The Obama administration's stimulus package may have boosted spending in the short-term, but savings have a more lasting impact on the broader economy.
Should we put more into the ATM or take more out?
Despite the struggling economy, President Obama keeps arguing that his stimulus package is producing GDP growth that's far better than the disaster that would have ensued without the $862 billion in emergency spending. The reason, he and his advisors maintain, is that what really counts is spending -- the more the better, at least for now.
The sole thrust of the administration's policy is to boost consumer and government spending by borrowing heavily, and then recycling those dollars to people who are most likely to spend them on restaurant meals, PCs or toys. At the same time, it's vastly lifting federal outlays on everything from auto fleets to subsidies for solar panels.
All that "new" spending supposedly saved the economy. As Obama stated in December, "When you lose a trillion dollars in demand, you need to have a big enough recovery package to make up for the lost demand." In August, Treasury Secretary Timothy Geithner used the "consumption is king" rationale to champion keeping the Bush tax cuts for middle-income Americans who typically spend the cash, and ending them for high-earners, who save most of it.
But the administration's policy has a fundamental flaw. By basic economic math, it's impossible to raise GDP by borrowing from one group of people who would otherwise save that money, and transferring it to another group of people, and to the government, to spend. Savings, in the short term, have precisely the same impact on national income as spending.
The reason couldn't be simpler: All savings are spent. Let's look at the big picture. GDP measures all spending on all the goods and services that America produces. Savings translate, dollar for dollar, into a major component of that total spending: investment. All the money that the administration successfully moves from savings to consumption simply channels one type of spending to another, in precisely offsetting amounts. It's like filling a swimming pool from one end, and draining it from the other end. The level doesn't change. Nor does GDP change when the government drains investment to lift consumption.
We've all heard the argument that since consumer spending accounts for around two-thirds of GDP, a pro-growth policy must overwhelmingly concentrate on raising that number. But remember, GDP is composed of three other components, including government outlays, the surplus of exports over imports, and private investment. It's indeed possible to raise consumer spending by a significant amount, say from 65% to 75% of GDP, by reducing both private investment and net exports––in fact, that's what's happening right now. That's real legacy of Obamanomics.
What savings will finance
Over long periods, it's savings––not consumer spending––that finance the investments in mainframes, robots and other capital equipment that enhance productivity and drive economic growth. "President Obama keeps saying that only consumption counts," says Allan Meltzer, the distinguished economist at Carnegie Mellon. "It's foolish. Of course the money that people save doesn't go under the mattress. It goes to individuals to buy a house, or to businesses to build a plant."
Let's examine how savings translate into investments, and hence into a crucial source of spending––for the future, the most crucial. When people save, they either purchase stocks or bonds, or they deposit the cash in the banking system. When they buy newly-issued securities, those savers provide companies with the cash to purchase equipment, or buy factories and call centers via acquisitions. When they buy CDs or deposit money in savings accounts, the bank typically lends that money either to corporate customers that spend it to expand, or to the government by purchasing treasuries––and once again, the funds are quickly spent.
Indeed, the very purpose of the banking system is to guide savings into new spending. "If someone spends $20,000 on a new car, the money goes right into GDP," says John Cochrane of the Booth School of Business at the University of Chicago. "If the same person puts it in the bank, it's loaned to a company that buys a forklift. The savings go straight to investment spending, and lift GDP by the same amount."
What if the government borrows most of the money from foreign investors, as America does today? Unfortunately, luring cash in from China and Japan doesn't change the economics. To buy our Treasuries, foreign investors must first sell us far more of their products than we sell them, forcing the U.S. to maintain a trade deficit year after year. That gap between exports and imports lowers GDP by precisely the same amount that the money they loan us raises GDP. The result, as with sapping savings to raise consumer spending, is a wash.
In one theoretical case, government borrowing could actually raise total GDP. It's worth mentioning because this scenario was essential to the theories of John Maynard Keynes, whose prescriptions are extremely influential in the Obama administration. If lots of cash sits on the sidelines, outside the banking system, then the government can add to national income by enticing the people hoarding it to buy Treasuries. Indeed, when Keynes formulated his theories in the Great Depression, consumers mistrusted banks, and kept loads of cash in safes and safety deposit boxes. His solution was to get that idle money moving again.
Cash balances, or accounting entries?
Now, it's a different world. Only tiny amounts of cash generated from selling cars, say, or collecting interest, sits idle. While households have virtually no funds outside the banking system, the banks themselves are holding lots of idle money, or rather, potential money. Those funds have nothing to do with what constitutes GDP, the production of goods and services. They are an accounting entry generated by the Federal Reserve to increase the money supply. Banks keep that money on deposit with the Fed, and only draw it down––in other words, translate it into real money––when demand for loans increases.
Right now, demand for credit is so weak that a gigantic $1 trillion in excess reserves are now on deposit at the Fed. "The Fed is simply giving the system the oil it needs to run smoothly," says J.D. Foster of the conservative Heritage Foundation and a former George W. Bush budget official. "That money doesn't provide any horsepower to the economy." As Foster points out, those reserves are so oversized that while they're unlikely to generate more growth, they can produce high levels of inflation.
So what is the real result of Obama's "stimulus?" The plan has surely shifted money from savings to consumption, although the amounts are impossible to determine. For example, the Making Work Pay program last year gave $800 in cash to middle-class families. It's probable that they spent more of that money than the folks who bought the bonds, who typically have higher incomes, would have spent. The grants to the states to maintain government jobs made those workers feel more comfortable about their futures, and doubtless gave them the money and confidence to spend more of their incomes. The government also spent tens of billions directly on goods and services.
So what would have happened if we'd had no stimulus at all? By economic law, all of the money that was borrowed and redirected to consumption would have gone somewhere else. Two other components of GDP would have to be larger to offset the almost $900 billion in spending and borrowing. First, private investment would be higher, because of the bigger pool of savings, a great sign for the future. "It's big increases in private investment that always drive a recovery," says Cochrane.
Second, the U.S. wouldn't have to borrow nearly as much from abroad. As a result, the dollar would be lower versus other currencies, reflecting its true value. Hence, imports would be more expensive, and our exports far more competitive on the world markets. The rise in exports would help offset the hit to GDP caused by lower consumer spending. Bigger investment and exports on a tear? That's certainly a good alternative to the results of the stimulus.
To be fair, GDP might not be any stronger than it is right now, and it certainly wouldn't be any worse, either. And our economic future would look at lot brighter.
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This argument is essentially correct. Keynes saw deficits as counter-cyclical measures. Deficits during recession, counterbalanced by offsetting surpluses during the expansions. He never endorsed large secular deficits. Constant growth in anything, including GDP, is inherently unsustainable as any physicist will tell you. We have lived beyond our means for too long and the reality is that we need to shrink our way out of this problem.
Scale-back, re-calibrate and live within our means. In other words - austerity.
Jeff, we would receive less in interest if the banks didn't lend out our money. Our interest is derived from the interest being paid on the loans that the bank makes, if it doesn't make any loans it isn't paying interest.
Clearly some of the people commenting here have not taken basic econ classes. The author makes a perfectly sound argument, of course its simplified but still correct.
Fiscal policy had NOTHING to do with Japan being dug out of their economic hole. The central bank in Japan had set interest rates too high, it was when they finally lowered them that they started to see results, this is why Bernanke has lowered the rates as much has he has, that is monetary policy not fiscal policy. Constant government spending in Japan did NOTHING for years. The so called "stimulus package" is a joke and the logic behind Keynesian economics is poor at best.
Saving Money? How's this going to protect and grow our money? Buying stocks and bonds?? No way! This is an OLD economic strategy!! We live in a "New Economy" and need "new economic strategies" to prosper.
Too many people stealing our money right now right from beneath us, and not enough people know about the Conspiracy Against Your Money. watch the video....http://www.TheConspiracyAgainstYou.com/?t=cnn
Glad to see all the others pointing out the flaws inb this argument. The general public might buy this argument, but it's written so that most people wouldn't understand it. And those who know enough about economics easily see that even the author refutes his own argument.
Another criticism of the author who "blames" the spending plans on the Obama administration. This is rewriting history - it all began with the George W. Bush administration, and was continued with the Obama administration. Someone referenced "yellow journalism." Perhaps so.
This is flawed logic of a sort not ascribed to by the majority of the profession. Has the author not herd of a liquidity trap. Savings operate to stimulate the economy by increasing the quantity of and reducing the price of credit. This function works quite well when the economy is operating within a normal range of activity, but not when faced with near-deflationary conditions. In these circumstances, as Keynes taught, fiscal policy is needed to spur the economy and provide a stop-gap until there is a return to self-sustaining growth through the savings-investment function.
Interesting read but I have to disagree. The idea of savings resulting in stimulus is potentially true over a very long time horizon but is not necessarily what is required or desired when attempting to jolt an economy out of recession. The US is a consumption driven economy and getting money into the hands of the consumer and keeping people employed in the short term is what will keep factories producing, malls open and restaurants serving food. Capitalist economies run on confidence and when people stop spending, confidence erodes and more people stop spending. Ultimately this is a death spiral and the investments will not occur regardless of the savings since the return on investment is no longer guaranteed.
The author must not be a Keynesian and likely thinks the Great Depression played out as it should have.
This guy needs to go back and retake econ 101. Epic. Fail. When you're in a liquidity trap and facing deflation, you don't encourage saving...that's why Japan lost a decade!
For private business/investor, no one is out there to lose money. Everyone is out there to make a profit preferably. When unemployment is sky high(it would be higher without stimulus and government spending), everyone feels bleak about the future so they would hoard cash. Hence no one is spending and business don't ramp up production by hiring and investing in equipment. The result would be further shrinking of production on goods and services. The economy would be in a downward spiral so why shouldn't government take the lead and keep economy going?
Interesting article at best. A few points: B uying stock, bonds and real estate is only investment if they are new issues. Calling your broker up and buying stock is not investing, it is an asset purchase. This may drive asset prices higher, but does not go back into the economy. That money is out of play until the stock is sold.
The money that is used for lending must be paid back, with interest. This actually takes money out of the economy, producing profits for an industry that invests in credit (more loans). Once loans cannot be serviced, no further credit can be extended and the money goes to assets (stocks, bonds, golde).
If there is a $1t sitting on the sidelines, and the reason is that demand for credit is low, what could you possibly do to increase demand for credit?
The author is delusional. Savings do not equal spending. When someone buys a car, the manufacturer must make another to keep inventory. So all of the suppliers of parts and all of the workers keep their jobs to maintain that production. If someone takes that same amount of money and parks it in the bank, the author argues, that the bank then has that money to lend to businesses that would buy things. The problem with this theory is that companies are currently sitting on record levels of cash so they don't need to borrow more. Also, banks have plenty to loan (via TARP), so they don't need the consumer to put more money into the bank. The banks already have a source of funds outside of joe consumer. And what happens if that money that the saver has is then invested overseas - in real estate, foreign stocks, etc. It does nothing for the local economy. The key is to get money into the hands of consumers to spend - not save. There is a difference.
When did a career in journalism qualify one to interpret macro-economics?
These posturing journalists presenting themselves as sophisticated when they probably don't understand velocity, or even marginal rate of return.
Thks kind of poorly informed journalism is nearly "yellow sheet" in my opinion.
sounds like bs to me
savings, at least in part, are extracted form the economy they are not spent until consumers feel "safe' they are likely to maintain a higher than average savings rate, compared to the recent past the kicker is the new reserve requirements for banks that lock these savings up and keep them out of the economy
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