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January 15, 2011

A Dearth of Savings

By Sterling T. Terrell
The economy is floundering as a result of increasing regulations, ill-advised monetary and fiscal policy trying to prop everything up, and more international competition at every turn.  One other thing is also true: as a nation, we are told, we are not saving enough.

Well.  Maybe that's not true.  What is "enough," really?  And enough compared to what?  The personal savings rate is actually up from its all-time lows of the last decade.  (Historically, U.S. saving has also been low compared to in other countries.)  But in this case, comparisons matter little.  The reason that we don't save enough is simple: We don't save "enough" because economic growth has slowed -- making us worse off; and savings fuels economic growth -- making us better off.

Any student taking an undergraduate intermediate macroeconomics course should be able to expound on the subject through a reasoned explanation of what is called the Solow Growth Model, also referred to as the Exogenous Growth Model.  In a short, non-technical manner, the Solow Model says that, all other things equal, the savings rate will basically determine economic growth.  Said differently, more saving means more output.  And more output is good.

This line of thought makes sense if you think about it.  People save.  The more savings there are, the more capital accumulation there will be.  The more capital that is accumulated, the more capital per person there is in a given society.  The more capital per person there is, the higher a given worker's productivity will be.  And the higher a worker's productivity is, the higher that worker's wages will be.

Because of this, from a policy standpoint, America should encourage savings and discourage borrowing.

But is that what we do?  Of course not.  We do the opposite.  We encourage borrowing and penalize savings.

In the housing market, in particular, America encourages borrowing by those who can least afford it, through manipulative bank regulations with help from the likes of Fannie Mae and Freddie Mac.  This issue really begins with the Community Reinvestment Act of 1977.  On the CRA, economist Thomas DiLorezo holds nothing back:

When the CRA was created during the Carter administration, the administration also funded with tax dollars numerous "community groups" that have helped the Fed, the Comptroller of the Currency, and other federal regulatory agencies to enforce the act. Under the CRA, if a bank wants to make virtually any change in its business operations - merging, opening up a new branch, getting into a new line of business - it must first prove to regulators that it has made "enough" loans to the government's preferred borrowers. The (partially) tax-funded "community groups" like ACORN (Association of Community Organizations for Reform Now) can file petitions with regulators that stop the bank's activities in their tracks, perhaps defeating them altogether. The banks routinely buy off ACORN and other "community groups" by giving them millions of dollars as well as promising to make even more dubious loans.

The issue is the same when it comes to other forms of credit.  In the housing markets, as well as the credit card market, restrictions are made on "predatory" lending.  All that means is that lenders are by law prevented from being able to match interest rates on loans with the amount of risk associated with that loan.  Only having to pay 10 percent interest, when one's risk profile dictates a 20-percent interest rate, leads to more borrowing.

At the same time that America is encouraging borrowing, it is also penalizing savings through confiscatory estate taxes, one of the world's highest corporate tax rates, the double-taxation of corporate dividends, high state property taxes, and progressive income taxes.

For what?  More earmark spending?  Higher pay for civil "servants"?

Maybe even more significantly, savings is also penalized through inflation.  The late economist Ludwig von Mises provides a great explanation of the effects of inflation from years gone by:

An example of what I mean was furnished by the president of a bank in Vienna. He told me that as a young man in his 20s he had taken out a life-insurance policy much too large for his economic condition at the time. He expected that when it was paid out it would make him a well-to-do burgher. But when he reached his 60th birthday, the policy became due. The insurance, which had been a tremendous sum when he had taken it out 35 years before, was just sufficient to pay for the taxi ride back to his office after going to collect the insurance in person. Now, what had happened? Prices went up, yet the monetary quantity of the policy remained the same. He had in fact for many, many decades made savings. For whom? For the government to spend and devastate.

Inflation does make sense, however, in the face of hard decisions.  Facing the facts of large budget deficits, there are really only four alternatives that can turn the tide back: Grow the economy faster than the debt (the opposite of what America is currently doing), make huge cuts in government spending (that are public and unpopular), raise taxes to pay off the debt (also public and politically ill-advised), and finally, inflation (a move that is quiet and essentially invisible).  What politician wouldn't prefer an invisible tax?  Look to the nation of Zimbabwe for an exaggerated recent example.

(Some economist argue for "measured" inflation as a means of avoiding deflation at all cost.  For the life of me, I can't understand why.  Would you rather that, with every year that passes by, that dollar in your pocket be worth more and more, or less and less?  The answer seems obvious.)

Until America and its policymakers decide to foster a culture of savings in an environment that does not destroy it, we will suffer the consequences.

And indeed, we are.

Sterling T. Terrell is an economist and writer living in Texas.
on "A Dearth of Savings"