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.

Did this recession happen because we just ran out of stuff worth doing?

I posted this comment to a Paul Krugman blog posting noting that this recession was different than most recessions in that with this one interest rates low going into it.

One that that struck me over and over again during the Greenspan years was that GDP was growing at a lackluster rate (around 3%) despite big deficit spending and very low interest rates. It was like seeing a person get a huge doses of amphetamines but still have barely enough energy to drag themselves through the day. It made me think our economy must be on the brink of collapse if the economic equivalent of crystal meth was required to just make it seem normal.

Keynes once said that the long term interest rate is determined by what kind of future profit borrowers expect from capital investment. If borrowers see lots of opportunities to make a lot of money, they will be willing to pay more to borrow, and vice versa. In other words, look at interest rates for what they say about demand for borrowed funds instead of what they say about the supply of money.

Putting this together, maybe the story of this recession is that all through the Greenspan years people saw the prospects for profit from real capital investment (investing in new businesses that generate profits from selling new goods and services) getting dimmer and dimmer so interest rates had to be pushed lower and lower to get them to continue to borrow and invest, until the point was reached where there were no worthwhile real capital investments left to invest in and the recession began.

This model isn't inconsistent with the bubbles we saw. It makes sense to me that when one runs out of worthwhile real capital investments then one would start to put easy money into speculating on assets and commodities. If there were ways to make a solid 10% profit from buying new capital assets and opening new businesses would there have been any market for subprime mortgage backed securities?

Housing Bubble 2: Rental Properties

Investors are swarming to buy up foreclosed houses in Phoenix to rent out to tenants (Amid Housing Bust, Phoenix Begins a New Frenzy)

I wonder what will happen to monthly rental rates in Phoenix when all those surplus houses are converted to rentals.

I wonder what will happen to housing prices when rental rates start to fall and all the would-be landlords run for the exit?

I wonder what will happen to all the lenders to the would-be landlords?

The NY Times fixes their faux pas in another article

Yesterday I mentioned that the NY Times ran a silly front page story saying that the new credit card legislation would cause the credit card companies to get rid of reward programs and other perks for customers who pay their balance every month.  Today, Ron Lieber mocks that notion in a Your Money piece, but doesn't mention that it was his own paper that bought this industry propaganda hook line and sinker the day before.

Your Money: Consumers Are Dealt a New Hand in Credit Cards

Why is the NY Times running credit card industry propaganda on the front page?

This front page story in the New York Times today struck me as really weird:

Credit Card Industry Aims to Profit From Sterling Payers

The thrust of the story seems to be that if Congress passes legislation to more tightly regulate credit cards then all the people who pay their balance in full each month are going to get charged higher rates, have to pay annual fees, and lose all perks like cash back plans, etc. To me it seemed like the piece was slanted to generate opposition to the pending legislation by people who would otherwise be neutral about it (the people who pay their balances each month promptly). While I know that seems paranoid, the article completely failed to mention an obvious flaw in the thesis that credit card companies would raise rates and fees on good customers: People who pay their balances every month don't need credit cards at all, and the only reason they have them is because they can get cash back and pay no annual fee. If the credit card industry tries to raise rates on people who don't really need consumer credit they are going to lose those customers in droves. Not to mention that each credit card company is going to have a strong incentive to poach "sterling payers" from its competitors by continuing to offer perks like no annual fees and cash back.

There is a reason that all these perks evolved in the first place: it was the only way to attract and retain these "sterling payers," and new legislation that makes it harder to squeeze the less-than-sterling payers is not going to change that reality. It reminds me of the delusion currently popular with the media that just because they are losing advertising revenue their readers are going to have to pay more for content. There are reasons that free content evolved in the marketplace, and the loss of advertising revenue doesn't change any of the market forces that created free content.