I've heard these arguments a lot recently and they always seem to stem from the idea that there is only one sort of "savings", namely retail deposits in banks and building societies. And indeed, the usual definition of "savings" does mean cash, in its various forms, so bank deposits are "savings" whereas pensions are not - they are "investments". I'm not sure people necessarily make such a clear distinction in everyday parlance. But Phelan's argument is an economic one. How does economics define savings?
In economics, "saving" is the residual of income left after consumption. If S = saving, Y = income and C = consumption, S = Y - C. Note that S is the dependent variable: its value depends on the values of Y and C. When these change, so does S. This is fundamental to understanding what the present policies of central banks are intended to achieve.
Keynesian economics also says that all saving should be invested productively in the economy to generate future growth. Indeed, Phelan's entire argument rests on this - after all, if savings aren't invested productively, it is hard to argue that they are essential for future economic growth. If investment is I, therefore, S = I.
Now you can see that we immediately have a problem. If savings = cash, then all investment is cash. Clearly this is wrong. It seems savings has two, quite different, definitions - the common one (savings = cash) and the economic one:
S = Y - C = I
This is really important. Back in the good old days when people were paid in cash, people's idea of saving was to put money in the bank or building society. And many people in the UK still think like this. As someone put it in a comment on Phelan's post, "if I take my money out of the building society, where do I put it?" To this day, in the UK, when people talk about saving, they think "bank".
But cross the Pond, and you find people thinking very differently about how to save. There, stock market investments are a way of life. Very ordinary people have stocks & shares, and bank deposits are much less important as savings vehicles. Are we going to argue that because our American cousins invest their residual income in stocks and shares rather than putting it in the bank, that they don't have "savings"? Clearly this is nonsense. The common definition of savings is simply inadequate. People's "life savings" are the sum total of all the residual income they have stashed away over the years, whatever form it is in. To call stashing away cash "saving" and everything else "investing" is economic nonsense. All of it is S.
And ideally, all of it is I, too. The heart of Phelan's argument is that savings are essential if there is to be productive investment. I completely agree. But bank deposits are not the main source of such investment. These days, even in the UK, the main sources of savings for productive investments are funds - pension funds, money funds, wealth funds. And as more people are enrolled in private and corporate pension schemes, those sources will become ever more important. Though in fact bank deposits are really only another sort of fund. The idea that they are in some way "different" from any other sort of investment is fundamentally wrong.
Money in bank deposit accounts has been lent to the bank. It is no more "your money" than any other sort of investment. When you put money in the bank, you exchange cash for a financial asset - a balance on a deposit account. That is no different from buying a bond. In fact you can view bank deposit accounts as bonds: the interest on the account is the coupon, there may or may not be a maturity date (if there isn't it is a "perpetual"), it may or may not be liquid (how easily can you sell it/take your money out). And banks treat deposits in the same way as bonds. As I've explained elsewhere, to banks deposits are simply a source of funding. You have lent your money to the bank just the same as if you have bought its bonds. The bank has no responsibility for "looking after your money" or investing it to generate a good return for you. It will invest your money, yes, but to benefit itself, not you.
So, does S really equal I? Is all saving really productively invested in the economy? Or is there saving that isn't productively invested - and where does it fit in?
No, S does not necessarily equal I. At the moment they are a very long way apart:
(Chart from Paul Krugman via Monetary Realism. Source: FRED. US data, but a similar picture of collapsed private investment and high private saving applies in the UK too - though in the UK it is more corporate saving than domestic).
As the chart above shows and Aziz explains, at the present time there is a glut of savings and a shortage of productive ways of using them. The story of the last five years has been a massive failure of corporate and government investment, not because corporates haven't got any money - they have enormous cash balances - but because they can't think of anything useful to do with their money apart from buying back their own stock. And long-term, the need for investment capital seems to be declining as manufacturing becomes more efficient and services more dominant in the economy. But at the same time there has been a huge growth in saving, both domestic and corporate.
This is the real reason why interest rates are so low. Savings that aren't productively invested can't generate a genuine return for their owners. All they can do is extract rents from wage earners and taxpayers to create the illusion of a return. Unless we can find productive uses for all this saving, it simply isn't needed. And when there is a glut of anything, it makes sense to discourage producing it and encourage activities that reduce the glut - in this case, since it appears corporates aren't investing because of a shortage of demand, most obviously consumption (since S = Y - C). Despite what Phelan says, therefore, discouraging saving and encouraging consumption until the economy is growing again makes complete sense from a macroeconomic standpoint.
Unfortunately it doesn't make sense from the point of view of people's needs over their lifetimes. People need to save, particularly to support themselves in retirement and to cover unexpected expenses. This creates a considerable dilemma: from an economic perspective we don't need more saving, but from a personal perspective we do. I am not unsympathetic to this problem, but it seems to me that attempting to persuade those responsible for macroeconomic policy to favour personal needs over economic needs is doomed to fail. The central bank is not responsible for ensuring that people can save. That is the responsibility of the fiscal authorities.
There is a lot that governments could do to help people save in a low-growth, low-investment world, but first they have to get out of the straitjacket they have made for themselves. The primary purpose of government debt is not to finance government - after all, it can create all the money it needs - but to provide safe savings vehicles for citizens. Governments should produce the amount of debt instruments for which there is (domestic) demand, and stop worrying about future debt service. After all, those debt instruments are the current savings of those who will be old in the future. Either those people buy government debt, and are supported in the future from taxes levied on future generations to pay debt service, or they don't, and are supported in the future from taxes levied on future generations to pay old age pensions. Really there is no difference. We have to stop getting so hung up about public debt. Public debt is the savings of the people of the country, and they should have as much of it as they need.
So where does QE fit in? Does it really create "fake" savings, as Phelan suggests? No. The deposits created by QE are real. They are indistinguishable from any other sort of savings.
In the real economy, deposits are created as a consequence of bank lending. The savings deposited in banks by savers, or paid into their pension funds, were ultimately created as a result of someone else's borrowing - perhaps their employer, in the form of working capital finance enabling him to pay their wages: or perhaps someone who borrowed to buy products from their employer, providing business income from which wages are paid. The loans that originated the funds deposited by our savers can be some distance removed from them, which is why it is hard for people to understand that they only have money because others have debt. But it is important to understand that loans create deposits, not the other way round.
So normally, in our economy, saving is only possible because others have debt. This is the S = I rule looked at the other way round, of course. As Andy Harless suggests (following Keynes), S is only possible because there is I, where I is some form of debt, physical asset or equity (equity is really only a bonded form of debt, as people enslaved because of indebtedness could tell you). Substituting Monetary Realism's breakdown of I, that means that when I is falling because of lack of productive investment opportunities, either S must falls too (dis-saving or debt increase) or unproductive hoardings of financial assets must increase. It might help to look at the equation again:
S = Y-C = I + (S-I)
When it is doing QE, the Bank of England buys bonds, mainly from investors (though some from banks), in return for newly-created money. These bonds were originally bought with cash, either by individuals or by institutions (funds) on behalf of individuals. In buying the bonds, all the Bank of England does is replace an interest-bearing asset - a bond - with a non-interest-bearing one, i.e. cash. And what do investors do with this cash? They put it in a bank, or they spend it, or they invest it in some way. If the seller of the bond is a bank, it invests the money in some way, or it parks it at the central bank. QE money is real money replacing real assets that have been previously bought with real money. The only difference is that instead of the assets being bought by other savers with money that banks have created through lending, they are bought by the central bank with money created by the central bank. Other savers are therefore forced either to compete for the remaining bonds, or to invest their money in some other way (ideally by buying riskier assets, thus encouraging I to increase) or spend it (reducing S by increasing C). Phelan's suggestion that QE money is somehow disconnected from individuals' savings is simply wrong. It would not be possible to do QE unless individuals (and institutions representing individuals) already had savings in the form of government bonds and other securities that could be bought by the central bank. What QE does is influence how people invest their savings, not create "fake" savings as Phelan suggests.
It may be that in the future, the economy will have a greater need for saving for investment - though thirty years of interest rate decline is not exactly promising:
UK 10-year gilt yield
(source: Trading Economics)
Or maybe there will be such a decline in saving that demand for what remains forces up interest rates - though successive governments trying to encourage people to save for their futures without providing enough vehicles for them to do so doesn't help matters. If there is a criticism I would make of QE from the point of view of savers, it is the fact that it reduces the stock of safe assets for long-term savings, raising the price and reducing the returns. Savers who don't want risk aren't going to diversify into riskier assets: savers who are saving for retirement aren't going to spend the money instead. They will either pay the higher prices for safe assets or put money in the bank. Either way they will get rubbish returns, since the fact that deposit accounts and gilts are substitutes means the rates will be pretty much the same on both. In other words, they will simply substitute one low-yielding safe asset for another, while moaning about how unfair it is. This strikes me as pretty pointless. But then my regular readers know I am no fan of QE.
In summary, although I agree with Phelan that saving is necessary for investment in a healthy economy, at present we have more savings than we know what to do with. Central banks see the present problem as principally a demand shortfall, which is depressing economic activity and discouraging corporate investment (if companies can't see adequate sales opportunities for the foreseeable future, they won't invest). Their strategy is to discourage saving and encourage consumption. This brings forward demand from the future to the present, which should generate economic activity and encourage companies to start investing again.
This is what lies behind Carney's observation that the best thing for savers is a strong economy. Raising interest rates would reduce household and business consumption, increase corporate finance costs and further discourage already low corporate investment. Keeping interest rates low until the economy is stronger is painful for savers in the short-term, but in the longer-term it will benefit both them and the future generations on whom they will rely for their income.
I suppose everyone will now think I've really got it in for Save Our Savers. Actually I really haven't. But I do wish they would get things right.
Since a couple of people have pointed out that S can only exceed I if either the public sector is in deficit or the external sector is in surplus (or both), I am adding a section on sectoral balances.
The full equation is:
S = Y - C = I + (G - T) + (X - M)
where G = government spending, T = tax revenue, X = exports and M = imports.
Rearranging this equation gives us S - I = (G - T) + (X - M).
Clearly, if S > I then either G > T (fiscal deficit) or X - M (trade surplus), or both. So S - I, which is the "bit left over" after the private sector has made all the productive investments it desires, is made up of fiscal deficit and/or trade surplus.
If C increases and Y does not, I may decrease (less private sector capital investment). This is what we fear, and if there really are few profitable investment opportunities despite increasing C, this is what we will see. However, if central banks are correct to believe that increasing demand stimulates investment, it seems unlikely that increasing C would result in falling I. The opposite - increasing I - is what we want and is the reason for encouraging C to rise. However, it is also possible that I could remain unchanged and (S-I) could change. In an economy that is over-producing, this outcome is certainly possible. However, the FRED chart shows I rising and (S-I) remaining pretty much unchanged until very recently. The UK's corporate investment picture is not so promising: gross fixed capital formation over the last few years has been dismal.
Save Our Savers' argument is that we need C to FALL, not rise, to increase S, and therefore they want higher interest rates to encourage saving and discourage (leveraged) consumption. This is based on an assumption that increasing S always feeds through into increasing I. I'm afraid the story of the last few years is that it does not.
This sectoral balance stuff is not easy. I got it wrong in the first version of this postscript! Please read JKH's link (Monetary Realism). He explains it much better than I do.
Why suppressing savings will lead to another recession - John Phelan, Save Our Savers
Why savers should put up or shut up - Azizonomics
Investment makes saving possible - Andy Harless
JKH on S-I-S-I - Monetary Realism
Paul Krugman does S-I-S-I - Monetary Realism
Lender, beware - Frances Coppola, Pieria
Government debt isn't what you think it is - Coppola Comment
Quantitative Easing Explained - Bank of England (with pdf links for more detail)
Quantitative Easing: Lessons we've learned - St. Louis Federal Reserve
Bank of England boss warns against choking off recovery - Evening Standard (with video)
The investment problem - Coppola Comment