Sunday, January 15, 2012

Simon Wren-Lewis — Savings Equals Investment?


Read it at Mainly Macro
Savings Equals Investment?
by Simon Wren-Lewis | Oxford University
(h/t Mark Thoma)

5 comments:

Clonal said...

There was an interesting comment from Nick Rowe in there, and I commented as below


Quote:

there is no Paradox of Thrift. There is a Paradox of Hoarding Money (the medium of exchange).........Keynes was wrong on this; Silvo Gessel was right.

This leads me to ask the question. What happens when financial institutions "invest" in other financial assets while at the same time leveraging the money (medium of exchange) they have - I am thinking CDO's SIV's etc. which were like a stack of cascading bets of increasing size, based on a very small "real" asset base.

How does this work in the National Income macroeconomic accounts?

Tom Hickey said...

Clonal, the problem as I see it is that market price, which is determine at the margin, that is, by the most recent transaction, is equated with real value. Owing to market action this can become wildly distorted and that implies an inevitable correction. For example, multiplying the most recent quote by shares outstanding yields the present market capitalization. Financial analysts are pretty well aware of the real value of the assets in terms of cost, replacement value, and other real measurements.

The difference between the market valuation and the fundamental or actual valuation is the amount of "good will" the market is extending based on expectations of future growth. Due to the use of leverage and trading wrt momentum instead of real value, that is, relying on technical analysis to the exclusion of fundamental analysis, can lead to asset overvalue valuation in terms of market price.

Since the market valuation is marginal, it doesn't take much to collapse when the trend shifts and there are more sellers than buyers in a market previously dominated by buyers. What happened during the GFC is proper estimation of risk exposure went on holiday. It was, as Chuck Prince, put it a game of musical chairs that risk managers, ultimately the CEO's, had to play as long as the music was playing and hope they weren't left without a chair when the music inevitably stopped.

Clearly, this was not "investing" in the financial sense of the term. It was wild speculation that was essentially gambling using high leverage. It was crazy in a sector that is supposedly chiefly fiduciary and carries government guarantees, explicit and implicit. It was a textbook case of moral hazard.

This was based on the same sort of mistake in valuation in local RE markets. Pricing the land and cost of building gives the actual value. Comparing that to the market price often revealed a huge discrepancy. Some people I know made a lot of money just buying up lots and putting modular homes on them, a job that can be finished in short order and turned over. This was easy money so a lot of people rushed in to do it, bidding up lots and costs, since the subcontractors were in great demand and could raise prices on their work and get it.

Anonymous said...

This is all part of the maddening conceptual framework of mainstream macroeconomics that encourages fallacious reasoning by burying natural categories under idiosyncratic professional semantics.

"Investment" and "savings" are implicitly defined so that savings = investment by definition. But then we are told that "investment" in the macroeconomists' sense includes both stock-building and spending on capital equipment. But stock-building is precisely what normal people call "savings", while investment is more sensibly understood as the employment of income or stocks in a productive process. Everybody understands the difference between saving some surplus grain in storage, on the one hand, and feeding it to some laboring animals who plow the field or get fattened up for slaughter, on the other hand.

Why does any of this matter? Because if you ask an economist whether it would be a good thing to tax away the surplus savings of the wealthy in order to transfer them to others who will either consume them or invest them in a productive process, he will probably start getting slippery on you again and say, "Oh no, we can't do that! Don't you know that savings = investment? If we tax away the savings of the wealthy we are just shifting wealth out of investment in one place and into a combination of consumption and investment elsewhere. This is no net help!"

It makes you think that a good part of professional economics is devoted to cooking the national accounting books with bogus labeling to hide the unemployed surplus wealth of the wealthy under a bogus blanket with the Pickwickian label "investment" on it.

Clonal said...

Tom,

My question had more to do with -- how do you account for money creation by the banks (leverage) in National Income accounts where the assets being bought are themselves financial assets, with little or no linkages to corresponding real assets - for example I take out cheap insurance on your house which is built on an eroding river bank, knowing that no insurance company will check on the physical viability of your house, as the insurance companies rely on "the law of averages" rather than an actual inspection -- but now say 10,000 insurance policies are taken out on the same property. How do you account for that?

Some thing similar was taking place prior to the GFC and continues taking place today.

Tom Hickey said...

Well, all those derivatives had to be insured against loss as part of risk management, and that's were the CDS came in. Again, part of the musical chairs with the moral hazard of the government having to supply the missing chairs, e.g., by bailing out GS through its takeover of AIG.

I'm sure that the accounting was perfect through, every asset matched with a corresponding liability. "No laws were broken. Nothing to see here, move on."

However, Bill Black tells a different story, as does Michael Hudson and others.