Thursday, February 16, 2006
The Savings Tradeoff
Bernanke's testimony to Congress today was significantly more upbeat and enlightening than yesterdays. He spoke at length on numerous relevant issues such as the deficits and savings.
Bernanke had this to say about our savings, or rather lack of:
The reason that we have a current account deficit is that we invest more, including housing, than we save, and we have to make up the difference by borrowing abroad. So our national saving is not sufficient to fund our domestic investment opportunities. It's a good thing in a sense that we are able to go to the capital markets and find funding for good domestic investment opportunities, but we'd be better off in some sense if we ourselves could fund those investment opportunities creating more wealth for Americans and greater capacity in the future for us to deal with the long-term challenges associated with demographic changes and the like.
I disagree that funding our own business opportunities would create more wealth. If this were true, then that's what we would be doing. The way our system works we maximize profit by default. If there were a more profitable way of doing things, we'd be doing that instead. It also isn't mathematically sound.
Brother A has a widget making business and takes in $100k a year exporting widgets. He needs $100k to double the size of his operations. Brother B has $100k in savings.
Brother A can borrow the money from Brother B at 10% annual interest and pay it back over a period of ten years. Brother A expands and doubles his revenues to $200k less $16k in loan payments to Brother B.
The aggregate income for both brothers is the $200k in revenue Brother A brings in.
Alternatively, Brother B goes into the widget business with his brother, putting in his $100k in savings, and Brother A borrows $100k from an outside investor. Together they triple operations and revenue less the same $16k in loan payments. The aggregate income is $284k.
Obviously, the brothers are significantly better off in the second scenario.
Now think about the two brothers as representing a country borrowing from another country instead of from itself.
The reason that the U.S. invests more and saves less than other countries is because we have more investment opportunities. Why save at 4% when we can make 10% in the financial markets, or a 25% profit margin in a business?
We contradict ourselves saying we should save more. If we did, we'd complain that consumers weren't spending and investing enough. We want more people to own homes. But when more people do buy homes, they hand their savings over to the banks and take on more debt, and then we complain that people have too much debt and aren't saving enough. We can't have it both ways.
It reminds me of back when I was working my way through college in a UPS package sorting hub. Management pushes the workers to move more packages per hour, but the more packages per hour the workers moved the more packages were damaged or misrouted. You can train the workers to improve their efficiency, but moving a hundred thousand packages a night through just the one hub, it doesn't take long to reach the maximum point of human capability or human willingness to improve.
We can't have more savings, more consumption, more investment, and more income. There are unavoidable tradeoffs. More investment means lower savings, but more income and consumption. More savings means less of everything else.
posted at 4:27 PM
