When desired savings exceeds desired investment

In his recent lecture series, The Return of Depression Economics, Paul Krugman described the current global economic situation as one where desired savings exceeds desired investment. In other words, a savings glut where people are saving more money than what other people want to borrow to invest in new enterprises.

That got me thinking. What should we expect to see in a recession with a savings glut? What happens when there is more money looking for a place to be invested than there are worthwhile productive enterprises to invest in? One thing that occurred to me is that in the absence of a sufficient quantity of worthwhile investments in productive capacity the excess savings would tend to flow into commodities and assets that are perceived as having the potential to appreciate in value. You don't want to just leave the money in cash or T-bills earning nothing, and commodities at least have the potential to rise.

If the excess savings (defined as the excess in savings over the demand for investment in new productive capacity) flows into commodities (at least in part) its going to drive up the price of the commodities. The rising prices of commodities will push the prices of finished products higher. In non-recessionary times this would lead to inflation. However, since the economy is in recession, with high unemployment, lots of excess productive capacity, and increasing savings rates, the rising prices will reduce real demand. Consumers won't spend more, so rising prices will just result in a reduction in the quantity of goods sold. Falling consumer demand will reduce profits and increase unemployment and at some point the bubble in commodity prices will pop as investors realize that the bubble commodities are sure to fall and stream for the exits.

So, I am seeing the potential in the near to medium term for a pattern of serial asset bubbles in the context of a fundamentally stagnant economy. Excess savings will flow into some asset or commodity, creating a bubble. The bubble will fuel a perception that things are looking up ('green shoots'), drawing more money into the bubble. Prices will rise. Consumers will fail to increase spending to match the rise in prices. The softening consumer demand will put the money invested in the bubble at risk. Speculators will exit the bubble, triggering another slide.

Paul Krugman's Robbins Lectures: The Return of Depression Economics

I just finished listening to podcasts of Paul Krugman's recent lecture series at the London School of Economics "The Return of Depression Economics."  What he was saying made a lot of sense to me, and it didn't leave me feeling optimistic.

You can download MP3s of the 3 lecture series here at the London School of Economics website.  You have to scroll down and find them.

You can get the slides that go with the lectures here:

Lecture 1: The Sum of all Fears
Lecture 2: Eschatology of Lost Decades
Lecture 3: The Night They Reread Minksy


The New York Times is already taking 'the recovery' for granted

I was struck by this headline in today's New York Times:

High Gas Prices Could Slow Recovery

All this green shoots talk has apparently convinced the New York Times that its a foregone conclusion that the recovery will start in the next few months.  Here is how I would have written the headline:

High Gas Prices Could Deepen Recession

My view is that high gas prices won't slow recovery, they will kill the "green shoots" outright before they have a chance to grow.  If oil and gas prices continue to grow for the rest of 2009 it will cause consumer spending on all other sectors to continue to fall.  I don't see how we can have any meaningful recovery if consumer spending falls.

My personal intuition, which I haven't taken the time to try and support with evidence, is that the recession was triggered by the spike in oil and gas prices last summer.  I suspect that rising gas prices were the straw that broke the camel's back for a lot of people who went into default on their mortgages.