by L. Randall Wray
A Bloomberg report
by Rich Miller and Alison Sider recently noted that “Americans are shutting their wallets and building their nest eggs at the fastest pace in 15 years.” It went on: [T]he household savings rate rose to 6.9 percent in May, the highest since December 1993, as personal spending increased less than incomes. The rate in April 2008 was zero. Most of the rise in income in May was due to one-time government stimulus payments to seniors, said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts.
These should not be surprising events, as we have explained in previous posts (
here,
here and
here). Government sector spending creates private sector income; government sector deficits create private sector savings. These are identities that virtually no one recognizes. I can recall that during the Clinton administration’s budget surpluses, the Wall Street Journal ran two front-page stories side-by-side, one congratulating the government for finally getting its budget in order—supposedly adding to national savings–and the other chastising consumers for spending more than their incomes—reducing national savings. The rising Obama budget deficit will help our private sector to accumulate savings and retire debt, part of the necessary remedy to the run-up of debt that occurred over the past dozen years. Unfortunately, fiscal policy remains too tight, as evidenced by continued (and, I think, growing) stress in the retail sector.
The report goes on: “the trend will put the country’s finances in better balance and reduce its dependence on Chinese investment”. Now this is utterly confused. Yes, our household sector’s finances will improve and might eventually recover—if the fiscal stance loosens and job losses are turned around to employment growth. However, the US did not, indeed in a significant sense cannot, rely on the Chinese. Our spending is in dollars, and we are the source of those dollars. Needless to say, every dollar spent by the Chinese was generated by us. In fact, we “financed” their accumulation of dollars, mostly through our current account deficit (we bought more stuff from them than they bought from us). This allowed them to “net save” in dollar assets. As our trade deficit with China shrinks (by the way, not necessarily a good thing for us!), China’s net saving in dollars will also shrink. It is quite unlikely that the trade balance will reverse any time soon (China is not going to become a net importer in the near future), so China will continue to accumulate dollar assets although (probably) at a reduced pace. But that does not “finance” US domestic spending.
"Government sector deficits create private sector savings."I can't agree with this statement. The government may decide to increase expenditures in excess of taxes, and try to fund the difference by sellling bonds. It is up to the private sector to decide whether it wants to buy these assets or not. If it decides not to, then the government must reduce the deficit. As such, the deficit does not "create" savings.Likewise, it is possible for the private sector to save while the government runs a fiscal balance. The counterpart is, of course a current account surplus.Although I haven't been reading this blog for very long, I wish it would say something definitive about the US fiscal stance. I am looking for something like "the deficit is way too big, and the US could be on the verge of a fiscal crisis". Alice
Dear Alice,See "will the run-up in government debt doom us all?" by Stephanie Kelton a few weeks ago.You are correct that the only way for the private sector to net save given a government surplus is a large enough current account surplus, but as Wray points out, not likely to happen.Your analysis of bond sales is incorrect for a flexible exchange rate monetary regime such as ours, and would apply only under a gold standard or currency board. Under the former, deficits come first, before taxation or bond sales, by definition. Tax liabilities and government bond auctions are settled only via reserve balances in the US . . . and reserves are created when the Fed buys a US govt bond that resulted from a previous deficit.Best,Scott
Scott,You need to take a close look at the UK crisis of 1977. At the time, the UK was still a reserve currency, although the role was much diminished. The UK still had significant "sterling balances" held by other central banks.Second, all UK debt was sterling denominated. We could issue as much as we wanted so long as we were prepared to accept the market interest rate.Third, we had a large fiscal deficit.Fourth, we also had a current account deficit, but North Sea oil was just starting to flow. Within a year or so, everyone knew we would have a large external surplus (which happened by 1979-80)Yet, we had a fiscal crisis. Investors stopped buying our debt, there was capital flight and we ended up in the arms of the IMF.The US is on an unsustainable trajectory. Don't ever think that bad things can't happen.Alice
Scott,You need to take a close look at the UK crisis of 1977. At the time, the UK was still a reserve currency, although the role was much diminished. The UK still had significant "sterling balances" held by other central banks.Second, all UK debt was sterling denominated. We could issue as much as we wanted so long as we were prepared to accept the market interest rate.Third, we had a large fiscal deficit.Fourth, we also had a current account deficit, but North Sea oil was just starting to flow. Within a year or so, everyone knew we would have a large external surplus (which happened by 1979-80)Yet, we had a fiscal crisis. Investors stopped buying our debt, there was capital flight and we ended up in the arms of the IMF.The US is on an unsustainable trajectory. Don't ever think that bad things can't happen.Alice
Dear AliceYou've again missed the point. The point is that a sovereign currency issuing government DOES NOT need to issue bonds to finance its spending. The bond sales are to drain reserves so that the central bank can achieve its target rate. Right now in the UK Charles Goodhart is not coincidentally advocating that the UK Treasury cease issuing bonds. That a government acts as if it must finance itself simply means it doesn't understand how the monetary system works. Yes, bad things can happen (and are happening) as a result.Further, in looking at the UK Treasury bond data on the BOE's website, I can't see that bond rates were out of line with current and expected BOE target rates during this period. Indeed, if the UK Treasury really did have a fiscal crisis in that markets weren't willing to buy its bonds, why were rates on UK Treasury bonds falling on average during 1977? (Not coincidentally, the BOE's target was falling, too.) Perhaps I'm looking at the wrong data . . . if so, please advise.Best,Scott