I have been reading up on the difference between household and national savings. On the surface it may seem as if the difference between the two is quite subtle, but actually that is not the case. Understand the difference and you may be close to understanding the single biggest factor that is causing the Eurozone to stay in depression. Understand that difference and you are close to understanding the single most important force behind the economic turmoil of the last few years.
I have been inspired for today’s article by this account by Michael Pettis: ‘Excess German Savings, not Thrift, Caused the European Crisis’ It is a good article, but it is long, and not easy to understand. So I attempt to simplify the key arguments here.
Let me begin by making two observations: you can’t eat money, and back in the 1990s Germany had problems.
It may seem as though saving is a good idea, and for individuals it usually is. But for the economy as a whole, saving does not achieve much. Instead, for the economy, it is investment that counts. For the global economy savings must equal investment. If a sector of the economy suddenly starts to save more, to balance the equation either investment rises in tandem with the rise in savings, or another sector of the economy must save less. And this means that one of three things must happen. Either something happens to discourage the sector wanting to save more from doing so, or the money this sector saves funds a rise in consumption elsewhere, or we see a fall in GDP.
In practice this means as follows. When one sector of the economy tries to save more, but investment does not rise either income is redistributed from the richest to the poorest – who tend to save less – we get a consumption boom funded by debt, or we get a rise in unemployment. The ideal scenario is that a rise in savings leads to a rise in investment, of course, but companies may not be keen to invest if they see reasons to believe consumption will fall.
During the boom years we did indeed see certain sectors of the global economy save a lot more. This rise in savings largely funded credit, and as some sectors saved more, others saved a lot less, which manifested itself in the form of a consumer credit boom.
Now let’s look at the causes. Well, today I look at one cause. You may recall that during the late 1990s, Germany struggled. The cost of reunification seemed to have been too high a burden for the country. Then under Chancellor Schroder and subsequently Mrs Merkel, things changed. Germany quite deliberately went about reforming its labour market. German wages to GDP fell. I remember that period well. Until the mid-noughties Germany was often compared with Japan, a country that had once seemed on course for economic dominance but had lost its way.
It is often said that the problem, as far as Germany and the Eurozone is concerned, is that German households save too much. But this mixes up the difference between national savings and household savings. It is true to say that German households do save rather a lot, but you can’t really blame them. The real problem is that in Germany wages make up a relatively modest proportion of GDP. It is not consumer savings that is the problem, it is corporate and government savings. And that is why the difference between household and national savings is crucial.
Now I said above that for the global economy, savings must equal investment. But Germany is not the global economy; it has the luxury of being able to export its savings.
During the noughties, German savings funded consumer spending in countries such as Spain. This continued until 2008 when we hit a kind of tipping point and it was no longer possible for households to run up debts.
Saving equals investment; savings are high in Germany, but investment is not rising so fast across the Eurozone, therefore something else must give. That is why we have such high levels of unemployment.
What are the possible fixes? Either German wages to German GDP must rise, or German savings must be allowed to fund investment elsewhere. And since companies don’t want to invest – because of low demand – the only way this can happen is if governments take these savings and invest them.
By the way, and in this respect I refer to Michael Pettis referring to the ‘FT’s’ Martin Wolf, who in turn refers to work carried out by the European Commission: “It takes a current account deficit of 4 per cent of GDP as a sign of imbalance. Yet, for surpluses, the criterion is 6 per cent.”
My conclusion today is this. The reforms to the Eurozone are occurring and there are signs that the Spanish economy is becoming more Germanic. This is seen as a good thing, but it ain’t. If wages across the euro area to GDP start to fall, as they have already done in Germany, then the region must export its savings elsewhere. This is a recipe for economic depression, especially when you consider that China too adopts a Germanic type of economic model.
PS: On the subject of savings equalling investment, think of it this way: what we don’t consume we must invest. For the global economy, where government spending is either a form of consumption or investment, GDP equals consumption plus investment. If we save more, but don’t invest more, GDP automatically falls until reduced consumption plus investment equals GDP.
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