Bernanke Be(e)n blogging a whole lot in recent days. His latest touches on low interest rates and his theory of the “global savings glut”. This theory has been thoroughly refuted in these papers (see here and here), but I wanted to touch on one particularly important point in the Bibow paper because it dovetails with my earlier post so well.
Bibow cites an old comment from Bernanke on the rationale for his global savings glut hypothesis:
“these countries increased reserves through the expedient of issuing debt to their citizens, thereby mobilizing domestic saving, and then using the proceeds to buy U.S. Treasury securities and other assets. Effectively, governments have acted as financial intermediaries, channeling domestic saving away from local uses and into international capital markets”
Did you catch that? That’s just loanable funds theory and more financial crowding out. In other words, Bernanke’s global saving glut theory is based on the same myths I discussed in my previous post. In essence, Bernanke is working from the view that savings drives investment rather than the reverse. Keynes called this a “nonsense theory” long ago:
“The classical theory of the rate of interest seems to suppose that, if the demand curve for capital shifts or if the curve relating the rate of interest to the amounts saved out of a given income shifts or if both these curves shift, the new rate of interest will be given by the point of intersection of the new positions of the two curves. But this is a nonsense theory. For the assumption that income is constant is inconsistent with the assumption that these two curves can shift independently of one another. If either of them shift, then, in general, income will change; with the result that the whole schematism based on the assumption of a given income breaks down. The position could only be saved by some complicated assumption providing for an automatic change in the wage-unit of an amount just sufficient in its effect on liquidity-preference to establish a rate of interest which would just offset the supposed shift, so as to leave output at the same level as before. In fact, there is no hint to be found in the above writers as to the necessity for any such assumption; at the best it would he plausible only in relation to long-period equilibrium and could not form the basis of a short-period theory; and there is no ground for supposing it to hold even in the long-period. In truth, the classical theory has not been alive to the relevance of changes in the level of income or to the possibility of the level of income being actually a function of the rate of the investment.”
In other words, investment drives saving. It’s very common for financial “experts” and economists to argue that saving finances investment or that saving is the key to financial success. Although it’s an intuitively attractive framework (because we all think our quantity of savings finances everything) this is exactly backwards in the aggregate. Investment (not the financial type you’re probably aware of with regard to buying stocks and bonds) is spending, not consumed, for future production. When you invest in your future you build an intangible (or tangible) asset that (likely) makes you more valuable. In other words, when you invest in yourself you make your future production more valuable which makes your future income more valuable which allows you to save more of your income in the future. Importantly, investing adds to aggregate saving because one does not dissave in order to spend on investment. That is, when you invest you have an asset that is as valuable or more valuable than your prior savings PLUS someone else has your spending as their income. So investing drives saving.
Bernanke’s global saving glut hypothesis gets these points exactly backwards. Not only does it perpetuate the loanable funds myth (ie, the pool of aggregate savings is some fixed supply that we all tap into), but it promotes the misguided view that savings drives investment.
That’s a very general overview here. For much more thorough debunkings of Bernanke’s views please see these excellent papers by Jorg Bibow of the Levy Institute and Claudio Borio and Piti Disyatat of the BIS.
- Saving is not the key to financial success
- Global Imbalances, Jorg Bibow
- Global imbalances and the financial crisis: Link or no link?, Claudio Borio and Piti Disyatat
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.