"Kee" Points with Jim Kee, Ph.D.

Markets breathed a sigh of relief last week as Scotland’s voters rejected independence and as The People's Bank of China incepted $81 billion of credit into the banking system. In the US, The Conference Board’s Leading Economic Index (LEI) for the US increased in August, a good sign. That’s because this third quarter is the one to watch for recession signs following the negative first quarter. According to the Conference Board’s Ken Goldstein, “the leading indicators point to an economy that is continuing to gain traction.” The biggest concern in the US is probably the housing market, which I think is aptly described as continuing to be “weak to moderate, not moderate to strong” (Cornerstone Macro).


Thoughts on savings: I attended a lunch last week hosted by the Federal Reserve’s branch bank here in San Antonio. Blake Hastings gave a reliable overview of Fed actions, pointing out that the tremendous amount of excess reserves of the banking system created through the Fed’s various asset purchase programs are still there at the central bank. During the Q&A, one of the attendees asked what the right level of savings in the US should be. Is the US rate of just over 5% of disposable income too low, and the Japanese rate (close to 15%) too high? As an economist, I have always found it interesting that savings discussions are usually discussed in the context of a morality play - the virtuous savers (the Japanese in this case), and the not-so-virtuous spenders (US).


The question could have been lifted straight out of a discussion from the 1980s. In fact, 25 years ago economist Milton Friedman wrote a piece titled “What is the Right Amount of Savings?” His answer, basically, was that the right amount of savings is whatever amount emerges from the individual decisions of separate households if undistorted by government policies.


Policies do influence savings decisions. You are probably aware that some policies discourage savings in the US. For example, taxes fall more heavily on savings than spending (consumption). Income is taxed when earned. If it is then spent, there is usually no further federal tax, but if it is saved, the returns to that savings are taxed as interest, dividends, capital gains, or non-corporate business profits. Additionally, when savings are used to purchase corporate stock, corporate taxes are paid on the income before it is paid out to shareholders. And at the end of it all, the cumulated after-tax assets that are amassed are taxed when transferred on through estate and gift taxes (Institute for Research on the Economics of Taxation). That’s what is meant by the “multiple layers of taxes on savings.” In Japan it has been the opposite. As the late Merton Miller used to point out, policies in Japan have typically ‘coerced’ people to save by restricting the types of investments (like mutual funds) that they could pursue with their savings. The goal was to fund the Japan Post, which was the largest holder of personal savings in the world (this, in turned, provided funds to banks and companies). The Japan Post was privatized by Prime Minister Koizumi in 2007, a move that was later put on hold. The point is that policies in the US discourage savings, while those in Japan encourage it. That leads to the prediction that Japan will save more than the US without resorting to explanations based upon the virtues and vices of the people. That’s economics at its best!


But isn’t spending better for the economy than saving? In theory, no. In a properly functioning market economy, increased savings doesn’t change the level of spending, just its composition. Savings is usually channeled, through financial intermediaries, into loanable funds for investment spending. So the idea is that increased savings leads to increased investment spending which, in the long run, leads to higher growth and incomes. The problem occurs when the savings aren’t channeled into investment spending but rather just built up or seated on the sidelines. That’s what we’ve seen during this expansion. Even with the increase in excess reserves of the banking system (reserves that could be loaned out), uncertainty regarding bank capital requirements and lending standards have hindered the process on the lending side. As an aside, given the nature of the financial crisis (the banking system was at the epicenter!), it is not clear that this uncertainty could have been avoided.  And fiscal policy (tax, spending, regulatory) uncertainty has hindered the process on the loan demand side.


In fact, it is this latter point that drove Hasting’s discussion regarding the economy at the lunch I attended: loan demand just hasn’t been there, and that has little to do with this or that “quantitative easing” program. That is precisely why Hasting’s boss, Richard Fisher (Dallas Fed President) voted against the latest round of asset purchases by the Fed. He felt that excess reserves in the banking system were already adequate, and that it is the fiscal side of the policy mix that needs attention. That doesn’t necessarily mean that the programs have been bad; they may well have put a floor under individual and business confidence. And of course, the Chairman of the Federal Reserve System has much more skin in the game than the regional bank presidents.


*Two weeks ago I mentioned that the International Monetary Fund (IMF) is forecasting flat to negative 0.4% growth for 2014 for Europe.  That number should be 1.1%.  And last week, I mentioned research suggesting that the relative attractiveness of stocks versus bonds is two standard deviations above normal.  Actually it is bond valuations that are two standard deviations avove normal, not the relative valuation of stocks versus bonds.