Credit Expansion, Crisis, and the Myth of the Saving
Glut
Introduction
Readers who are
already familiar with the nature of credit expansion and
the concepts of standard money and fiduciary media
should skip the first section. Readers who are also
already familiar with the role of credit expansion and
fiduciary media in generating the stock market and real
estate bubbles should skip the second section as well
and proceed directly to the third section “Evasion
of Responsibility for the Bubbles.”
Credit Expansion, Standard Money, and Fiduciary
Media
Since the mid-1990s, the United States has experienced
two major financial bubbles: a stock market bubble and
a housing bubble. In both instances, the bubble was
inaugurated and sustained by a process of massive credit
expansion, i.e., the lending out of newly created money
by the banking system, operating with the sanction and
support of the country’s central bank, the Federal
Reserve System.
The concept of credit
expansion rests on two further concepts: standard money
and fiduciary media. Standard money is money that is not
a claim to anything beyond itself. It is that which,
when received, constitutes payment. Under a gold
standard, standard money is gold coin or bullion. Under
a gold standard, paper notes, which were claims to gold,
payable on demand, were not standard money. They were
merely a claim to standard money, which was physical
gold. The dollar was defined as a physical quantity of
gold of a definite fineness, i.e., approximately
one-twentieth of an ounce of gold nine-tenths fine.
Today in the United
States, standard money is the irredeemable paper
currency issued by the United States government. That
money is not a claim to anything beyond itself. Receipt
of such money today constitutes final payment.
The total of standard
money today is the sum of the outstanding quantity of
paper currency plus the checking deposit liabilities of
the Federal Reserve System. Since the Federal Reserve
has the power to print as much currency as it likes, and
thus is always in a position to redeem its outstanding
checking deposits in currency, these checking deposit
liabilities can properly be viewed as a kind of
different denomination of the paper currency, much like
hundred dollar bills that are to be redeemed for notes
of smaller denomination, or one-dollar bills that are to
be redeemed for notes of larger denomination. Thus the
total supply of standard money is to be understood as
the sum of the supply of paper currency in the narrower
sense plus the checking deposit liabilities of the
central bank.
These two magnitudes,
currency plus checking deposit liabilities of the
central bank, when taken together, are known as the
“monetary base.”
In December of 1994,
the monetary base was $427.3 billion. In December of
1999, it was $608 billion. In December of 2007, it was
$836.4 billion. In all years prior to 2008, the
overwhelming portion of the monetary base consisted of
currency. For example, in December of 2007, currency was
$763.8 billion, while, as just noted, the monetary base
as a whole was $836.4 billion.
A portion of the
currency outstanding and a portion of the checking
deposit liabilities of the Federal Reserve constitute
the reserves of the banking system. These reserves are
the standard money that the banks possess and can use to
meet the withdrawals of depositors requesting currency.
The reserves are also used to meet the demand of other
banks seeking to redeem net balances accruing in their
favor in the process of the clearing of checks.
In December of 1994
such reserves were $61.36
billion; in 1999, they $41.7 billion; in December of
2007, they were $42.7 billion.
Normally, as the
overall quantity of money in the economic system
increases, bank reserves increase more or less in
proportion. The fact that reserves were almost one-third
lower in December of 1999 than in December of 1994, and
then barely higher in December of 2007 than they were in
December of 1999, despite major increases in the
quantity of money over these years, is a major anomaly.
It reflects the long-standing, deliberate policy of the
Federal Reserve System of reducing and even altogether
eliminating reserve requirements.
As a recent scholarly
paper noted,
The Depository Institutions Deregulation
and Monetary Control Act of 1980 had begun phasing out
interest-rate ceilings on deposits and modified reserve
requirements in complex ways.
Combined with subsequent administrative deregulation
under Greenspan through January 1994, these changes left
all the financial liabilities that M2 adds to M1—savings
deposits, small time deposits, money market deposit
accounts, and retail money market mutual fund
shares—utterly free of reserve requirements and allowed
banks to reclassify many M1 checking accounts as M2
savings deposits. M2 and the broader measures became
quasi-deregulated aggregates with no legal link to the
size of the monetary base.
The concept of
standard money underlies the concepts of fiduciary media
and credit expansion. As I wrote in Capitalism,
“Fiduciary media are transferable claims to standard
money, payable by the issuer on demand, and accepted in
commerce as the equivalent of standard money, but for
which no standard money actually exists.”
The overwhelmingly
greater part of our money supply today consists of
fiduciary media in the form of checking deposits of one
kind or another. For example, as of December 2007, the
total money supply of the United States, i.e., currency
plus bank deposits of all kinds that are subject to the
writing of checks, including the making of payments by
debit card, was $6901.9 billion;
at the same time, the monetary base was $836.4 billion.
Accordingly, the amount of fiduciary media in the United
States was equal to the difference, which was $6065.5
billion. This was the sum of money representing
transferable claims to standard money, payable on demand
by the various banks that issued them, accepted in
commerce as the equivalent of standard money, but for
which no standard money actually existed.
The only standard
money that the banks had available with which to redeem
their checking deposits was
$42.7 billion in
standard money reserves. These $42.7 billion of reserves
were the standard-money backing for a total of $6108.2
billion checking deposits, i.e., deposits equal to the
sum of $42.7 billion + $6065.5 billion. To say the same
thing in different words, there was full, 100 percent
standard-money backing for $42.7 billion of deposits,
and no standard-money backing whatever for $6065.5
billion of deposits, which latter constituted fiduciary
media.
The quantity of
fiduciary media in existence at any time represents the
cumulative total of all of the credit expansion that has
taken place in the country’s money supply up to that
time. It represents the sum of all of the loans and
investments that the banking system has made based on
the foundation of the creation of money out of thin air.
The difference between the amount of outstanding
fiduciary media at two points in time represents the
credit expansion that has taken place in the interval.
The simplest way in
which to understand the process of the creation of
fiduciary media and credit expansion is to imagine a
deposit of standard money in the form of currency into a
checking account. After making the deposit, the
depositor has just as much spendable money in his
possession as he did before making it. Instead of a roll
of currency, he has a checking balance of equal amount.
Either way, he can spend the same amount of money.
Before making his deposit, he would have had to peel off
bills from his roll in order to make payments. Now,
instead, he writes checks and makes payment by check.
Instead of his roll of currency diminishing each time he
peels off a bill, his checking balance diminishes each
time he writes a check. In the one case, the spendable
money in his possession is his roll of currency; in the
other it is his checking balance.
Up to this point in
our imaginary scenario, there has been no creation of
fiduciary media and no credit expansion. The money
supply does not exceed the quantity of standard money.
In the one case, before making his deposit, the standard
money is in the possession of an individual. After the
individual makes his deposit and holds money in the form
of a checking balance, the same quantity of standard
money is in the possession of his bank. Under such
conditions, the quantity of money in the economic system
is equal to the quantity of standard money held either
by individuals as holdings of currency, or by banks as
reserves against the checking deposits of those
individuals and equal in amount to the size of those
checking deposits.
Fiduciary media and
credit expansion enter the picture insofar as the banks
in which standard money has been deposited proceed to
lend out the standard money that has been deposited with
them. To the extent they do this, borrowers from the
banks now have spendable money in their possession which
is in addition to the spendable money in the hands of
the banks’ checking depositors. There has been a
creation of new and additional money, which new and
additional money represents fiduciary media and an
equivalent expansion of credit.
The currency which the
banks lend out can easily, and almost certainly will, be
deposited. When it is deposited, the same process of the
creation of fiduciary media and credit expansion can be
repeated. Indeed, under the conditions largely created
by Greenspan, checking deposits came to stand in a
multiple of more than 160 times the standard money
reserves of the banks. In December of 2007, there were
$6901.9 billion of checking deposits backed by a mere
$42.7 billion of standard money reserves.
In modern conditions,
of course, banks do not lend currency. Rather, they
simply create new and additional checking deposits for
their borrowers. When the borrowers spend those checking
deposits by writing checks of their own, the people who
receive the checks in turn deposit them in their banks.
Those banks then call upon the banks that have created
the deposits, for payment. This entails a shifting of
standard money reserves from the one set of banks to the
other.
To the extent that all
banks have engaged in the process of checking deposit
creation, the reserve balances due from any bank may be
more or less closely matched by the reserve balances due
it from other banks. This is because the checks written
by its customers to the customers of other banks will be
more or less closely matched by checks written by the
customers of other banks to customers of this bank. In
such a case the only movement of reserves will be the
net amount due in the clearing.
From December of 1994,
prior to the start of the stock market bubble, to
December of 2005, shortly before the end of the housing
bubble, the quantity of fiduciary media increased from
$1.91 trillion to $4.93 trillion. This represented a
compound annual rate of increase in excess of 9 percent
over the eleven-year period. From December of 1999,
shortly before the start of the housing bubble, to
December of 2005, the amount of fiduciary media
increased from $3.25 trillion to $4.93 trillion, which
represented a compound annual rate of increase of 7.21
percent.
The increase in the
quantity of fiduciary media over the period as a whole
is significant, not just the increase that took place
over the period of the housing bubble itself. This is
because fiduciary media created in the years prior to
the housing bubble played an important role in financing
that bubble. And the same was true of the role of
fiduciary media created in the years prior to the stock
market bubble in financing that bubble.
As interest rates rose
in the latter parts of these two bubbles, vast checking
balances created earlier, that had been held as though
they were savings accounts, and on which a modest rate
of interest was being earned, were drawn into the
financing of stock market purchases in the one case and
housing loans in the other. The transformation of these
deposits from de facto savings accounts into de facto
checking accounts was based on the combination of their
having had the potential for check writing all along,
together with a rise in the rates of return that could
be earned by switching their use from a vehicle for
savings into a vehicle for buying investments. The rise
in rates of return in the one case was in the gains to
be had from stock market investment; in the other, in
rates of interest on various vehicles for financing
housing and real estate purchases.
It might be thought
that what I have said of the transformation of deposits
on which checks could be written would largely apply
also to genuine savings deposits, on which checks could
not be written. For the rise in rates of return would
provide the same incentive to move funds from them into
more lucrative investments. This is true. But
nevertheless, there is a crucial difference.
Before the savings
deposits can be spent, they must first be converted into
checking deposits. All of the checking deposits that
come under the heading of M1, most notably those held
at commercial banks, require that those banks hold
significant reserves, typically in an amount equal to
10 percent of a bank’s total deposits in excess of $44
million. Savings deposits in contrast have not required
the holding of any reserves whatever for many years, and
even when they did require the holding of reserves, it
was at a far lower percentage than applied to checking
deposits.
As a result, any
movement of funds from savings into checking accounts
entails an increase in required reserves. To obtain
these additional reserves, banks must sell various
assets, the effect of which would be to reduce their
prices and to raise their effective yields to the new
buyers. Unless the Federal Reserve intervened to provide
new and additional reserves equal to the increase in the
need for reserves, the effect would be not only a rise
in interest rates but a general tendency toward a
contraction of credit. This last would result from the
loss of reserves by banks whose reserves were already at
the bare minimum necessary to conduct operations.
In contrast, the use
of savings held in accounts with already existing
check-writing privileges to make purchases does not
require any additional reserves. The problem of a need
for additional reserves arises only insofar as a net
movement of funds might occur, through the clearing,
from checking accounts of a kind requiring no reserves
to checking deposits of a kind that do require reserves.
Checking deposits with no legal reserve requirements are
money-market deposit accounts and retail and
institutional money market funds. Checks drawn on such
accounts and then deposited in other such accounts do
not require any additional reserves. Additional reserves
are required only when and to the extent that checks
drawn on such accounts and deposited in conventional
checking accounts exceed the volume of checks coming
from conventional checking accounts and deposited in
such accounts.
To the extent that the
Federal Reserve is willing to supply the necessary
additional reserves to meet the greater need for
reserves arising from such a movement of funds, all
checking deposits come to stand on an equal footing as
sources of spendable money. And so too do savings
deposits that end up being convertible into checking
deposits with no net increase in the scarcity of
reserves because the Fed has enlarged the supply of
reserves to the same or even greater extent than the
increase in the amount of reserves required as the
result of such conversion.
Consistent with the
fact cited earlier that total reserves were
substantially lower in December of 1999 than they had
been in December of 1994 and grew only slightly from
December of 1999 to December of 2007, it must be
pointed out that additional reserves can be supplied by
the Fed by means of its reducing or eliminating reserve
requirements at various points in the banking system.
Thus, for example, when the Fed eliminated the
requirement that once existed that a 3 percent reserve
be held against savings deposits, all of the reserves
previously held to meet that requirement became
equivalent to a supply of new and additional reserves of
that same amount.
The same was true when
the Fed allowed commercial banks on weekends and
holidays to “sweep” substantial parts of their
outstanding checking deposits into types of accounts
that did not require reserves. This too made a
substantial portion of already existing reserves the
equivalent of new and additional reserves. Indeed, the
amount of such new and additional reserves constituted
such an excess of reserves above the now diminished
reserve requirements, that the Fed was obliged to reduce
the outstanding amount of reserves by means of resorting
to “open-market operations” in which it sold some of its
holdings of government securities in exchange for newly
excess reserves.
The Stock Market and Real Estate Bubbles
Credit expansion was the source of the funds that fueled
both the stock market and the real estate bubbles. In
the case of the stock market bubble, credit expansion
provided funds for the purchase of stocks. The sellers
of the stocks then used the far greater part of their
proceeds to purchase other stocks, whose sellers did
likewise. In this way, the new and additional money
created by credit expansion traveled from one set of
stocks to another, raising the prices of the great
majority of them. It continued to do this so long as the
credit expansion went on at a sufficient rate.
Ultimately, a
sufficient rate would have had to be an accelerating
rate. This is because rising share prices resulted in
people feeling richer and thus believing themselves able
to afford more luxury goods. It also led to a stepped
up demand for physical capital goods by firms coming
into possession of the new and additional money by
virtue of sales of stock of their own. The issuance of
such stock and use of the proceeds to finance the
purchase of physical capital goods was encouraged by the
fact that the rise in stock prices made it more and more
attractive in comparison with acquiring capital goods
through the purchase of stocks in other companies.
Thus,
an important later effect of the credit expansion was a
tendency for funds to be withdrawn from the stock
market, for the purchase of luxury consumers’ goods and
also of physical capital goods. To offset this
withdrawal of funds, more rapid credit expansion would
have been necessary.
When, instead of an
acceleration of the credit expansion, there was a
diminution in its rate, the basis of the market’s rise
was doubly undercut. Since the funds provided by credit
expansion had come to represent an important part of the
demand for stocks, the reduction in credit expansion
constituted a reduction in that demand. Coupled with the
outflows of funds just described, the result was that
share prices began to plummet. Their fall was compounded
by the unloading of shares by people who had purchased
them for no other reason than their expectation of a
continuing rise in stock prices.
The more recent, real
estate bubble originated in the Fed’s panic-response to
the collapse of the stock market bubble it had caused
earlier. To overcome the effects of that collapse, it
progressively reduced its target federal-funds rate,
i.e., the rate of interest banks pay one another on the
lending and borrowing of funds that qualify as reserves
against commercial-bank checking deposits. In this way,
it launched a new and more momentous credit expansion.
For the three years
2001-2004, the Federal Reserve created as much new and
additional money in the form of additional bank reserves
as was necessary to drive and then keep the
federal-funds rate below 2 percent. And from July of
2003 to June of 2004, it drove and kept it even further
down, at approximately 1 percent.
The new and additional
money created by the banking system on the foundation of
these new and additional reserves appeared in the loan
market as a new and additional supply of loanable funds.
The effect was a reduction in interest rates across the
board.
Because interest is a
major determinant of monthly mortgage payments, the fall
in interest rates made home ownership appear
substantially less expensive. As a result, a great surge
in the demand for mortgage loans and the in the purchase
of homes took place. Instead of pouring into the stock
market as in the previous bubble, the funds created by
credit expansion now poured into the real estate market
and drove up the prices of homes and commercial real
estate rather than the prices of common stocks.
In the stock market
bubble and even more so in the real estate bubble there
was both large scale overconsumption and malinvestment.
These are the two leading features of booms as explained
by the monetary theory of the trade cycle developed by
Ludwig von Mises. In both cases, the rise in the price
of major assets—most notably, stocks and homes
respectively—led people to believe that they were richer
and could thus afford to consume more. In both cases,
particular branches of industry were greatly
overexpanded relative to the rest of the economic
system, resulting in a subsequent major loss of capital.
In the stock market bubble, the malinvestment was mainly
in such things as the “dot.com” enterprises that later
went broke. In the real estate bubble, it was in housing
and commercial real estate.
Evasion of
Responsibility for the Bubbles
Credit
expansion is what was responsible for both the stock
market and the real estate bubbles. Since its
establishment in 1913 and certainly since the expansion
of its powers in World War I, responsibility for credit
expansion itself has rested with the Federal Reserve
System. The Fed is the source of new and additional
reserves for the banking system and determines how much
in checking deposits the reserves can support. It has
the power to inaugurate and sustain booms and to cut
them short. It launched and sustained the stock market
and real estate bubbles. It had the power to avoid both
of these bubbles and then to stop them at any time. It
chose to launch and sustain them rather than to avoid or
stop them.
To be responsible for
a bubble and its aftermath is to be responsible for a
mass illusion of wealth, accompanied by the misdirection
of investment, overconsumption, and loss of capital, and
the poverty and suffering of millions that follows. This
is what can be traced to the doorstep of the Federal
Reserve System and those in charge of it. It is
destruction on a scale many times greater than that
wrought by Bernard Madoff, the swindler who first made
his clients believe they were growing rich, only to
cause them ultimately a loss of more than $50 billion.
Madoff is one of the most justly hated individuals in
the United States.
In contrast to the $50
billion of losses caused by Madoff, the losses caused by
the Federal Reserve System and those in charge of it
amount to trillions of dollars, probably to more
than $10 trillion if the stock and real estate bubbles
are taken together. Instead of affecting thousands of
people as in the case of Madoff, tens of millions
have been made to suffer hardship. Indeed, practically
everyone has been harmed to some extent by what the
Federal Reserve has done: the owners of stocks that have
plunged, pensioners, the unemployed and their families,
towns and cities suffering the consequences of business
failures and plant closings.
It is difficult to
imagine living with the knowledge that one is personally
responsible for such massive destruction. Such knowledge
might easily drive someone to suicide or at least to
some means, such as drink or drugs, of not having to
allow it into consciousness.
Alan Greenspan, who
was Chairman of the Federal Reserve’s Board of Governors
from 1987 to 2006, the period encompassing both bubbles,
is clearly the single individual most responsible for
the bubbles. The present Chairman, Ben Bernanke, also
bears substantial responsibility, though not to the same
extent as Greenspan. While Chairman only since January
of 2006, Bernanke has been a member of the Federal
Reserve Board since 2002. Thus he was present in a major
policy making position during most of the housing bubble
and crucial years leading up to it.
Neither Greenspan nor
Bernanke have resorted to drink or drugs to conceal
their responsibility from themselves. Instead they have
resorted to specious claims about the cause of the
bubbles, the housing bubble in particular.
One can read through
their widely disseminated public statements and not find
a single explicit reference to credit expansion and
fiduciary media, nor to malinvestment and
overconsumption. To avoid recognition of any need to
discuss these phenomena, Greenspan seems to have wiped
his mind clean of all knowledge of how Federal Reserve
interest-rate policy affects interest rates in the
economic system.
In what appears to be
his closest reference to credit expansion, he wrote, in
an article in The Wall Street Journal of March
11, 2009:
There are
at least two broad and competing explanations of the
origins of this crisis. The first is that the "easy
money" policies of the Federal Reserve produced the U.S.
housing bubble that is at the core of today's financial
mess.
The second,
and far more credible, explanation agrees that it was
indeed lower interest rates that spawned the speculative
euphoria. However, the interest rate that mattered was
not the federal-funds rate, but the rate on long-term,
fixed-rate mortgages. Between 2002 and 2005, home
mortgage rates led U.S. home price change by 11 months.
This correlation between home prices and mortgage rates
was highly significant, and a far better indicator of
rising home prices than the fed-funds rate.
This should
not come as a surprise. After all, the prices of
long-lived assets have always been determined by
discounting the flow of income or imputed services by
interest rates of the same maturities as the life of the
asset. No one, to my knowledge, employs overnight
interest rates—such as the fed-funds rate—to determine
the capitalization rate of real estate, whether it be an
office building or a single-family residence.
In these
passages Greenspan invents a version of the opposition
to Federal Reserve sponsored credit expansion that no
opponent of credit expansion or “easy money” has ever
held. No opponent of credit expansion has ever claimed
that reductions in the federal-funds rate need directly
affect long-term interest rates. To the contrary, the
significance of reductions in the federal-funds rate is
that what is required to bring them about in the actual
market for those funds is an increase in member-bank
reserves. The increase in those reserves is then the
foundation of credit expansion to a vast multiple of the
additional reserves. That credit expansion is what then
serves to lower long-term interest rates, such as
mortgage rates.
The way the
process works is as follows. To actually achieve the
lower federal-funds rate that it announces as its
target, the Federal Reserve goes into the market and
buys government securities from banks or the customers
of banks. It pays for those securities by means of the
creation of new and additional standard money. When the
Fed purchases securities from banks, the banks directly
and immediately have equivalently more reserves in their
possession. When it purchases securities from the
customers of banks, the banks gain equivalently more
reserves as soon as those customers deposit the checks
they have received that are drawn by the Fed on the Fed.
These checks are then forwarded to the Fed and the
reserve accounts of the banks in question are
equivalently increased.
Depending
on the amount of their increase, the immediate effect of
the additional reserves is to reduce or eliminate
deficiencies in the required reserves of some, many, or
all of the banks that have had such deficiencies, to
replace deficiencies of reserves with excesses of
reserves, and to increase the excess reserves of some,
many, or all of the banks that have had excess reserves.
The effect of this in turn is to reduce the demand for
federal funds, i.e., funds that qualify as reserves,
while increasing their supply. This combination is what
brings down the federal-funds rate in the market for
federal funds.
What is far
more significant is that the creation of new and
additional excess reserves by the Fed—reserves beyond
the amount legally required to be held—places the
banking system in a position in which it can expand the
supply of checking deposits and thus fiduciary media to
a multiple of the additional reserves. And thanks
largely to Mr. Greenspan that multiple came to be
enormous. By December of 2005, it exceeded 126 times.
Two years later, it exceeded 160 times.
Thus for
each dollar of additional excess reserves created, a
credit expansion was made possible on the order of a
vast multiple. The new and additional fiduciary media
corresponding to the credit expansion were the source of
the funds for stock purchases in the stock market bubble
and for housing and commercial real estate purchases in
the housing bubble. Their pouring into the home mortgage
market was what drove down mortgage interest rates.
Between December of 1999 and December of 2005, almost
$1.7 trillion of new and additional fiduciary media were
created and lent out.
As market
interest rates started rising in the second half of 2004
and then through 2005, increasing amounts of deposits
earning a modest rate of interest and on which checks
could be written, came to be used more and more as
checking accounts rather than savings accounts. They
were drawn into the spending stream in response to the
higher comparative rates of return that could be earned
through investment in securities. This allowed the life
of the housing bubble to be extended until 2006.
The Saving
Glut Argument
Along with denying the causal role of Federal Reserve
expansionary monetary policy in the housing bubble,
Greenspan advances the claim, greatly elaborated by
Bernanke, that what was actually responsible for the
bubble was an excess of global saving. He argues in his
Wall Street Journal article that
[T]he
presumptive cause of the world-wide decline in long-term
rates was the tectonic shift in the early 1990s by much
of the developing world from heavy emphasis on central
planning to increasingly dynamic, export-led market
competition. The result was a surge in growth in China
and a large number of other emerging market economies
that led to an excess of global intended savings
relative to intended capital investment. That ex ante
excess of savings propelled global long-term interest
rates progressively lower between early 2000 and 2005.
In a series of
lectures beginning in March of 2005 and continuing into
the current year, Bernanke elaborates on this claim. At
a lecture given at the Bundesbank in Berlin, Germany,
on September 11, 2007, titled
“Global Imbalances:
Recent Developments and Prospects,” he argued that
stepped up saving in developing countries was largely
responsible for “the
substantial expansion of the current account deficit in
the United States, the equally impressive rise in the
current account surpluses of many emerging-market
economies, and a worldwide decline in long-term real
interest rates.” (For the benefit of non-technical
readers, the “current account” balance encompasses the
difference between exports and imports both of goods and
services, the difference between incomes earned abroad
and incomes paid to abroad, plus the difference between
remittances from and to abroad.)
These developments,
he held, “could be explained, in part, by the emergence
of a global saving glut, driven by the
transformation of many emerging-market
economies—notably, rapidly growing East Asian economies
and oil-producing countries—from net borrowers to large
net lenders on international capital markets.”
In a speech delivered
on April 9 of this year at Morehouse College in Atlanta,
Bernanke stressed that “the
net inflow of foreign saving to the United States, which
was about 1-1/2 percent of our national output in 1995,
reached about 6 percent of national output in 2006 an
amount equal to about $825 billion in today's dollars.”
He then proceeded to blame the housing boom on this
inflow of foreign savings. “Financial institutions,” he
declared, “reacted to the surplus of available funds by
competing aggressively for borrowers, and, in the years
leading up to the crisis, credit to both households and
businesses became relatively cheap and easy to obtain.
One important consequence was a housing boom in the
United States, a boom that was fueled in large part by a
rapid expansion of mortgage lending.”
Thus, according to
Bernanke, it was not credit expansion or anything that
he and the Federal Reserve System and Mr. Greenspan were
responsible for, but the inflow of foreign savings. That
inflow, representing a “global saving glut,” was
responsible for the bubble and its aftermath.
Bernanke uses the
expression “saving glut” repeatedly: 9 times in his
lecture at the Bundesbank in September of 2007, 11 times
in his lecture at the Virginia Association of Economics
in March of 2005, and 10 times in his
Homer Jones Lecture
in St. Louis in April of 2005. Despite his constant
repetition of the claim, it turns out to have absolutely
no substance. Nowhere is the existence of anything
remotely approaching a saving glut in any way
substantiated.
The
Non-Existence of a Saving Glut
The very
notion of a saving glut is absurd, practically on its
face. As I wrote in Capitalism:
Before the scarcity of
capital … could be overcome, capital would have to be
accumulated sufficient to enable the 85 percent of the
world that is not presently industrialized to come up to
the degree of capital intensiveness of the 15 percent of
the world that is industrialized. Within the
industrialized countries, capital would have to be
accumulated sufficient to enable every factory, farm,
mine, and store to increase its degree of capital
intensiveness to the point presently enjoyed only by the
most capital-intensive establishments, and, at the same
time, to enable all establishments to raise the standard
of capital intensiveness still further, to the point
where no further reduction in costs of production or
improvement in the quality of products could be achieved
by any greater availability of capital….
Long before such a
point could ever be reached, time preference would put
an end to further increases in the degree of capital
intensiveness.
It is doubly absurd to
believe that the source of a saving glut would be
precisely countries possessing very little capital
compared to the United States and other industrialized
countries. But that is what Bernanke claims. He claims
that countries such as Thailand, China, Russsia,
Nigeria, and Venezuela are the source of the alleged
saving glut.
There are further
theoretical considerations that argue specifically
against any form of “saving glut” being responsible for
the housing bubble.
First, if
saving had been
responsible, and not credit expansion and the increase
in the quantity of money, then the additional saving
taking place in the countries providing it, would have
been accompanied by a reduction in consumer spending in
those countries. People would have had to spend less for
consumption in those countries, in part, in order to
make available funds for additional spending on capital
goods that were exported to the United States. Such
export of capital goods to the US would not have fueled
a boom here. To the contrary, it would have resulted in
lower prices of capital goods in the US. Only the
portion of funds saved that was used to finance
purchases within the US could have contributed to any
higher prices of capital goods and land in the US. And,
of course, whatever rise in the prices of capital goods
and land that might have taken place in the US would
have tended to be matched by a fall in the prices of
consumers’ goods in the countries that had stepped up
their saving. The only way that the demand for capital
goods and land could rise without the demand for
consumers’ goods falling would be on the strength of an
increase in the quantity of money and the total, overall
volume of spending in the economic system.
Indeed, the fact that
in the absence of an increase in the quantity of money
and volume of spending in the economic system, shifts in
spending serve to reduce prices as much as increase them
has a parallel in the further fact that increases in the
relative size of some of the countries in the world’s
economy imply equivalent decreases in the relative size
of other countries in the world’s economy. In the
absence of an increase in the quantity of money and
volume of spending, growth in the relative size of the
economies of many Asian countries would not by itself be
sufficient for greater saving in those countries serving
to increase global spending for capital goods. For that
greater spending would be accompanied by reduced
spending for capital goods in other countries, i.e.,
countries that were already in the category of developed
economies and now had to yield some portion of their
previous relative size.
In the present
instance, what this means is that greater spending for
capital goods and land in the US, financed by saving in
parts of Asia, would be accompanied by less spending for
capital goods in the US (and possibly elsewhere)
financed by saving in the US or financed by saving
elsewhere in the world. If spending for capital goods
financed by saving in Asia is not accompanied by reduced
spending for capital goods financed by saving elsewhere,
the only ultimate explanation is an increase in the
quantity of money and volume of spending in the world’s
economy. Of course the source of such an increase in
today’s conditions is none other than the Federal
Reserve System.
Second, contrary to
popular understanding, when saving is divorced from the
increase in the quantity of money and volume of
spending, and takes place without such increase, it does
not tend to grow larger from year to year. Nor does
consumer spending tend to decrease from year to year.
And thus more saving would not serve to raise the prices
of capital goods or land from one year to the next. Its
effect would essentially be limited to a discrete,
one-time only increase.
Yet for the prices of capital goods and land to rise
from one year to the next on the strength of an increase
in the demand for capital goods and land based on an
increase in saving, the increase in saving would have to
become progressively larger from year to year. And this
would mean that the demand for consumers’ goods would
have to become progressively smaller from year to year.
For example, imagine
that at the expense of an equal fall in the demand for
consumers’ goods, the demand for capital goods rose by
some given amount, say, 100. This 100 can represent
however many billions or hundreds of billions of dollars
as may be required to make it realistic in terms of
present spending levels. In such circumstances, there
would be nothing present that would make the prices of
capital goods or land any higher in the second and later
years of 100 of additional such spending than in the
first year.
Indeed, as the years
wore on, the increases in production achieved by a
greater supply of capital goods would start reducing
prices, including the prices of capital goods
themselves, as the supply of capital goods itself was
increased on the foundation of a general increase in
production. Even land prices would fall to the extent
that improvements in the supply of capital goods
permitted the adoption of methods of production that
allowed the economical use of previously submarginal
land or so increased the output per unit of land as to
make part of its supply redundant.
In circumstances of an
unchanged supply of money and demand for money for
holding, each act of greater saving and accompanying
greater expenditure on capital goods operates in a
manner analogous to the relationship between force and
acceleration in the physical world. In the physical
world, in the conditions of a friction-free environment,
a single application of force to an object imparts
continuous motion at a constant velocity. Similarly, in
the economic world, in the conditions of an unchanged
quantity of money and volume of spending, each act of
reduced expenditure for consumers’ goods and increased
expenditure for capital goods, causes the economic
system to adopt a greater relative concentration on the
production of capital goods and a reduced relative
concentration on the production of consumers’ goods.
This produces an inertial effect on capital
accumulation.
The first result of
the greater relative concentration on the production of
capital goods is a greater production of capital goods,
alongside a smaller production of consumers’ goods.
These additional capital goods, however, obtained on the
foundation of additional saving, are the basis of an
increase in the ability to produce both consumers’ goods
and further capital goods. That is to say, the
additional capital goods make possible a general
increase in production, an increase in the production of
consumers’ goods and a further increase in the
production and supply of capital goods as well. The
process of an increasing supply both of consumers’ goods
and capital goods, based on the foundation of a single
fall in consumption and increase in saving, can go on
indefinitely if it is accompanied by further scientific
and technological progress. In these circumstances, a
further fall in the demand for consumers’ goods and rise
in the demand for capital goods would be analogous to a
further application of force to an object and would
result in an acceleration of the increase in production.
A further point must
be mentioned here. And that pertains to the durability
of capital goods and its implications for capital
accumulation, saving, and spending. Thus, if the average
life of the capital goods in our example of 100 of
additional spending for capital goods were, say, 10
years, then a diminishing process of saving would go on
for 10 years with no further fall in the demand for
consumers’ goods nor rise in the demand for capital
goods. Net saving and equivalent net investment in the
economic system would take place in a pattern 100, 90,
80, …10, as the 100 of additional spending for such
capital goods was accompanied by successive increases in
annual depreciation charges. The additional depreciation
charges would be 10 in the year following the first
year’s expenditure of an additional 100 for such capital
goods. In the next year, when there were two such
batches of capital goods, depreciation would be 20. At
the end of the tenth year, the depreciation charges on
ten such batches of capital goods would be 100, and net
saving and net investment would disappear, unless, of
course, there were a further decline in consumption
expenditure and increase in demand for capital goods.
What is particularly
important to realize here is that the net saving of
years 2 through 10 would not serve at all to raise the
demand for capital goods and land nor their prices, but
would contribute to the supply of capital goods being
larger, production in general consequently being
greater, and prices in general, including the prices of
capital goods, being lower as a result. Such results,
and those of the process of saving and capital
accumulation in general that were described a moment
ago, cannot be reconciled with the conditions of a
bubble. They should not be cited as the basis of
explaining a bubble.
Third, if somehow
saving were responsible for the housing bubble, why did
it suddenly collapse? Why did people suddenly stop
saving and stop making funds available for the purchase
of homes? Obviously, the explanation was that the bubble
did not depend on saving but on credit creation and its
acceleration and that when the ability to create
sufficiently more credit came to an end, the props
supporting the bubble were removed and it collapsed.
Fourth, if saving were
responsible for the bubble, why have banks and countless
other firms found themselves confronting an acute lack
of capital? Saving provides new and additional capital.
How can it be that an alleged process of saving has
resulted in widespread major capital deficiencies? This
situation of insufficient capital is the result of
malinvestment and overconsumption, which are the
consequences of credit expansion, not saving.
Fifth, if saving had
been responsible for the increase in spending on capital
goods and land, the rate of profit would have modestly
fallen from the very beginning, and continued its fall
until net saving came to an end. It would not have
risen, let alone risen dramatically, as it did during
the bubble.
This is the
implication of the discussion, above in this section, of
the second reason why saving was not responsible for the
bubble. In particular it is the implication of the
example of 100 more of spending for capital goods
financed by 100 of saving derived from 100 less of
spending for consumers’ goods. In that example, in which
there is no increase in the quantity of money or total
volume of spending, the global economic system would
have had the same total aggregate business sales
revenues, with the sales revenues coming from the sale
of consumers’ goods diminished by the amount of saving,
and those coming from the sale of capital goods
equivalently increased. At the same time, however, it
would have had a tendency toward a rise in the
aggregate costs of production deducted from those sales
revenues.
The rise in costs
would have been the result of such things as additional
depreciation charges on the new and additional capital
goods purchased, or additional cost of goods sold
following additional purchases of materials and labor on
account of inventory. In the example of 100 more being
spent for capital goods each year with an average life
of 10 years and accompanying depreciation charges in the
respective amounts of 10, 20, …, 100 in the 10 years
following the rise in demand for capital goods,
aggregate profit in the economic system would have been
falling year by year by an amount equal to the increase
in depreciation.
A falling aggregate
amount of profit together with the increasing amount of
capital invested in the economic system, would have
progressively reduced the economy-wide average rate of
profit. It would have been a case of a falling
amount-of-profit numerator divided by a
rising-amount-of-capital denominator.
Totally contrary to
what one would expect from these effects of a rise in
saving, the reality, of course, was a sharply higher
average rate of profit in the economic system so long as
the bubble lasted. This can be explained only on the
foundation of credit expansion and an expanding quantity
of money and volume of spending, not on the basis of
saving.
If none of these five
reasons are sufficient to dispel the notion that a
saving glut was responsible for the bubble, then
hopefully it will be sufficient to point out that
there simply was no saving glut, but rather only a
very modest rate of saving, a mere trickle of saving.
For it turns out that over the 13 year period 1994-2006,
the rate of saving in the US, together with all foreign
saving entering the country in connection with deficits
in the current account, never exceeded 7 percent, and in
8 of those 13 years was 3 percent or less. In 5 of those
years it was a mere, 1 or 2 percent. And what is of
special significance is that in the years of the housing
bubble, 2002-2006, it was especially low: 2 percent in
2002, 1 percent in both 2003 and 2004, 3 percent in
2005, and 4 percent in 2006.
To see this result, it
is necessary to begin by removing all fictional elements
in the reported amounts of domestic net saving and GDP.
These fictional amounts consist of various
“imputations.” The leading imputations that are relevant
here are those that arbitrarily convert what is in fact
consumption expenditure into investment expenditure.
These have the effect of reducing reported consumption
and equivalently increasing reported saving.,
The two most important
such imputations are these: 1) the treatment of the
purchase of single family homes that the buyer intends
to occupy and that thus will not be a source of any
money revenue of income to him, as though they were
nonetheless income producing assets and therefore
represented an investment; 2) the treatment of
government expenditure for fixed assets such as
buildings, as though it were an investment expenditure
rather than a consumption expenditure.
When such imputations
are removed from the calculation of net saving and from
GDP, the very modest extent of saving that has been
going on over the last decade or more is clearly shown.
Indeed, since 2002, domestic net saving has been
negative to the extent of several hundred billion
dollars each year.
The following table
describes the situation:
Year |
Current
Account Balance
in billions
(times -1).
Source: BEA International
Table 1
Line 77* |
Net
Saving Less Imputations
Source: BEA Table 7.12 Imputations in the
National Income and Product Accounts, line 123**
|
Current Acct. Balance + Saving Less Imputations
(2+3) |
GDP Less
Imputations
in billions
Source: BEA Table 7.12 Imputations in the
National Income and Product Accounts, line 3** |
(Current Acct. Balance + Saving Less
Imputations) /(GDP Less Imputations) (4)/(5) |
(1) |
(2) |
(3) |
(4) |
(5) |
(6) |
1994-Dec. |
98.5 |
-53.3 |
45.2 |
6,057.00 |
0.01 |
1995-Dec. |
96.4 |
18.6 |
115.0 |
6,357.40 |
0.02 |
1996-Dec. |
104.1 |
48.2 |
152.3 |
6,739.50 |
0.03 |
1997-Dec. |
108.3 |
146.5 |
254.8 |
7,180.20 |
0.04 |
1998-Dec. |
166.1 |
185.3 |
351.4 |
7,556.30 |
0.05 |
1999-Dec. |
265.1 |
149.7 |
414.8 |
7,986.00 |
0.06 |
2000-Dec. |
379.8 |
135.9 |
515.7 |
8,437.20 |
0.07 |
2001-Dec. |
365.1 |
-100 |
265.1 |
8,655.90 |
0.03 |
2002-Dec. |
423.7 |
-325.3 |
98.4 |
8,914.50 |
0.02 |
2003-Dec. |
496.9 |
-463.3 |
33.6 |
9,352.40 |
0.01 |
2004-Dec. |
607.7 |
-487.3 |
120.4 |
9,961.50 |
0.01 |
2005-Dec. |
711.6 |
-478.9 |
232.7 |
10,606.30 |
0.03 |
2006-Dec. |
753.3 |
-327.7 |
425.6 |
11,264.50 |
0.04 |
*http://www.bea.gov/international/xls/table1.xls
**http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=299&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=1985&LastYear=2007&3Place=N&Update=Update&JavaBox=no
The table has 6 columns. Column 1 lists the years 1994
through 2006, the period encompassing both the stock
market and the real estate bubbles. Column 2 shows the
current account deficit in those years. This deficit is
taken as representing the foreign savings coming into
the United States. (For this reason it is shown as a
positive number.) Column 3 shows net saving in the
United States in those years when such savings are
calculated free of imputations. Column 4 is the sum of
Columns 2 and 3. It shows total saving in the United
States as the sum of foreign saving entering the country
together with domestic saving. Column 5 is GDP year by
year, with all imputations removed. Column 6 is the sum
of imputation-free foreign and domestic saving divided
by such GDP, presented in decimal format.
The notion that there
was a saving glut behind the housing bubble is simply a
fiction. Its proponents could manufacture as much of a
glut as they like simply by reclassifying such things as
expenditure for automobiles, major appliances,
furniture, and clothing as investment expenditures, on
the grounds that these goods too are durable, like
houses. That would equivalently reduce consumption
expenditure and increase reported saving in the economic
system.
Current
Account Deficits as a By-Product of the Increase in the
Quantity of Money
Bernanke
and Greenspan et al. focus on deficits in the current
account as representing the counterpart of foreign
saving and investment, which they believe must be
present to finance the deficits. There is certainly a
very close relationship between foreign saving and
investment on the one side and the financing of deficits
in the current account on the other. The following
example may help to highlight this relationship.
Thus imagine Saudi
Arabia back in the days when geologists had determined
that the country possessed vast oil reserves but before
it had any oil wells, pipelines, refineries, or
facilities for the handling of supertankers. Those
things had yet to be built.
Now how could those
facilities be built? The only way was by means of the
arrival of shiploads of equipment and construction
materials from Europe and the United States. In
addition, large quantities of various consumers’ goods
were required for the foreign engineers and other
workers who were required to carry out the construction.
All these goods coming into Saudi Arabia were imports of
foreign goods. But Saudi Arabia had hardly anything to
export before its ability to produce oil was developed.
Thus, in the interval, there was a massive excess of
imports over exports. That excess represented foreign
investment in Saudi Arabia. Its physical form was all of
the facilities under construction and then, ultimately,
the completed facilities for producing oil.
Foreign investment
very often, perhaps most of the time, has this kind of
close connection to the existence of an excess of
imports over exports and, more broadly, an excess of
outlays of all kinds on current account over receipts of
all kinds on current account. (As previously explained,
the balance on current account includes not only the
difference between the imports and exports of goods, but
also of services. In addition, it includes the
difference between incomes paid to abroad and incomes
paid from abroad, and finally, the difference between
remittances to
and from abroad.)
Nevertheless, it
should be realized that the essential, core concept of
the current account, namely, the so-called balance of
trade, which is the difference simply between the import
and export of goods, was developed long before the
emergence of any significant international investment.
It was developed and employed by a school of writers
known as the mercantilists, who were current from the 16th
to the third quarter of the 18th Century,
when the school was laid to rest by Adam Smith.
The main concern of
the mercantilists was the accumulation of gold and
silver within the borders of their country and the
prevention of any loss of gold or silver by their
country. Gold and silver were the money of the day
everywhere and, it was believed, needed to be
accumulated within the country in order to be available
if and when the government might need them, in order to
finance military operations outside the country or any
other activities in which circumstances might operate to
draw precious metals away from the country.
Inasmuch as already
by that time, most of the European countries had no gold
or silver mines within their territory, the only way
they could gain gold or silver was by means of the
export of goods. The import of goods was seen as
constituting a loss of gold or silver by the country.
Accordingly, the goal of mercantilist policy was to
maximize exports while minimizing imports. That would
allegedly ensure the greatest possible accumulation of
the precious metals within the country.
Centuries later, in
the chapter “On Foreign Trade” in his Principles of
Political Economy and Taxation, Ricardo developed
the principle that the supply of the precious metals
tends to be distributed among the different countries
essentially in proportion to the relative size of their
respective economies. He wrote: "Gold and silver having
been chosen for the general medium of circulation, they
are, by the competition of commerce, distributed in such
proportions amongst the different countries of the world
as to accommodate themselves to the natural traffic
which would take place if no such metals existed, and
the trade between countries were purely a trade of
barter."
The operation of this
principle can, of course, be modified by the operation
of other principles working alongside it. Thus a country
with a relatively small economy, but with an exceptional
reputation for the security of property and the
enforcement of contracts, might well have a quantity of
money within its borders far in excess of what
corresponded to the relative size of its economy. By the
same token, countries with larger economies but in which
property rights and the enforcement of contracts were in
retreat, could possess a proportion of the world’s money
supply substantially less than what corresponded to the
relative size of its economy.
It follows from
Ricardo’s principle that countries with gold and silver
mines will experience a chronic excess of imports over
exports. The gold and silver that they mine cannot all
be retained within their borders. If they were retained,
the country would have a disproportionately large supply
of the precious metals. This would serve to raise prices
in that country relative to prices abroad. The effect
would be an outflow of the precious metals until their
buying power at home did not fall short of their buying
power abroad by more than the costs of shipping them
abroad.
Today, the US dollar
is in a position similar to that of gold under an
international gold standard. The dollar is a virtual
world money—not completely, but substantially. The
United States is the country with the “dollar mines.”
When dollars are created in the US, a substantial
portion of them will flow abroad. And this applies not
just to currency, but also to checking deposits and all
other short-term financial instruments easily
convertible to currency.
Most of the dollars
that “flow abroad” need not actually circulate abroad
but to a large extent serve as mere precautionary
holdings of money, and, to an important extent, as
reserves for financial institutions that create various
moneys other than dollars. These other moneys that are
created on the foundation of additional dollars
circulate abroad.
Now the fact that the
United States compared to almost all other countries in
the world still has the most reliable protection of
property rights and enforcement of contracts, is
responsible for the fact that much or most of the money
that “flows abroad” does not in fact leave the country.
Rather it passes into the ownership of foreign
individuals, firms, and governments who continue to hold
it within the United States.
The increase in such
foreign owned assets within the United States has the
appearance of foreign investment. Actually, it is
nothing more than the by-product of credit expansion and
the increase in the quantity of money within the United
States.
There is no genuine
surge in foreign saving. There is domestic credit
expansion and money supply increase that serves to
increase imports and shift ownership of a substantial
portion of the additional money supply, and short-term
claims to money, to foreigners.
Ironically, Bernanke
himself helps to confirm this interpretation of the
increase in the current account deficit. He says: “First,
the financial crises that hit many Asian economies in
the 1990s led to significant declines in investment in
those countries in part because of reduced confidence in
domestic financial institutions and to changes in
policies—including a resistance to currency
appreciation, the determined accumulation of foreign
exchange reserves, and fiscal consolidation—that had the
effect of promoting current account surpluses.” (Bundesbank
Lecture, Berlin, Germany, September 11, 2007.)
What Bernanke
describes here is not any sudden increase in foreign
saving but rather decisions to change the way in which a
portion of previously accumulated savings are held,
i.e., to hold them to a greater extent in the form of US
dollars and short-term claims to dollars.
In the same passage,
Bernanke presents a second reason for the alleged growth
in foreign savings, namely the sharp increase in the
price of oil that had taken place. He says, “sharp
increases in crude oil prices boosted oil exporters'
incomes by more than those countries were able or
willing to increase spending, thereby leading to higher
saving and current account surpluses.”
Here, Bernanke
overlooks the role of credit expansion and the increase
in the quantity of money in bringing about the higher
price of oil. He also overlooks the effect of the higher
price of oil on the real incomes and ability to save of
everyone who had to pay that higher price.
The role of credit
expansion and the increase in the quantity of money in
causing the rise in oil prices was confirmed by the
subsequent plunge in oil prices once credit expansion
was brought to an end and appeared to be about to turn
into massive credit contraction. It has since been
further confirmed by the recent rise in oil prices
following the growing belief that the government’s
program of renewed credit expansion will be sufficient
to eliminate the danger of a financial collapse and
will serve to maintain and increase the demand for oil.
Net Saving as a By-Product of the Increase in the
Quantity of Money
My
discussion of the fallacy of a saving glut as being
responsible for the housing bubble and its aftermath
would not be complete if I did not point out that the
continued existence of net saving is itself a by-product
of the increase in the quantity of money and volume of
spending in the economic system. In the absence of
increases in the quantity of money and volume of
spending, economy-wide, aggregate net saving would tend
to disappear. It would cease when total accumulated
savings came to stand in a ratio to current incomes and
consumption that people judged to be sufficiently high
that they had no further need to make still greater
relative provision for the future.
What keeps net saving
in existence is that the increase in the quantity of
money and volume of spending tends continually to raise
incomes and consumption in terms of money. In order to
maintain any given ratio of accumulated savings to a
rising level of income and consumption, it is necessary
to increase the magnitude of accumulated savings. At the
same time, the increasing quantity of money provides the
financial means of spending more and more each year for
capital goods as well as consumers’ goods and for thus
maintaining the desired balance in the face of growing
magnitudes of spending.
Thus it is the
increase in the quantity of money and the volume of
spending that it supports that is responsible for net
saving continuing in being. In the absence of the
continuing increase in the quantity of money, net saving
would disappear, and capital accumulation would take
place simply by means of a continually increasing
purchasing power of the same capital funds. That growing
purchasing power would be created by the increase in the
production and supply of capital goods and the fall in
prices of capital goods that would result.
Summary and Conclusion
The real estate bubble, like the stock market bubble
before it, was caused by credit expansion. The credit
expansion was instigated and sustained by the Federal
Reserve System, which could have aborted it at any time
but chose not to. As a result, the Federal Reserve
System and those in charge of it at during the real
estate bubble bear responsibility for major harm to tens
of millions of Americans.
In order to avoid
having to accept this responsibility, a specious
doctrine has been advanced by Alan Greenspan and Ben
Bernanke, the former and present Chairman of the system,
and others. That is the doctrine of a “global saving
glut.” Not credit expansion but the saving glut was
responsible, they claim.
The truth is that time
preference puts an end to further saving long before it
could outrun the uses for additional saving. This makes
a saving glut impossible. In addition, there are five
major reasons why saving could not have been responsible
for the real estate bubble in particular. First, if
saving had been responsible, rather than credit
expansion and the increase in the quantity of money,
there would have been a corresponding decline in
consumer spending in the countries allegedly doing the
saving. The fact is that there was no such decline.
Second, saving implies
a growing supply of capital goods, more production, and
lower prices, including lower prices of capital goods
and even of land. These are results that are
incompatible with the widespread increases in prices
typically found in a bubble.
Third, if somehow
saving had been responsible for the housing bubble, the
spending it financed would not suddenly have stopped.
Such stoppage is a consequence of the end of credit
expansion and the revelation of a lack of capital.
Fourth, if large-scale
saving rather than credit expansion had been present,
banks and other firms would have possessed more capital,
not less. They would not be in their present predicament
of having inadequate capital to carry on their normal
operations. This situation of insufficient capital is
the result of malinvestment and overconsumption, which
are the consequences of credit expansion, not saving.
Fifth, in the absence
of increases in the quantity of money and overall volume
of spending in the economic system, saving also implies
an immediate tendency toward a fall in the economy wide
average rate of profit. This is another result that is
incompatible with what is observed in a bubble or boom
of any kind, which is surging profits so long as “the
good times” last.
Especially noteworthy
is the fact that in the real estate bubble, there simply
was no saving glut. In the 13 year period 1994-2006, the
rate of saving in the US, together with all foreign
saving allegedly entering the country in connection with
deficits in the current account, never exceeded 7
percent, and in 8 of those 13 years was 3 percent or
less.
What has served to
conceal how low the actual rate of saving has been is
the fact that major fictional items have been counted in
saving, which add hundreds of billions of dollars every
year to its reported amount. The most notable instance
is that purchases of single family homes that the buyers
intend to occupy and that will thus not be a source of
any money revenue or income to them, are treated as
though they were nonetheless purchases of income
producing assets and therefore represented an
investment. Similarly, government spending on account of
buildings and structures is treated as investment. Such
overstatement of investment correspondingly understates
consumption expenditure in the economic system. And when
the artificially reduced amount of consumption is
subtracted from any given amount of national income or
GDP, saving appears to be equivalently larger.
The alleged saving
entering the American economy via deficits in its
current account is in fact largely not saving at all,
but the by-product of US credit expansion and money
supply increase. Dollars today are a virtual global
money. And in conformity with Ricardo’s principle
concerning the distribution of the precious metals
throughout the world based on the relative size of the
economies of the various countries, most of the
additions to the supply of dollars and short-term claims
to dollars cannot remain in the possession of Americans
but must gravitate into the ownership of foreigners.
This creates a deficit in the balance of trade and in
the whole of the so-called current account. While it may
appear that increased foreign holdings of dollars and
short-term dollar-denominated securities represent
foreign investment, the truth is that much or possibly
even all of the alleged foreign saving entering the
United States is nothing other than a consequence of US
credit expansion and money supply increase.
Finally, net saving
itself, as a continuing phenomenon is nothing more than
a by-product of the increase in the quantity of money,
in that it would come to an end if the money supply
were to stop increasing.
The conclusion to be
drawn is that the housing bubble was indeed the product
of credit expansion, not a “saving glut.”
Copyright © 2009 by George Reisman.
George Reisman, Ph.D. is the author of
Capitalism: A Treatise on Economics
(Ottawa, Illinois: Jameson Books, 1996) and is
Pepperdine University Professor Emeritus of Economics.
He is also a Senior Fellow at the Goldwater Institute.
His web site is
www.capitalism.net
and his blog is
www.georgereisman.com/blog/.
A pdf replica of his book can be downloaded to the
reader’s hard drive simply by clicking on the book’s
title, above, and then saving the file when it appears
on the screen. The book provides further, in-depth
treatment of the substantive material discussed in this
article and of practically all related aspects of
economics.
NOTES
David R. Henderson and Jeffrey Rogers Hummel,
Greenspan’s Monetary Policy in Retrospect,
Cato Institute Briefing Paper 109, Cato
Institute, Washington, D.C.,
November 3, 2008, pp. 4f.