, let alone caught up with the long term trend line:


The causes of this are multiple and complex. We are in an the midst of an ongoing industrial revolution, a great whirling flourish of creative destruction in which both foreign labour and automation are displacing both manufacturing and increasingly service industries. This creates real ongoing instability. Furthermore there remains the fallout from the crisis — confidence in new job-creating and growth-creating business ventures may have become inherently depressed, as economic expectations drift lower and lower in the context of low growth. Then there is the ongoing trend of government austerity, taking money and jobs out of the economy. Energy prices remain relatively high by historical standards, as we rely on old and increasingly expensive oil-based infrastructure (although I expect energy costs to begin to fall as we transition to newer energy architectures). The private sectors in most Western countries remain in deleveraging mode from a very large private debt overhang from before the crisis, limiting their consumption and investment and paying down debt. These are just some of the possible causes of depressed growth and elevated unemployment that we see.

Governments particularly in Britain and the Eurozone have attempted to fight depressed growth using austerity policies (in the context of expansionary monetary policy). The proponents of austerity theorise that by promising to bring down taxes and spending, they will unleash private sector spending by reducing future expectations of taxes. To me, this has always seemed like a boneheaded and Rube Goldberg-style approach. Simply, the issue of depressed private economic activity is far more complex than future taxation expectations. And aggressive monetary policy has not succeeded in reversing the depression(even if it has probably made the depression less severe). So it has been entirely unsurprising to me to see this approach largely failing. I approach the problem in a far more direct manner. The solution to lowered growth and elevated (and involuntary) unemployment is relatively simple. Eventually someone will start using up the idle resources. This will either be the private sector once it independently gets over its slump in animal spirits, or it will be the government. With such huge volumes of idle capital, interest rates will remain very low until stronger appetite for credit re-emerges. In equilibrium theory, the low cost of credit will by itself start to re-energise borrowing appetite by making more projects potentially profitable. Of course, interest rates are far from the only factor that borrowers take into account when seeking credit, and so it is perfectly plausible that the economy — as it has done — can remain depressed even with very low rates due to deleveraging pressures, low expectations and low confidence, etc. So if the market is ill-suited to taking up the idle resources any time soon — lying as it is in a depressive, irrational strop — the only agent that can do so is the state. The fact of low interest rates allows this to kill two birds with one stone — the state can borrow money (utilising idle capital) to create jobs (utilising idle labour), raising interest rates and bringing down the unemployment rate. And this approach does not require anyone to make accurate predictions about the future. It simply requires a market economy, and a state willing to employ idle resources when they are idle, and to ease off using idle resources when unemployment becomes low and interest rates start to rise.

Many — including probably Hayek himself — would argue that using up idle resources in such a manner will not allow the structure of production to adjust to the new economic reality. The state, Hayek would argue is a poor allocator of capital because it lacks the informational efficiency of the market. I would mostly agree with Hayek’s objection, and note that I favour a predominantly market-based economy. Government interventions should be kept to a necessary minimum. Yet, in a depressionary environment, the structure of production deteriorates as resources lie idle. Unemployed workers lose skills, lose competitive edge and spend and invest less, further depressing the economy. Capital — factories, buildings, amenities, ideas, etc — deteriorates. Young workers may enter the labour force but never find a job. Crime rises, and shady fringe businesses like loan sharks thrive as the unemployed struggle to pay the bills. The social costs of mass unemployment are exceedingly high. The adjustment occurring in a depression is more like a rot. And it is absurd to rot your way to growth. Instead, by lowering unemployment and using up idle capital (preferably in a mix of state-run infrastructure and technology projects, and lending to new businesses) more businesses can be born into existence. Potentially successful new ideas can be tried out, and may find success in the marketplace. The formerly unemployed get to develop skills, habits and ideas, instead of sitting at home all day doing nothing, or hunting for jobs in a scarce and depressed marketplace. And money will go into people’s pockets, spurring investment and consumption, fomenting more new business growth. This, in my view, is the best shot at getting a depressed and rotten structure of production out of the doldrums and back toward strong organic growth. Sooner or later, of course, the private sector will come back and begin to use up resources. But that could be a very, very, very long way away. If we want the structure of production to adjust to the new world and to continue adjusting as the world continues to change, letting huge quantities of resources sitting idle seems like a bad way to do it. Targeted fiscal policy can change that.

On the Possibility of Hyperdeflation


Even given the failure of hyperinflation to pass since a variety of pop-Austrian TV finance pundits predicted it since 2008 in the wake of the various quantitative easing programs, the world at large continues to talk of the possibility of hyperinflation in the future. The value and purchasing power of money is a significant topic for the entirety of society — savers, debtors, large and small businesses, workers, welfare recipients, pensioners, etc — so it is no surprise that people fixate upon historical events in which the purchasing power of money has gone to zero. Yet this previously-known and widely talked about phenomenon may not occur in the future for most countries. Instead, a previously unknown phenomenon that I now tentatively coin hyperdeflation may be far more common.

Hyperinflation is an interesting phenomenon. As I have noted in the past, it seems to be predominantly associated with collapses in agriculture, infrastructure and transport, the loss of a war or natural disasters. Faced with dire economic breakdown and spiralling prices and wages (as plentiful paper money chases after increasingly scarce and limited goods) monetary policymakers are forced to print in an attempt to keep a broken economy going. In a functional economy like present day Japan, Britain or America with no mass breakdown of institutions, transport or infrastructure (and thus with with freely available food, energy and resources) printing (or digitally multiplying) money does not lead to huge, soaring inflation. But in an economy already disrupted — like the many countries on this list that experienced hyperinflation — the inflationary impact of new base money just continues to spiral, and all the extra paper dumped into the system is simply abandoned and rejected by the public as its purchasing power gravitates toward zero.

And in the modern world, some countries and places may have become more susceptible to the kinds of economic breakdowns that could lead to hyperinflation given a bad-enough shock. In an increasingly interconnective and trade-dependent world, natural disasters or wars can shut off the supply of important products or components that countries or regions do not and cannot manufacture. That makes this a particularly fragile phase of history, even if it does not seem so given the huge and widespread affluence not just in the West, but also increasingly in the developing world.

Yet beyond this phase of history, stretching out into the long run, the opposite may become true. Society is shaped by its technological capacities — this has been true since the days of the spear, the wheel, the bow, etc — and our technological evolution continues at ever rapider rates. The internet has already provided a channel for mass cultural interconnectivity, and the effective decentralisation of media. I have written at length on the possibility of superabundant decentralised energy from falling solar and alternative energy costs, combined with the possibility of mass decentralised molecular manufacturing. Simply, if every house has an advanced 3-D printer that can transform soil and waste into food, consumer electronics, or tools (etc), and a superabundant energy source from high-efficiency solar panels (or artificial fossil fuels, or even micro-nuclear reactors) then the era of material scarcity is effectively over, and humanity can concentrate its energies on other matters (cultural, religious, philosophical, space colonisation, etc). Now, we are still a while away from a single house having such capacities, but the implications of the beginning of that era will be profound.

My supposition is that the era of superabundance will be characterised by very strong deflation as the supply of goods and energy becomes increasingly superabundant. This trend has already begun in the West, where inflation and interest rates have — in the context of cheap Eastern labour, computerisation and automation — been falling for the last 20 years. Even strong quantitative easing by central banks has not reignited strong inflation. My guess is that unless we experience some huge shock that dramatically shakes the foundations of society — like a megatsunami, or a nuclear war, or a mass pandemic that wipes out half the population — it will be hard for strong inflation to ever return no matter how much money central banks print. Central bankers may be able to keep inflation close to zero with strong activist monetary policy, but even that may be challenging especially as the age of superabundance draws onward.

Of course, in a world of material superabundance, trade and business will not end. While everyone may have a molecular factory in their house that can build anything from a huge library of open-sourced 3-D designs downloadable from the internet, people will still have to design things and create things. Although at some stage the machines may become sentient and creative, this appears to be at least a very, very long way away. So all the 3-D printers, robots and unlimited energy in the world won’t for the foreseeable future invent things, or write a Hamlet or a Breaking Bad, or a Dark Side of the Moon or an Emperor Concerto, leaving humans an important niche as designers, empathisers and imagineers. While with superabundant energy and goods, people will have all the resources necessary to devote themselves to such pursuits, people as they have done throughout history will still choose to co-ordinate and collaborate, so they will still need some currency. Whether this will take the form of state fiat money, or private currencies like Bitcoins, Facebook and Youtube likes, or Whuffies, or a mixture of the above remains to be seen.

Another possibility, of course, is that there will still be scarcities even in the era of superabundance. While every house may be able to manufacture an unlimited quantity of food, household goods and gadgets, some highly-desired technologies and goods like interstellar spacecraft or particle accelerators or exotic matter may remain far beyond the reach of a typical household or community either on technological grounds or on the grounds that they are contraband (it is quite easy to imagine that manufacturing of certain goods — weaponry in particular — may be made illegal by states, who may create increasingly sophisticated and Orwellian surveillance structures to prevent the distribution of illegal materials). These post-superabundance scarcities may form the basis of new widespread media of exchange and units of account, especially if state fiat money hyperdeflates its way to irrelevance.

(And yes — in an age of superabundant energy, gold will in all likelihood lose its scarcity, as with enough energy it is possible to transmute lead into gold in a particle accelerator. This means it is quite possible that gold’s all-time high of $1917 in September 2011 may be the highest dollar-denominated price gold ever trades at).