Correction or Crisis?


After almost seven years of relative calm and stability, a stock market crash is finally upon us.

This is a very predictable crash stemming from a very widely known cause. Hundreds of analysts including myself — following the trail illuminated by Michael Pettis — have for a long time been banging on about a Chinese slowdown gathering an uncontrollable momentum, sending China into a panic, and infecting global markets.

What’s less clear yet is whether this is a correction or a crisis. My view is toward the latter, simply because confidence is fragile.  Once the animal spirits of the market turn negative, it takes a heck of a lot to soothe them. And the markets look increasingly spooked. The fear is rising. Last week I tweeted that I felt the risks of a new financial crisis are greater than ever.

The reasons why are simple: Western central banks have gone a bit nuts, and are trying to hike rates even though inflation is close to zero even after interest rates being at zero for seven years. And Western governments have gone a bit nuts (especially in the eurozone and Britain but also to a lesser extent in the United States) and are trying to encourage growth with austerity even though all the evidence illustrates that austerity is only a helpful policy in a booming economy, not in a slack one.

Those two factors weren’t too destructive in an economic situation where there was moderate economic growth. More like a minor brake on growth. Keep swimming forward, and sooner or later inflation will rear its head, and rates will have to be raised. But with a stock market crash and a growth downturn, and an unemployment spike, and deflation, things get very problematic very fast.

Let me explain how I think this plays out: interest rates are at zero. Inflation is almost at zero, and a stock market crash will only push that lower. Simply, this is the bottom falling out of the bottom. A crash here is like falling off the bicycle in spite of the Fed’s training wheels. Unconventional monetary policy has already been exhaustively tried, and central bank balance sheets are already heavily loaded with assets purchased in quantitative easing programs. Now the Fed’s balance sheet does not excessively concern me — central banks can print all the money they like to buy assets up to the point of excessive inflation. But will that be enough to reverse a new crash?

Personally, my doubts are growing. At the zero bound, I believe Keynes was right, and fiscal policy is the best answer. The post-2008 economic landscape has been defined by monetarists trying desperately to perfect new tools like quantitative easing to avoid outright debt-financed fiscal policy. But there have been problems upon problems with the transmission mechanisms. Central banks have succeeded at getting new money into the banking system. But the drip of that money into the real economy where it can do its good work and create growth, employment and prosperity has been slow and uneven. The recovery is real, but weak, even after all the trillions of QE. And it has left us vulnerable to a new downturn.

If the effects of the crash cannot be reversed with monetary policy, that leaves fiscal policy — that old, neglected, unpopular tool — to fight any breakouts of deflation or mass unemployment.

Or it leaves central banks to try really radical policies that emulate the directness of fiscal policy, like literally throwing money out of helicopters or OMFG.

Deflation is Here — And The Government is Poised to Make it Worse

Consumer prices may not be deflating as quickly as Labour’s electoral chances did earlier this month, but — even after £300 billion of quantitative easing — price deflation for the first time in more than half a century is finally here. The Bank of England continues to throw everything at keeping prices rising at close to their 2 percent target. Yet it’s not working. And this is not just about cheaper oil. Core inflation has also been dropping like a rock.

I argued that “deflation was looming” for Britain last year, and feel a little vindicated that it has come to pass. But I don’t feel at all gratified about the thing itself.

In a highly indebted economy such as Britain’s — where private debt dwarfs government debt — deflation is a dangerous thing. Past debts — and the interest rates paid on those debts — are nominally rigid. Unless specifically stipulated as being inflation-adjusted (like TIPS) they don’t scale to price changes in the broader economy.

Under positive rates of inflation, inflation assists in keeping debt under control, by shrinking the present amount of goods and services and labour that equate to a nominal amount of currency. Under deflation, the opposite process occurs, and the nominal value of currency — as well as that of historical debt — rises, making the debt harder to service and pay down, especially with the ongoing accumulation of interest.

On the face of it, that is good news for net savers and bad news for net debtors. But raising the difficulty of deleveraging and debt service can often be bad for both, because debtors who cannot pay default, bankrupting themselves and injuring their creditors. It can also depress the economy, as individuals and firms are forced to stop spending and investing and start devoting more and more of their income to the rising real cost of deleveraging.

With growth last quarter dropping to 0.3 percent from 0.6 percent, this process might very well already be under way. This raises the prospect of the nightmarish debt-deflationary spiral above.

The last thing that the economy needs under that circumstance is more money being sucked out of it through slashing public spending. Sucking money out of the economy will make deleveraging even more difficult for debtors, and slow growth further as individuals and firms adjust their spending plans to lower levels of national and individual income. Yet that is the manifesto that the country elected to power in the election earlier this month. And although Osborne and Cameron can get out of it — via offsetting cuts in spending with tax cuts — if they go through with their election promises, the prospect of recession, continued deflation and rising levels of unemployment loom clearly.

What the economy really needed in 2010 was a deep and long commitment to public stimulus to provide the economic growth needed to let the private sector deleverage. Unlike the public sector, which is a sovereign creditor borrowing in its own currency — the private sector is far from a secure debtor. Private borrowers can — unlike the central government — “become the next Greece” and run out of money.

With interest rates in the last parliament having sunk down to new historic lows, such a thing was affordable and achievable. Instead, by trying to do public deleveraging at the same time as the private sector was deleveraging Osborne, Cameron and Clegg chose a much rockier path, one in which private deleveraging and public deleveraging are slow and grinding. With private debt levels still very high, the country remains vulnerable to another deleveraging-driven recession.

How To Euthanize Rentiers (Wonkish)

In my last post, I established that the “rentier’s share” of interest — resulting from as Keynes put it the “power of the capitalist to exploit the scarcity-value of capital” — can be calculated as the real-interest rate on lending to the monetary sovereign, typically known as the real risk free interest rate. That is because it is the rate that is left over after deducting for credit risk and inflation risk.

However, I have been convinced that my conclusion — that euthanizing rentiers should be an objective of monetary policy — is either wrong or impractical.

It would at very least require a dramatic shift in monetary policy orthodoxy. My initial thought was thus: the real risk-free interest rate (r) can be expressed as the nominal risk free interest rate minus the rate of inflation (r=n-i). To eliminate the rentier’s share, simply substitute 0 for r so that 0=n-i and n=i. In other words, have the central bank target a rate of inflation that offsets the expected future nominal risk free interest rate, resulting in a future real risk free interest rate as close to zero as possible.

There are some major problems with this. Presently, most major central banks target inflation. But they target a fixed rate of inflation of around 2 percent. The Fed explains its rationale:

Over time, a higher inflation rate would reduce the public’s ability to make accurate longer-term economic and financial decisions. On the other hand, a lower inflation rate would be associated with an elevated probability of falling into deflation, which means prices and perhaps wages, on average, are falling — a phenomenon associated with very weak economic conditions. Having at least a small level of inflation makes it less likely that the economy will experience harmful deflation if economic conditions weaken. The FOMC implements monetary policy to help maintain an inflation rate of 2 percent over the medium term.

Now, it is possible to argue that inflation targets should vary with macroeconomic conditions. For example, if you’re having a problem with deflation and getting stuck in a liquidity trap, a higher inflation target might be appropriate, as Jared Bernstein and Larry Ball argue. And on the other side of the coin, if you’re having a problem with excessive inflation — as occurred in the 1970s — it is arguable a lower inflation target than 2 percent may be appropriate.

But shifting to a variable rate targeting regime would be a very major policy shift, likely to be heavily resisted simply because the evidence shows that a fixed rate target results in more predictability, and therefore enhances “the public’s ability to make accurate longer-term economic and financial decisions”.

A second sticking point is the argument that such a regime would be trying to target a real-variable (the real risk free interest rate), which central banks have at best a very limited ability to do.

A third sticking point is Goodhart’s Law: “when a measure becomes a target, it ceases to be a good measure.” By making the future spread between the nominal risk free interest rate and inflation a target, the spread would lose any meaning as a measure.

A fourth sticking point is the possibility that such a severe regime change might create a regime susceptible to severe accelerative macroeconomic problems like inflationary and deflationary spirals.

And in this age of soaring inequality, the euthanasia of the rentier is simply too important an issue to hinge on being able to formulate a new workable policy regime and convince the central banking establishment to adopt it. Even if variable-rate inflation targeting or some alternative was actually viable, I don’t have the time, or the energy, or the inclination, or the expertise to try to do what Scott Sumner has spent over half a decade trying to do — change the way central banks work.

Plus, there is a much better option: make the euthanasia of the rentier a matter for fiscal policy and specifically taxation and redistribution. So here’s a different proposal: a new capital gains tax at a variable rate equal to the real risk-free interest rate, with the proceeds going toward business grants for poor people to start new businesses.

The Subtle Tyranny of Interest Rates

Interest rates are the price of credit. They are the price of access to capital.

Now, it is obvious that pricing credit is not tyrannical in and of itself. Interest compensates a lender for default risk and the risk of inflation eroding the purchasing power of the money that they lend.

The tyranny I am getting at is subtle. It is the tyranny that Keynes pointed to when he proposed a euthanasia of the rentier. Keynes proposed that low interest rates would:

mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital.

Keynes pointed to an important feature of interest rates: the fact that capital has a cost is not just the result of default risk and the risk of inflation. It is also a result of the scarcity of capital.

Now, that is inevitable in a world where financial capital consists of metal that you dig up out of the ground.

But in our brave new state-backed fiat monetary system, why should capital be so scarce that those who have it can profit from its scarcity?

Obviously, central banks should not print money to the extent that it becomes worthless. But capital availability is absolutely critical to the advancement of society: the investment of capital is how societies become productive. It is how technology improves, and it is the key to wealth accumulation.

What Keynes didn’t specify was what exactly in the interest rate paid was the part that represented the “scarcity value” of capital.

Obviously, it doesn’t include the part that compensates for inflation, which is why we need to look at inflation-adjusted interest rates. And it isn’t the part that compensates for default risk. This is easily calculable too: it is the excess paid over lending to the monetary sovereign.

In the U.S. and Britain, that would be the American and British governments. In the eurozone — for complicated political reasons — there is no monetary sovereign exactly, but we might measure it by looking at it in terms of the spread against German government borrowing, because Germany seems to be the nation calling the lion’s share of the shots.

Here’s the real interest rate on U.S. 10-year government borrowing (I chose the 10-year because it is a benchmark, although I would have preferred to use a harmonized rate from across the yield curve.):


So what are we really seeing? The general trend is that real interest rates on U.S. government borrowing are overwhelmingly positive, with a few periodical exceptions where real rates on borrowing went a bit negative. This bias toward positive real interest rates on lending to the monetary sovereign, I would argue, is the rentier’s profit resulting from the scarcity of financial capital.

Year over year, that is going to compound heavily. It is these rentiers, I would argue, who should be euthanized. Not because they should be resented for doing well out of the system.  No. They should be euthanized because of the opportunity cost of devoting resources to enriching rentiers, resources that could be deployed productively elsewhere.

And how to euthanize the rentiers? Because we have identified what the rentier’s share is, the answer is very simple: making a real interest rate of zero on lending to the monetary sovereign an objective of monetary policy.

Update: After much debate, I have decided that euthanizing rentiers is not a matter for monetary policy, but a matter for fiscal policy. I have written another post discussing this.

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.


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?


Paying For Our Past Sins

Michael Kinsley’s argument for immediate austerity is about “paying for our past sins”:

Krugman also is on to something when he talks about paying a price for past sins. I don’t think suffering is good, but I do believe that we have to pay a price for past sins, and the longer we put it off, the higher the price will be. And future sufferers are not necessarily different people than the past and present sinners. That’s too easy. Sure let’s raise taxes on the rich. But that’s not going to solve the problem. The problem is the great, deluded middle class—subsidized by government and coddled by politicians. In other words, they are you and me. If you make less than $250,000 a year, Obama has assured us, you are officially entitled to feel put-upon and resentful. And to be immune from further imposition.

Austerians don’t get off on other people’s suffering. They, for the most part, honestly believe that theirs is the quickest way through the suffering. They may be right or they may be wrong. When Krugman says he’s only worried about “premature” fiscal discipline, it becomes largely a question of emphasis anyway. But the austerians deserve credit: They at least are talking about the spinach, while the Krugmanites are only talking about dessert.

To Kinsley, austerity is the necessary spinach. I don’t really understand this. In the United States a crisis in shadow finance spread into the banking industry leading to a default cascade throughout the financial system, which resulted in a wider crisis throughout the economy, and ever since 2008 even after the banking sector was propped-up, unemployment throughout the wider economy has been rife, economic output has fallen far below its long-term trend line, and bank deposits are soaring as the weak economy has damaged confidence and convinced possessors of money to save and not spend or invest.

So many activities in the boom — from home speculation, to NINJA loans, to subprime securitisation, and ultimately the 40-year cycle of total credit growth that led to the Minsky Moment in 2008 — proved unsustainable. But a huge cost has already been paid for those unsustainable activities in the form of the initial crash, and depressed growth, and unemployment, etc. The structure of production has been irrevocably changed by the bust. But are the people suffering the unemployment, the depressed real wage growth, etc, the people who created the total debt growth? No, of course not. Any connection is arbitrary — the people creating the credit default swaps and structured securitised products (ABS, MBS, etc) and NINJA loans that triggered the banking crises in many cases have kept their jobs and been promoted. Certainly, some bankers like Dick Fuld who were involved in creating the crisis lost their jobs, but while people who had nothing whatever to do with the banking crisis have lost their jobs or worse have never even got a job.

So who does Kinsley want to consume the spinach? The people who take the hit to their purchasing power in an austerity program aren’t the ones who caused the financial crisis. Perhaps financial regulators and central bankers were to some degree responsible, but the overwhelming majority of people dependent on government income had nothing whatever to do with financial regulation. Though certainly one side-effect of the crisis has been falling tax revenues, which has meant bigger deficits. But structural deficits are actually relatively low, and nominal deficits are rapidly falling. And the actual interest rate cost of servicing the deficits are at record lows and with current soaring savings levels, unlikely to start rising anytime soon. So any appearance of a deficit problem is a side-effect of a depressed economy. Ultimately, austerity will reduce the government’s use of resources — capital, and labour. And what is the problem with the economy at the moment? Slack resources in capital and labour to such an extent that interest rates are at record lows and unemployment is very high. Kinsley’s “spinach” has nothing whatever to do with the problem. In the long run, once the economy is at full-employment and businesses are booming, and interest rates have risen some austerity will be helpful, not least to take the edge off the boom. But why now? Immediate austerity is iatrogenic medicine — misidentifying the problem, and prescribing a cure that harms the patient.

In my view a bust after an economic boom may be to some degree be unavoidable as an artefact of human psychology. Ultimately, we should remember that a credit-driven boom isn’t a sign of overproduction of goods and services, or a society living beyond its means. After all, the demand for goods and services really existed, and the capacity for the production and use of goods and services really existed. Humans are excitable animals, prone to strange twinges  of spirit both in mania and depression. The business cycle delivers the dessert and the spinach in recurrent cycles. Actions have consequences, and the actions leading into the slump have had huge consequences. But what about our present sins? Having the government force more spinach onto a society already suffering from massive unemployment of people, resources and capital is a strange and cruel prescription. We have already had our spinach in the crash of 2008 and the following slump. Huge numbers of people are unemployed, or have dropped out of the labour force, or have not had the chance to enter the labour force. That is the spinach. If the economy was a man, spinach would be coming out of his ears. Michael Kinsley and his intellectual cousins want to offset spinach with more spinach. Yet the economy has much the same or higher pre-slump capacity for ice cream, and pizza and milkshakes and marshmallows. In the long run, society will rediscover its taste for economic growth, for income growth, and all the slack resources will be used up to produce things that people actually want and need. Yet that does not help the unemployed who have eaten plateful after plateful of spinach as a consequence of actions for which they were mostly not responsible. What could help the unemployed? Job creation and putting slack resources to use.

Of Joseph & Keynes

Although Keynes’ conceptual framework for macroeconomics was original, the economic ideas broadly known as Keynesianism — the possibility of unclearing markets, and countercyclical spending — are much older than John Maynard Keynes, and their continued predominating association with him is rather puzzling to me. Indeed, looking at Keynes’ ideas through the lens of his predecessors is illuminating.

According to Genesis in the Old Testament, in ancient Egypt, Joseph son of Jacob warned the Pharaoh that his dreams foretold seven years of abundant harvest to be followed by seven years of poor harvests. Farming in the Nile delta depended on good rainfall in the highlands of central Africa to flood the delta area with water and fertile topsoil. Without good rainfall, Egypt was susceptible to famine.

Joseph told the Pharaoh to store a surplus of grain during the first seven years so that the country would have grain during the drought. During the time of plenty, Joseph ordered the storage of 20 percent of farmers’ output in the Pharaoh’s granaries.

This was a countercyclical fiscal policy millennia before Keynes. If we are to be historically correct, Keynesianism might be better known as Josephianism. And although Joseph’s coat-of-many-colours might arouse the suspicions of certain homophobic critics of Keynes, it is noted that Joseph’s wife bore him two sons.


Keynes’ notion of disequilibrium was a reaction against an idea that only grew wings roughly 130 before Keynes with the industrial revolution — Say’s Law, the notion that “products are paid for with products”, that “a glut can take place only when there are too many means of production applied to one kind of product and not enough to another” and that subsequently “a rational businessman will never hoard money; he will promptly spend any money he gets “for the value of money is also perishable.”

Say’s Law is empirically false. Under certain conditions — including the present condition —  savings levels can soar uncontrollably even while interest rates languish at zero, and while unemployment is elevated. In fact, Say himself foresaw the possibility of massive involuntary unemployment and like Keynes and Bastiat, advocated public works programs to decrease unemployment. Indeed perhaps Say’s Law — at least in its post-Keynes incarnation — is more reflective of the ideas of Nassau Senior or David Ricardo than Jean-Baptiste Say.

Although the human sphere has always been driven to disequilibrium by the divergency of human plans and imaginations, prior to the industrial revolution — like in the time of Joseph and the Pharaoh — the possibility of involuntary unemployment (and starvation, etc) arising out of flood, robbery, famine, plague, drought, barbarian raids or some other externality was everywhere. The difference between the modern breakdowns in the Great Depression and the Post-2008 Depression and pre-industrial breakdowns of production is that the cause of the former is psychological (investors become grossly fearful of markets, etc, allowing resources to sit idle rather than being reallocated to productive uses) while the cause of the latter is actual material scarcity. But in the worst case the result is the same — needs and wants go unsatisfied and skills and trades stagnate. The outcomes of pre-industrial scarcity can seep into the post-industrial world through the channel of human psychology.

Keynes’ and Joseph’s recommendations on saving in the fat years to spend in the lean ones are ultimately apolitical in nature and apply just as much to the private sector as to the public sector. There is a widely-held conception that spending in the slump and saving in the boom is statist and favours central economic planning. This is not necessarily true. If a stateless society — let’s say, a future moon colony led by radical libertarians — becomes depressed, unemployment rises and resources lie idle, one solution to lift economic activity would be voluntary private infrastructure and capital spending. While Keynes himself rather unfortunately noted that “the theory of aggregated production… can be much easier adapted to the conditions of a totalitarian state”, infrastructure spending of private origin would be just as helpful in a depression in a stateless economy.

Yet Keynes sometimes pushed his arguments too far. Keynes suggested that “digging ditches is preferable to doing nothing” and proclaimed that the dawn of the Second World War meant that “the end of abnormal unemployment is in sight”. But wasting idle resources on unwanted projects like ditches or giant space lasers to repel a nonexistent alien invasion, or actively harmful projects like wars even though it may raise aggregate demand is still wasting resources. If the point of countercyclical policy is to avoid excessive levels of stagnation, it seems self-defeating to take idle resources and spend them on something entirely unwanted and unwarranted. Spending labour and capital on a destructive life-ending and infrastructure-destroying war rather than on useful infrastructural and scientific projects is akin to Pharaoh spending grain in a famine to support a war where just as many Egyptians die fighting as would have died in the averted famine.

So for successful countercyclical policy, I think it is important to emphasise quality projects that people actually want rather than simply emphasising aggregate levels of spending. In  Pharaoh’s Egypt, that was a store of grain…

The Long Run


Niall Ferguson’s misunderstanding of Keynes led me to the question of how humans should balance the present against the long run?

It’s hard for us primates to have a real clue about the long run — the chain of events that may occur, the kind of world that will form. In the long run — the billions of years for which Earth has existed — modern human civilisation is a flash, a momentary pulsation of order imposed by primates on the face of the Earth — modern cities, roads, ports, oil wells, telecommunications and so forth built up over a little more than a century, a little more than two or three frail human lifespans.

Human projections of the direction of the future are notoriously unreliable. Professional futurists who devote careers to mapping the trajectory of human and earthly progress are often far wide of the mark. And in the realm of markets and economics, human projectional abilities are notoriously awful — only 0.4% of money managers beat the market over ten years.

As humans, our only window to the future is our imaginations. We cannot know the future, but we can imagine it as Ludwig Lachmann once noted. And in a world where everyone is working from unique internal models and expectations — for a very general example, Keynesians expecting zero rates and deflation, Austrians expecting rising rates and inflation — divergent human imaginations and expectations is an ingredient for chaos that renders assumptions of equilibrium hopelessly idealistic.

A tiny minority of fundamental investors can beat the market — Keynes himself trounced the market between 1926 and 1946, for example by following principles of value investing (like Benjamin Graham later advocated). But like in poker, while virtually everyone at the table believes they can beat the game in the long run — through, perhaps, virtues of good judgement, or good luck, or some combination of the two — the historical record shows that the vast majority of predictors are chumps. And for what it’s worth, markets are a harder game to win than games like poker. In poker, precise probabilities can be assigned to outcomes — there are no unknown unknowns in a deck of playing cards. In the market — and other fields of complex, messy human action — we cannot assign precise probabilities to anything. We are left with pure Bayesianism, with probabilities merely reflecting subjective human judgments about the future. And in valuing assets, as Keynes noted we are not even searching for the prettiest face, but for a prediction of what the market will deem to be the prettiest face.

This means that long run fears whether held by an individual or a minority or a majority are but ethereal whispers on the wind, far-fetched possibilities. It means that present crises like mass unemployment have a crushing weight of importance that potential imagined future crises do not have, and can never have until they are upon us. As the fighters of potential future demons — or in the European case, self-imposed present demons — suffer from high unemployment and weak growth in the present (which in turn create other problems — deterioration of skills, mass social and political disillusionment, etc) this becomes more and more dazzlingly apparent.

But in the long run, the historical record shows that crises certainly happen, even if they are not the ones that we might initially imagine (although they are very often something that someone imagined, however obscure). Human history is pockmarked by material crises — unemployment, displacement, failed crops, drought, marauders and vagabonds, volcanism, feudalism, slavery, invasion, a thousand terrors that might snuff out life, snuff out our unbroken genetic line back into the depths antiquity, prehistory and the saga of human and prehuman evolution. While we cannot predict the future, we can prepare and robustify during the boom so that we might have sufficient resources to deal with a crisis in the slump. Traditionally, this meant storing crops in granaries during good harvests to offset the potential damage by future famines and saving money in times of economic plenty to disburse when the economy turned downward.  In the modern context of globalisation and long, snaking supply chains it might also mean bolstering energy independence by developing wind and solar and nuclear energy resources as a decentralised replacement to fossil fuels. It might mean the decentralisation of production through widespread molecular manufacturing and disassembly technologies. In the most literal and brutal sense — that of human extinction — it might mean colonising space to spread and diversify the human genome throughout the cosmos.

Ultimately, we prepare for an uncertain future by acting in the present. The long run begins now, and now is all we have.

A Visual Representation of the Zero Bound

I’ve been trying to understand the relationship between savings and interest rates in the economy. There are many theoretical models and constructs that purport to represent the relationship between savings and interest rates, but it is interesting to look at it from an empirical standpoint. This graph shows savings at depository institutions as a percentage of GDP against the Federal Funds Rate:


The actual cause of the desire to save rather than consume or invest is uncertain. Perhaps this is a demographic trend — with more people closing in on the retirement age, they seek to save more of their income for retirement. Perhaps it is a psychological trend — fear of investment in stock markets and bond markets, due to fear of corruption, or market crashes or a general distrust of corporations. Perhaps it is a shortage of “safe” assets — by engaging in quantitative easing, central banks are removing assets from markets and replacing them with base money, and deleveraging corporations are paying down rather than issuing new debt. Perhaps it is anticipation of deflation — people expecting that saved money will increase its purchasing power in future. Perhaps it is a combination of all these things and more. But whatever it is, we know that there is an extraordinary savings glut.

There have been a lot of assertions that interest rates at present are unnaturally or artificially low. Well, what can we expect in the context of such a glut of savings? Higher interest rates? Based on what?

There was a clear negative association between savings and interest rates up until interest rates fell to zero, while the savings rate continued to soar. Theoretically, lower interest rates ceteris paribus should inhibit the desire to save, by lowering the reward for doing so. But interest rates cannot fall below zero at least not within our current monetary system — there exist some theoretical proposals to break the zero bound using negative nominal interest rates, but these remain untested and controversial. Even tripling the monetary base — an act that Bernanke at least believes simulates an interest rate cut at the zero bound — has not discouraged the saving of greater and greater levels of the national income.

In the long run, the desire to save increasingly massive percentages of the national income will cool down. Sooner or later some externality will jolt the idle resources in the economy into action. But that is the long run. In the short run saving keeps soaring. Investors are not finding better investment opportunities for their savings and the structure of production does not appear to be adjusting very fast to open up new opportunities for all of that idle cash.