The people who run our country don't know what "investment" means.

It's very simple. Businesses 'invest' (in productive assets, tangible or intangible) and individuals (or pension funds on their behalf) 'save' (defer consumption), by either accumulating money in the bank or buying shares (directly or a pension fund does it on their behalf).

Individuals dissave (accelerate consumption) by cashing in a pension; withdrawing money from the bank and spending it; or selling shares and spending the proceeds. When one individual buys shares, another must have sold them, so the two sides cancel out and it's not even net saving, let alone net investment.

The actual businesses whose shares are bought and sold couldn't care less who buys and sells their shares and are unaffected. They make profits (hopefully), reinvest what is needed to make more profits in future and dish out the rest as dividends to whoever own the shares.

The people who run our country (from MPs to the Governor of the Bank of England) are too stupid to understand this not particularly subtle or difficult point. From City AM:

Three hundred MPs are calling on the trustees of the £700m Parliamentary Pension Fund to end their investments in fossil fuel companies...

The pledge, supporters of which include Labour leader Jeremy Corbyn, Lib Dem leader Jo Swinson, SNP Westminster leader Ian Blackford, and mayor of London Sadiq Khan, stated: “We believe members of parliament have a responsibility to act on climate change, and a unique opportunity to show leadership on climate action, responsible investment and the management of climate risk through addressing the practices of our own pension fund.”

Caroline Lucas MP, the leader of the Green Party, said: “I am encouraged by the huge number of MPs who now agree that we must move our investments away from the polluting industries of the past, and instead support policies that will bring about a clean energy future.”

Bank of England governor Mark Carney and the Environmental Audit Committee have warned that people’s pensions are exposed to overvalued carbon assets as the world moves quickly towards cheaper, greener renewables, and governments legislate for net-zero emissions.

OK, so all "ethical" pension funds simultaneously try to dump their shares in oil or mining companies, what happens? The price falls and they've lost a lot of money anyway - and the yield to future investors goes up. Other pension funds, whose very statutory duty is "getting the best return you  can for your pension savers" would be acting entirely unethically if they didn't snap up those cheap, high yielding oil and mining company shares on behalf of their pension savers. Oil companies won't care less either way.

And anybody who drives a car is contributing to oil companies' profits and encouraging them to continue extracting oil; there's no point them being squeamish about owning shares in oil companies and thereby getting a bit of their own money back.

"Five sticking plasters which will fail to transform the UK into a truly capital-owning democracy"

Some meddler from Policy Exchange has dreamed up five random measures which he thinks would encourage saving, see City AM.

Like all politicians, he ignores the fact that the main point in saving when you are earning well is to be able to dis-save (i.e. spend more than you earn i.e. use up your savings) when you aren't. It's about maximising the marginal utitlity of consumption. On an individual level, over a lifetime, the optimum savings ratio is precisely zero (you can't take it with you!), so on an aggregate whole-population level it must also be zero. But hey.

The infuriating thing is that he actually identifies much of the cause of our collective lack of savings in his opening paragraph:

As a nation, we are bad at saving. While the reasons for this are many and varied, the belief that house prices are a one-way bet..."

Correct. There is an easily identifiable, long run negative correlation between house price inflation and saving; people respond very quickly, so in 2008-10, people started saving again. If you kept house prices low and stable, that would be an extra 5% saving per year. And we know how to achieve that.

... the design of our welfare system...

Well yes and no. Asset-based means testing is spiteful, pointless and badly designed. If it somehow budged people into dis-saving in the bad times it would be OK but by and large, it discourages a lot of people from saving in the first place.

To the extent that they absolutely have to do asset-based means testing (to minimise cost of welfare state), at the very least they should only assume a reasonable return on savings (rather than making it all-or-nothing) and include housing wealth as well as proper cash savings and investments. And there is no need for means-testing, we already have a tax system to take away part of people's income.

But means-testing seems to be politically popular (or else they would have got rid of it years ago).

... and the inability of humans to properly judge their future financial needs all contribute to UK households putting less aside than their counterparts in other G7 counties."

The vast majority of the UK population doesn't have any spare income so it's a flawed sample, and other countries aren't quite as Home-Owner-Ist. Either people are struggling to pay off sky high mortgages and rent; or they are merrily doing mortgage-equity withdrawal and pissing it away.

Once you understand all this, it must be pretty obvious that all his silly gimmicks (like handing out free Lloyds and RBS shares) or having compulsory 12%-of-salary pension contributions are pointless at best and counter-productive at worst.

The supply and demand curve for "money" (2)

Continuing my post of last week, where I looked at the supply and demand curve down to about the interest rate which people are or would be prepared to borrow to spend on bricks and mortar, which is about 8%.


If we just look at this supply and demand curve, we observe that the net return to savers is pretty flat whoever the borrower is.

But there is something else dictating interest rates. There is a subtle difference between 'saving' and 'investing'. Basically, households 'save' and businesses 'invest'. (It is quite possible that household savings go into business investment, which is double plus good, but that is a overlap and not the main event).

The distinction is this: let's say a farmer normally harvest 52 units (weeks' worth) of food, exactly enough to see himself through the whole year. In a hypothetical good year he harvests an extra 20 units.

i. He can 'save' those 20 extra units by selling it to hungry people on credit, so when the harvest is not so good, he can call in the loan of food. He can also demand the payment of interest on that loan (he gets back more food than he lent out), so in future, he could, if he wished, consume an extra 2 or 3 units a year for the rest of his life, but that is only at the expense of the original borrowers, who have to make do with consuming 2 or 3 units less than otherwise.

ii. Or he can 'invest' that food by exchanging it for better implements, or by exchanging it with somebody who will improve his walls and drainage. In future, the farmer can now produce 2 or 3 extra units of food each year, but without anybody else having to consume less.

That is what drives the minimum interest rate which 'savers' will accept. If the farmer knew he could increase his future potential harvest by an extra 4 units a year by 'investing' 20 units this year, then a buyer on credit would have to offer to pay at least 4 units a year in interest before the farmer will consider 'saving' rather than 'investing', and so on.

(The problem is that savers cannot just invest in productive assets, because those are all monopolised by limited companies, so before savers can get a share of the profit from the underlying productive investment, they have to pay a ransom payment to an existing shareholder, which pushes up returns to existing shareholders at the expense of future shareholders and the economy in general, separate topic).

As we observed last week, the interest rate which people are willing to pay depends largely on how much they need to borrow, how quickly they need to spend the money, and how soon they hope to pay it back.

That all makes sense so far and the arrangement is to our overall benefit. Where it goes crazy is once interest rates drop below that rate of approx. 8%:

Broadly speaking, the descent into insanity goes in the following three stages, but the general rule is still that the further into the future the borrower's hoped for extra consumption will be, the lower the interest rate he is willing to pay:

1. If you can borrow money for less than 8%, then the lower interest rate just goes into higher land prices (rather than bricks and mortar), i.e. if you can rent a house for £6,400 (net of landlord's costs) and borrow at less than 8% to buy the building, you are happy to do so. But if you can borrow at (say) 5%, it is worthwhile paying/borrowing £128,000 (it still only costs you £6,400 a year), and that extra £48,000 just goes into the land monopoly black hole.

2. If people expect nominal land prices to continue to rise at a long term rate of 5% or more a year, then if you can borrow at less than 5%, it makes sense (on an individual level) to buy land for the sake of it (money into the LMBH), whether you need it or not, because you can realise a gain (more money into the LMBH) in future which will pay off the interest for you.

3. Because bankers seem to get paid according to the volume of loans they can make, rather than the bank's actual profit margin, bankers try to "grab market share" by lending out at very low rates (Bradford & Bingley, Northern Rock etc), the bank itself (the bankers' employers) make losses on such loans of course. It is no coincidence that the cumulative losses of all UK banks over the credit bubble decade were approx. equal to the total bankers' bonuses paid in those years.

None of these three stages are of any remote benefit to society in general or the productive economy as a whole, and are in fact incredibly damaging. They do not help people spread consumption over their lifetimes by borrowing/saving; they do not lead to any investment in productive capacity.

Bricks and mortar are of course productive capital if they are in the right place, but the land is not, and even it were, pushing up the price does not increase the amount available - and a society which believes that house price rises are A Good Thing tends to be a NIMBY society, so we end up with less productive capital (housing, factories and so on).

Why UK and other governments think it is a good idea to constantly nudge the economy towards these final three stages, and why so many people go along with this nonsense is a mystery to me.

Economic Myths: High interest rates encourage saving; low interest rates boost consumption

These platitudes are trotted out over and over again for example at Wiki.

There must be something in it, but Excel tells us otherwise.

1. The most important form of saving (apart from paying off your mortgage) is of course saving for your old age, i.e. a pension. Let's ignore tax subsidies/distortions and pension company charges (the two largely cancel out) and assume low and predictable inflation so all we need to consider is real interest rates.

2. Our idealised pension savers would like to have an annuity of £10,000 (the annuity company works on a remaining life expectancy of, say, 25 years) when they retire and start saving the same annual amount each year 25 years before they retire.

3. If real interest rates are 1%, they have to save up a final pot of £220,000, which requires savings of £7,798 each year. If real interest rates are 2%, they only have to save £6,095 a year to end up with £195,000. And if real interest rates are 3%, they only have to save £4,776 a year to end up with £174,000.

4. So if you are confident that real interest rates will be quite high, you can get away with saving £3,000 less every year than if real interest rates are going to be very low (they are currently negative, of course).

Of course, mortgages work the other way round.

5. Again, assuming a minimum spread for the banks of 1%, in a low real interest rate scenario, real mortgage rates are 2% and paying off a £160,000 mortgage over 25 years costs £8,200 a year. If interest rates are 4%, it costs £10,200 (£2,000 more).

6. So in a high real interest rate scenario, our typical saver couple is 2 x £3,000 better off for the 25 years they are saving for their old age and £2,000 worse off for the 25 years they are paying off their mortgage (there will be ten or twenty years in the middle where the two overlap).

7. All things considered, they are on average £4,000 a year better off with high real interest rates - they can spend £4,000 more each year - and that's ignoring the fact that they could optimise the position further by paying off the mortgage a bit more quickly and then saving more towards their pensions over a shorter period.

8. The real beneficiaries of low interest rates are of course banks and bankers, but as they are not producing anything, merely consuming other people's output (or do not produce anything extra, merely because interest rates are lower), total production is not increased whether real interest rates are high or low.

And if production is unchanged, then consumption is also unchanged, it is just that with higher real interest rates, the relative share of total output consumed by banks and bankers drops quite considerably and our hard-working hard-pressed etc. couple gets to consume more (of their own output).

10. UPDATE - as Bayard points out in the comments, large landowners benefit enormously as well because they can sell off bits of land for much higher prices.

Just sayin', is all.

"Well, transparency is one thing" says B of E spokesperson "but we didn't want to upset hard working, hard pressed families

who have one of these heavily advertised and strongly promoted 'bank with us and we'll reward you for depositing £1000 every month, aren't we just marvellous' type accounts ..."

Banks and building societies have since January knocked nearly £850m off the annual interest paid to savers, the Telegraph can disclose. The cuts coincide with banks making billions of pounds in profit in the first half of this year.

The clawback, buried in the details of a report published on Monday by the Bank of England, affects existing customers who hold easy-access savings accounts.

More than 750 cuts have been made to these accounts in just six months, despite the Bank of England Base Rate remaining unmoved at 0.5pc.

However, deeper analysis of the report exposes banks for hacking back the rates paid to loyal savers as well. These movements are made behind closed doors, never publicised and therefore rarely scrutinised.

The average rate on all easy access accounts is now just 0.97pc, down from 1.14pc in January, the figures show.

This is equal to a miserable £485 a year on each £50,000 of savings, compared with £570 in January - a reduction of around a sixth.

By shaving 0.17 percentage points off the return they pay loyal savers banks have been able to swell their coffers, as the lower outgoings free up cash to use in more profitable parts of the business. This is typically lending arms, where banks are taking advantage of renewed enthusiasm in the property market.

Based on the total amount of money in easy access accounts - £496bn according to the latest Bank of England report - this amounts to £843m in lost annual interest.

It must be just me, I guess ... I obviously live in a different world ...

Taking time out from the usual to enjoy a cup of that which refreshes but does not inebriate whilst scanning the MSM's on-line sites (those that aren't paywalled, any way) my eye was drawn to Does overpaying a mortgage beat saving? which turned out to be one of those "a reader writes and our expert answers" articles.

My suspicion that the expert was going to say "right now, probably yes given the piss-poor rates of interest available via most savings vehicles unless you have a considerable amount of free cash which you are willing to tie up and leave untouched for quite a long time" was borne out. And of course, readers are advised to apply their free cash to eradicating higher interest bearing debts like credit cards and loans first.

The line that brought me up with a start though was "As to which of your mortgages you should start overpaying first..."

Multiple mortgages and still worrying about "what best to do with our free cash each month"? Yes, in my haste I had skipped reading the actual question: "My wife and I have two mortgages with our lender and we reckon we can afford to overpay them by up to £500 a month. The larger mortgage is on a fixed rate of 5%; the smaller one, a top up to buy our second home, has a much lower tracker rate. Is it a good idea to overpay rather than saving the £500 a month? If it is, which mortgage is financially best to overpay first?"

Reply to Mark In Mayenne

Mark In Mayenne left a new comment on Surprisingly astute comment in The Daily Mail...

Help me out here Mark please.

If I have spare cash that I wish to invest, how is buying a house to rent out less productive than buying shares or gold or putting it in a bank account or whatever to store my wealth while I don't need it?

Thanks, Mark

If an "asset" already exists, then one person selling it to another (with the intention of collecting rent or capital gains*) does not add to the sum total value of human wealth by one penny, does it? And if you pack in your job (stop creating wealth) and become a BTL landlord (just collecting rents), then the total amount of wealth created goes down.  It's only people creating new stuff and exchanging it with other people's output that creates or adds to wealth.

So for that matter, buying shares or gold is not "productive" either. If you buy £20,000 of Volkswagen shares, then no wealth is created or added. If you want to spend your £20,000 on a new Volkswagen, then £20,000's worth of wealth will be created in response to that demand (the new car). Bank accounts are meaningless, it all depends on what the bank does with the money (do they use it for productive or unproductive lending?).

* Of course, part of the rent relates to actual services provided (maintaining and insuring the house, bearing certain risks such as damage or non-payment) and a capital gain might partly relate to improvement expenditure. That is not rent or capital gain for these purposes.

Outbreak of commonsense

From The Daily Mail:

Millions of people are ‘abandoning’ pensions and turning to tax-free Isas, a major report reveals today.

It accuses Britain of having a ‘failing pension architecture’, which is ‘hugely complex’, ‘unattractive’ and lost in ‘a forest of regulation’. The Institute of Directors’ study says faith in pensions is ‘dwindling’, with soaring numbers switching to the tax-free Individual Savings Accounts.

The latest figures from the Office for National Statistics show Britons put £22.9billion into a pension, such as a company scheme or a personal pension, in 2009 – a decrease on £24.9 billion in 2008 and £25.6 billion in 2007*. By comparison, they put £44billion into Isas during the 2009/10 tax year, according to HM Revenue and Customs. This rose £10billion to £53.9billion last year.

* This must mean individual contributions not employer contributions and net of the tax breaks, as total gross contributions incl. tax breaks are in the order of £80 billion, and the tax breaks are in the order of £30 billion (ignoring contracted-out NIC).

1. The usual justification for the insane tax breaks for pension saving (three-quarters of which are soaked up in fees and commissions) is that "we have to encourage people to save" and by implication "if we didn't encourage people to save, they wouldn't save at all", but this is proven, yet again, to be complete nonsense.

2. Yes, there are some superficial modest tax breaks for saving in an ISA (which are also probably soaked up in fees and commissions, to be honest) but let's gloss over tha, we can safely assume that those people saving into an ISA would have saved anyway even without the modest tax breaks.

3. The stat's show that there is little or no need to encourage a large chunk of the population to save as they'll do it anyway, let's say that's 50% of the working age population. Then there are people who are either spendthrifts or simply have no spare income, they'll never save, regardless of incentives, let's say that's 40% of the population.

4. So the tax breaks (£30 billion) are all spent on chivvying that marginal 10% of the population who wouldn't otherwise have saved into saving (whether pension or ISA or otherwise). The marginal 10% save up £8 billion (£80 billion x 10%), so the cost of the tax breaks is four times the amount saved. And those £8 billion savings might simply represent underpayments on a mortgage, so are not real savings (i.e. deferment of consumption) at all.

5. Even if that £8 billion represents deferred consumption, the purpose of saving up in the good times is to spend it in the bad times. The real benefit from saving is the extra marginal happiness you get from spending £5,000 every year of your life instead of spending £10,000 a year in the good times and £nil in the bad times. It is not an absolute loss, the point is just that the extra £5,000 you could have in the bad times bring you far more happiness than spending £10,000 rather than £5,000 during the good times. It's called 'marginal utility'.

6. So the £30 billion tax breaks increase the happiness (marginal utility) of the marginal savers by perhaps £2 billion (a quarter of £8 billion). That seems like a colossal waste of money to me.

Right, now all we need to do is explain to people that the best form of saving is paying off your mortgage, and even better than that is taking out a smaller mortgage in the first place, job done.

More savings myths debunked

1. The point of saving

When people talk about "saving" it's usually in warm and glowing terms and while holding out a hand for subsidies, but as ever, they are only looking at one half of the equation, i.e. the "not spending" and "building up assets" bit. The point of saving is not to build up assets, and saving still makes sense even if you get no investment returns at all. Saving still makes sense even if high inflation/low interest rates are eroding the value of your savings.

The point of saving is actually to spread consumption over time, and more than that, it's about maximising the value of consumption to yourself*. You could, if you wanted, take your monthly salary and go on a three day festival and then live like a pauper for the rest of the month, but most people find that they are happier if they spend (or consume) roughly the same amount every day or every week.

The same applies on the level of a lifetime, there will be times when you dis-save (when you're not earning money - by spending your savings or getting into debt) and there will be time when you save (by earning money and putting cash to one side or paying back debt). From the point of view of each individual, the ideal net savings minus dis-savings ratio over a lifetime is precisely nil (even better is to die in debt, but you'd have to time it right).

There is also the point that, apart from land prices in a Home-Owner-Ist system, most things get cheaper over time. If you wanted to buy a PC for £2,000 in the early 1990s but could only afford to save £10 a month, it would not have taken you 200 months to save up, because after 100 months, the price of a PC fell to £1,000. And you started saving up £10 a month towards a PC ten years ago, it would actually only have taken you 50 months to save up for an even better PC which by then only costs £500.

So when politicians wail on about the UK's low savings rate, they are missing the point. If the ideal net savings ratio for any individual over a lifetime is nil, then the ideal aggregate for the whole population, some of whom will be saving and some of whom will be dis-saving at any one point in time is also nil.

* The fancy terms used by economists is "marginal utility of consumption", people (usually) get the most happiness from the first few units they consume of anything and it gets less and less after that. If you like apples and spend £2 a week on a bag of nice apples, that's because eating one apple a day gives you (more than) £2's worth of happiness a week. But you would not spend £2 a day on them and force yourself to eat half-a-dozen every day. That would give a lot less than £2's worth of happiness a day.

Another way of looking at it is that rich people get much worse value for money. Instead of spending £8 a month on bags of supermarket apples, they might buy a single apple from a special Fair Trade farm run by African orphans of land-mine victims. Yes, this special apple might taste a bit nicer than yer supermarket apple (and give you the warm glow of righteousness), but only a bit.

In the same way, you can buy a perfectly usable second-hand car for about £2,000; for £20,000 you can buy a new one, which smells nicer, uses a bit less petrol and has all sorts of gadgets in it; and if you spend £200,000 you can get something really fancy (but probably completely impractical). But somehow I doubt that the man across the road gets a hundred times as much happiness from his Lamborghini than I do from my Mark II Golf.

2. Saving is not the same as investing

If we assume a clear split between 'households' and 'businesses' (there isn't of course, but it makes thinking about it easier), the reason why households and individuals save is to spread consumption over time. The ideal overall 'savings ratio' is nil. Of course, if you can earn interest on your savings (or any other investment return), that increases the amount that you can consume over your lifetime, so hooray. But the extra consumption you can afford because of investment income is a bonus and not a feature.

When businesses invest, this has the specific purpose increasing future production capacity, by and large, most of this is (or could be) paid for out of retained profits. The ideal 'investment ratio' for businesses is hitting the correct trade off between e.g. spending £1 billion on making 100,000 cars a year using the existing production line, or spending £1 billion on a brand new production line which is more efficient and can be used to manufacture 150,000 cars every year in future once it's finished.

That is real 'investment', there is no such thing as a negative production line. But when you buy shares in that car manufacturer in the hope that the decision to build the new production pays off, this is something quite different, assuming that the production line was paid for out of retained profits anyway; if you buying shares is 'investing' then whoever sold you the shares is clearly 'dis-investing', and this is not net investment in anything.

3. Home-Owner-Ism is anti-saving

As we have established before, taking out a large mortgage early in life in order to live in the largest possible house is not saving; it is dis-saving (running up debts is the opposite of saving). Living in a larger house, compared to living in a smaller house, is not saving, it is consumption. For sure, paying off a mortgage is a type of saving, but even better is to take out a smaller mortgage and to pay it off more quickly; once paid off, the extra spare cash you have which you no longer need to pay off the mortgage can be used for real saving.

There is also the wealth illusion. The Homeys believe that when land prices go up, they are getting richer, so they save less and do mortgage equity withdrawal. They are consuming more now in the hope that whoever buys the house from them will pay a much higher price, in other words, they are hoping that future generations will save even less.

As we see, the savings ratio drops when house prices are rising and recovers when house price bubbles pop again:Data from the ONS.

For sure, part of the reason why the savings rate jumps during recessions is because people tighten their belts, but what if house prices stayed low and stable? Then people wouldn't be able to do mortgage equity withdrawal (which is quite clearly dis-savings) and which adds about six per cent to people's disposable incomes (i.e. increases consumption) during house price bubble years: Chart from Duncan's Economics Blog.

Savings Myths

This general set of related topics was suggested by Chef Dave in a comment to my recent post on why the Multiplier Effect is a load of nonsense. We know that politicians love waffling on about "encourage people to save" or bemoaning a "low savings ratio" and so on in order to justify all manner of counter-productive policies, but what on earth does this mean in practice..?

1. First of all you have to decide for yourself what "savings" really are, or what the point of doing it is, and whether "savings" is not an aim in itself but merely the result of "people and businesses behaving rationally", in which case, there is no need for a government to do anything to "encourage saving" and it is quite sufficient to simply get rid of all the policies which discourage people and businesses from acting rationally.

2. Secondly, you have to decide how to measure "savings" or "the savings ratio" and if it cannot be done, then it would be impossibly to judge the success or failure of any policies designed to "encourage savings" in the first place. As far as I can see, the most important thing is looking at the actual substance of savings, wealth and investments in general, which i will lump together as SWIG for sake of a better word.

3. True SWIG is the actual productive capacity of the whole economy, taking public and private sector, businesses, households and individuals together. If businesses become more profitable, if output, employment and wages go up, then this is an increase in SWIG. We can argue the merits of the constituent parts, what is better - higher employment at lower wage rates or lower employment at higher wage rates? What is better - higher business profits or higher wages? But this level of detail is best left to market forces and are difficult to measure anyway - for example, does the income of a self-employed person count as 'profits' or 'wages'?

4. A fair measure of the total productive capacity are 'macro' things like GDP, or GNP if you want to subtract net imports. Of course these include 'made up figures' but as long as they are prepared consistently then an increase is good and a fall is bad. Employment and total wages can also be measured reasonably accurately, but quite what the level of unemployment is depends largely on how you define unemployment.

5. GDP and suchlike measures merely measure the flow or creation of wealth over a month or a year, and not the stock of SWIG at a fixed point in time. Is there any reliable way of measuring the actual stock of SWIG at any one point in time? To my mind, it is nigh impossible, or requires so many judgment calls as to be meaningless:

a. Total market capitalisation of companies, i.e. the market value of shares in issue and outstanding debt is unreliable, because share prices fluctuate a lot for reasons other than underlying profits, for example if profits go down by a tenth but interest rates fall by a fifth, then share and bond prices might still go up.

b. Land values (above and beyond bricks and mortar) are irrelevant, as they merely represent capitalised value of the future transfers of wealth from productive economy to land-owners, so for every £ in the selling price of land, there is a latent liability on everybody else to pay £1 in future. One man's gain by 'investing in land' may make sense on an individual level is less than the other man's loss on a macro-level. The value of bricks and mortar is not that reliable either. Although replacement cost can be measured, there are plenty of houses built which end up being worth less than what they cost to build, as happens when a land price bubble bursts (see ghost estates in Ireland, Spain, USA) or if you build a new house in an area prone to flooding or subsidence.

c. Cash in the bank is unreliable, it merely represents a claim on the bank's total assets, so we have to look through to how the bank has lent that money (or how the bank lent money to give rise to the deposits), which in turn gives the bank part-ownership of the assets of the borrower. If it was lending to productive businesses, then it would be sufficient to look at the income and assets of the borrowing businesses, if it is lending on (inflated) land values then this is not real wealth at all.

d. Money invested in government bonds or the future value of a public sector worker's pension is offset by an equal and opposite liability on the taxpayer, so that's meaningless, and because the recipient applies a higher discount rate to the likely receipt (uncertainty) than the payer applies to the liability (prudence), we actually end up with a net negative.

e. It is meaningless just to look at the assets of private sector businesses without looking at the corresponding assets of households. So if a hotel has TV sets in all of its rooms, or a launderette has washing machines, or a delivery company owns cars, those are worth no more or less than the TVs, washing machines and cars owned by private households. And how do you measure the value, even if you could count them all up? Replacement cost, value in use, depreciated cost, selling value? All these measures give quite different values.

6. Then we have the point that there is a fixed amount of SWIG (even though we have no real idea what it is worth in £'s at any one point in time), albeit hopefully growing at 3% or 4% a year, and that growth is simply down to businesses becoming more efficient or specialised as we get clever and cleverer in what we do. So that growth will happen anyway, who ends up owning it is a secondary issue.

7. On an individual level, of course any individual can be a net cash saver or a net cash borrower. It would be quite possible for every individual to have a small positive level of cash savings if the other side of the equation is a loan by the bank to a productive businesses (see 5c. above). This equation is self-correcting as regards productive investment - if everybody wants to save, then interest rates go down so more businesses can start up, or interest rates are so low that fewer people want to save.

If people's total cash in the bank is above and beyond that level required to fund true SWIG, then the chances are that the excess has merely gone into inflated land values or inflated share prices. Unfortunately, these bubbles become self-sustaining for a while, because people think that capital gains alone will pay off the interest, which is impossible in the long run (see 5 b.), and this all reduces total SWIG.

8. Further, the ideal savings ratio for any individual over his or her lifetime is precisely zero, by all means, borrow to finance your education or buy a house; then pay off those debts as fast as you can; then build up a surplus for a rainy day or retirement, but from a certain age, you maximise your own utility by spending it all again, because you can't take it with you. Unless it gives you greater happiness in your old age to give money to your children and grandchildren, which is an emotional thing, not an economic thing.
-------------------------------------------
Having established all that, let's have a detailed look at some of the savings theories and counter-productive policies doing the rounds:

8. The Austrian Theory of The Business Cycle "emerges straightforwardly from a simple comparison of savings-induced growth, which is sustainable, with a credit-induced boom, which is not."

There is no need for anybody to make a conscious decision to "save" to kick start anything. Underlying all this SWIG is the rational impulse of an entrepreneur to make more profits in future than he does today. Sometimes this involves spending money he has saved up, or working unpaid for himself, or persuading others to work for the business for low wages in exchange for getting a share in the business. Even if the entrepreneur borrows money from the bank, this is just a long-winded way for people who work for other employers reducing their disposable income in exchange for a share of profits in his business. (The same logic applies to studying or apprenticeships - lower wages or even running up debts for a few years in exchange for much higher wages in future. Employees are just entrepreneurs with only one customer - their employer.)

I would heartily agree with them that credit-induced booms are not sustainable, but they have a blind spot when it comes to describing the flip side of the credit induced boom - inflated land prices, and the obvious way of preventing those booms - shifting taxes from incomes to land values is anathema to them.

9. The Paradox of Thrift: "The narrow claim transparently contradicts this assumption [that what is true of the parts must be true of the whole], and the broad one does so by implication, because while individual thrift is generally averred to be good for the economy, the paradox of thrift holds that collective thrift may be bad for the economy.

Yes, it would be true that if all private households tried to spend as little as possible, the economy would soon collapse to a mere subsistence level. To some extent this effect explains recessions - when people are worried for the future, they spend less, so some businesses go out of business, then people get more worried etc in a vicious circle.

Further, it's easy to imagine that private households save by leaving cash in the bank (which is not really saving, on a macro level) but what about businesses? For them, real saving is reinvesting profits in greater capacity, so goods and services get cheaper until all but the parsimonious can no longer resist buying stuff, and under the 'paradox of thrift', business wouldn't be investing at all they would be running down plant and machinery, shedding staff and hoarding cash - does this count as saving or as dis-saving?

Finally, this paradox is never going to happen in practice, we are in the worst recession/depression since the 1930s but in most countries, GDP is only down five or ten percent (the same as in the 1930s). So any suggested solutions to the 'paradox' is tilting at windmills, we might as well devote the whole of our economy to dealing with the possible effects of the impact of a massive meteor (or climate change or something equally unlikely).

10. Some take this faintly silly argument to a dangerous conclusion: "Keynesians [who know little of what Keynes actually said, he was far more nuanced that this] argue that a liquidity trap means fiscal policy becomes very important for getting an economy out of a recession... The argument is that the rise in private sector saving needs to be offset by a rise in public borrowing. Thus government intervention can make use of the rise in private saving and inject spending into the economy. This government spending increases aggregate demand and leads to higher economic growth."

That site gives the monetarist counter argument to that. To my mind it's nonsense anyway.

a. There are things which only the government can do (such as overriding the interests of NIMBYs and other vested interests), some of these things are always worth doing, some are never worth doing. Some of these projects might not make sense when labour costs are high but might make sense during a recession when labour costs are lower, and contractors are willing to accept lower prices, but that's just common sense.

b. Doesn't this trample all over the freedom of the individual to save? What's the point in saving if the government is running up debts on your behalf - in the current context, by taking wealth from cash savers and transferring it to borrowers (land speculators and banks), which reduces SWIG.

c. Further, people worry a lot about large government deficits, so even if the government could find stuff worth spending money on (and they can't, we are way past that point), this extra worry might make people save even harder, thus exacerbating things under the Paradox of Thrift - see 9.

11. Then we have politicians wailing on about the savings ratio, a high savings ratio is seen as A Good Thing, this is more bunkum

a. The politicians have contradicted themselves completely by first wailing on about the Paradox of Thrift and using it to justify deficit spending and then trying to encourage saving at the same time. Even more bizarrely, they justify deficits by saying that it makes it easier for the private sector to save (do they want them to do so or not?) if the public sector is running up debts, it's perfectly circular non-logic.

b. The charts in Tutor2U (1980 - 1999, see previous link) and the chart here (1987 to 2009) show that the savings ratio is merely the mirror image of credit/land price bubbles. So if you want people to save (in the sense of genuine savings i.e. genuine increases in SWIG), the best thing is to prevent credit/land price bubbles (see 5b.).

c. Those charts mainly show the level of cash savings, which are in themselves an unreliable measure of real savings, i.e. real increases in SWIG (see 5c.). If you want to measure real SWIG, there are far better ways of going about it (i.e. to look at real GNP, or GDP minus net imports).

12. Then we have politicians wailing that people should be "encouraged to save", which all sounds very motherhood-and-apple-pie but leads to more nonsensical policies.

a. Some people will save anyway, some people (and i am one) will always try to restrict their spending to less than what they earn for fear that one day they will earn less. Some people will never save, regardless of the incentives. There is a small minority who wouldn't bother saving but for the incentives. These incentives are hugely expensive and incredibly badly targeted (they only affect the behaviour of the small minority and incentives paid to those who would have saved anyway are a waste of money). Finally, who pays for these incentives? Not the savers, but the non-savers. So this means that non-savers have even less money left over which they could save; and the small minority who "save" might not be net savers at all, they might just underpay their mortgage to take advantage of the incentives.

b. Tax arbitrage wipes out most of the gains to savers. Interest earned on cash in an Individual Savings Account is exempt from tax. Well big deal, all that happens is that banks offer lower interest rates on ISA accounts. The same larceny applies on a grand scale with pension funds. By and large, the return which a basic rate taxpayer gets by chipping post-tax income of £x into stocks and shares every month, or into a cheap tracker fund, will give him the same net-of-tax income in retirement (but with a lot more flexibility) as chipping in £x to an official pension fund.

c. There's a limited pool of SWIG for people to invest in. The total dividends paid out by UK plc's last year was £65 billion. The main asset of UK pension funds is shares, so the main source of income for pensions is dividends. There are 12 million people of pension age in the UK, so even if they'd all diligently saved into private pensions, then for every pensioner who gets a private pension of more than £5,400 a year, there's somebody who's getting less. These glossy adverts by private pensions companies which suggest that we can all have a super-comfy lifestyle in retirement are clearly bunk. For every couple who does, another couples can't, it's that simple. It's as insane as the Home-Owner-Ist idea that we can all be landlords and live off rental income, or that buying land is "investing".

13. Successive UK governments simply can't make up their tiny minds whether they want to encourage or discourage pension saving. As Iain Duncan Smith (the current welfare & pensions minister) points out in that second article, spending more taxpayers' money on a means-tested type of old age pension (Pensions Credit) actively discourages lower income people from saving up, because every £1 extra private pension (or investment income) they get means £1 less taxpayer-funded pension. So a good place to start is to have a non-means tested Citizen's Pension and leave people to their own devices if they want more than that.

14. Finally, we have the myth that rising house prices are a kind of saving or investment and should be treated as favourably as cash savings. They are not a kind of saving at all, they are merely a measure of how much wealth is being transferred from one group to another (see 5b.), best case, they purely paper capital gains and not real wealth at all. The interests of cash savers (to the extent that cash on deposit represents real savings on a macro-level, even if they are savings at individual or micro-level) and land-owners, particularly the highly leveraged speculators, which includes a lot of owner-occupiers are diametrically opposed and current government policies (low interest rates and corresponding high inflation) clearly favour the interests of those sitting on paper gains and are a kick in the teeth for those who have always lived within their means and put some money away.
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Right, that's enough to be getting on with, time for a coffee and cigarette in the back garden before the sun goes down.

The topsy turvy world of Mervyn King

From Mervyn King's opening remarks on this month's inflation report:

The story that inflation would be high in the near term but eventually fall back has been a feature of the past six Inflation Reports. We can take some reassurance from the fact that inflation is now falling. But we are still steering a course through choppy waters, and many people are experiencing difficult times.

Many savers continue to receive negligible returns on their savings. Over a million more people are out of work than was the case four years ago. And those who are working have seen the purchasing power of their pay sharply reduced. These are the consequences of the painful adjustment prompted by the financial crisis, and the need to rebalance our economy. Unfortunately there is no easy remedy.

We all want to return to a world with a more normal level of interest rates. But if we were to raise interest rates to such a level now, that would serve only to turn a gradual recovery into a recession, put more people out of work, and cut the value of assets on which many savers depend.

??? It's a bit worrying when the bloke who is supposed to be in charge of the monetary system can't tell the difference between "savers" and "borrowers", they are in fact opposites and their interests are diametrically opposed.

1. I see no evidence to suggest that increasing the Bank of England base rate a bit to its traditional level of inflation +1% would do much harm; that would mean interest rates going up to (say) 2.5% and inflation coming down to (say) 1.5%.

2. UK companies have deleveraged over the past few years and are not big interest payers; and for every £1 extra interest paid by borrowers (i.e. leveraged land price speculators), the disposable income of savers will go up by £1, net impact on the real economy precisely nil.

3. There are other things - like taxes, red tape, the National Minumum Wage, the welfare trap, and possibly even immigration - which have a far bigger impact on employment levels than nudging up the base rate ever so slightly.

4. Finally, what's all this chit-chat about "rebalancing the economy"? What he proposes is just more of the same old crap; he clearly sees propping up banks and leveraged land price speculators as his top priority, and to Hell with everybody else.

Workplace Pensions made easy

Click to enlarge:

A coincidence? I think not.

From The Daily Mail: SIX MILLION Britons have no savings at all

From The Evening Standard: Six million people employ home cleaner

I just can't make up my mind whether the six million people without savings are the ones who spent it on employing a cleaner, or whether the six million without savings are the ones doing cleaning for a living.

Either way, I'm surprised that only six million people have no savings - I thought the whole idea behind Home-Owner-Ism was to ensure that as few people as possible have any savings.

Fun Online Polls: Savings strategy and Fukushima

The results to last week's Fun Online Poll were as follows:

Which is the better investment?

Paying off your mortgage as quickly as possible/saving up cash to buy a house - 73%
Investing in stocks and shares - 27%

Please note that I was not trying to compare the respective merits of buying a house or buying shares as an investment, so I suppose I should have asked "Which is the better way of saving money?.

Nonetheless, I'm relieved that I'm with the majority on this one.
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The whole Fukushima catastrophe is still rumbling on, and we still don't know what the final outcome will be. For inexplicable knee jerk reasons, a lot of countries in non-earthquake threatened areas got the jitters about nuclear power, and nuclear power generally has taken a hiding in political terms over the last week.

So that's this week's Fun Online Poll: "Has the Fukushima catastrophe changed your attitude towards nuclear power?"

Vote here or use the widget in the sidebar.

On the continuing robust health of UK banks...

Alice Cook looked at the gross figures for interest received and paid by UK banks, and reckoned that UK savers have been stiffed out of £350 billion since the 'credit crunch'.

However the bulk of those figures relate to payments from one bank to another - what's more interesting is to go back to the original figures she used from the Bank of England (Table B3.1 available here) and look at the column for 'Net interest receivable' (Column X), i.e. interest paid by UK borrowers minus interest paid to UK depositors.

The results are as we suspected - annualised net interest receivable was about £40 billion until Q3 2007 and since then has risen steadily to £60 billion. Or another way of looking at it is that bank's long-run typical net interest spread of about 2% has risen to about 3% (UK banks' consolidated financial assets/liabilties are in the order of £2,000 billion*).

This probably understates the loss to savers, as the extra £20 billion the banks are earning might, for example, represent annual savings to mortgage borrowers of £20 billion and a reduction in interest paid to savers of £40 billion.

* For sure, their unconsolidated/gross assets are something mad like £6,000 billion, but two-thirds of that is inter-bank stuff, a trick they like to play to make each individual institution look as if it were 'too big to fail'.

Yeah, but I never said that...

KMcC left a comment on Please sir, may we take the piss?:

... your antipathy to pension saving is well-known to regulars here - but I do worry for your old age. What are you doing to provide for your golden years? (Any tips we happen to pick up in passing would be simply a bonus.)

As the world's most frugal man, I am all in favour of people saving up for rainy days, old-age etc. My antipathy is towards the propaganda that the only way of saving for your old-age is via "pension funds" (as defined). The best forms of saving are ...

1. Don't run up debts in the first place.

2. To the extent that you do (student debts, mortgage etc) then pay them off as quickly as possible, and pay off the one with the highest interest rate first. It is madness to have anything more than emergency money in the bank earning two or three per cent less interest than what you are paying on your mortgage. Ditto shares. The long run rate of return on shares is rather less than the average interest rate on a mortgage (unless you are a talented stock picker, which I am not ).

3. When, and only when, you are completely debt-free, do you start saving properly. Whether that's cash in the bank, currencies, shares or property is up to you - there's no right or wrong answer to this and you have to be prepared to shift from one to the other from time to time. This gives you the ultimate flexibility - you don't need to worry about retirement age, annuity rates, changes to the tax system, compulsory annuity age and the like. You are free to leave the UK taking everything with you, unlike a UK pension which will always be subject to UK tax at source, wherever you live

4. The value of any tax-breaks is largely illusory - to a large extent it is merely a timing difference/deferral, and most of the supposed tax saving is swallowed up by the pensions industry. And the value of this modest tax saving pales into insignificance compared to the loss of flexibility (see 3).

That's my plan, and I'm sticking to it. Don't worry about my old age, worry about your own :-)

Centre for Social Justice Part 5: Imprudence

Here's where we go from the sensible-but-timid to the downright evil.

I'm sure that it isn't news to anybody that saving (i.e. spending less than you earn, i.e. deferring consumption until later to smoothe out peaks and troughs) is pretty much the opposite of borrowing (i.e. spending more than you earn, i.e. accelerating consumption or acquisition in the hope that there won't be any troughs later on). Nonetheless, the CSJ manage to conflate the two in the introduction to Section 4.4 (pages 121 - 129 of 370, zip/pdf):

We have argued that the system is unfair in the amount of support it gives to different groups, and also that it discourages choices which are by and large in the interests of individuals and their children: the choice to work and the choice to stay in a couple when there is a child. Placed side by side, they highlight further the confusion that surrounds the welfare system.

Yup. All good stuff so far. Then they go on to claim that black is white:

There are other aspects which encourage what we might term ‘imprudence’. If a claimant has made some effort to save or to take a mortgage, then that effort is punished with decreased benefit. This effectively sends the wrong message: that one should not save and be prudent with money, as the Government will claw it back.

They discuss the 'savings penalty' at length and explain that benefit claimants who admit to having any savings end up considerably worse off than if they had none. They reckon that scrapping asset-based means testing would only 'cost' £1 billion a year and their final objective is "Over time, the savings penalty should become less stringent"

Wot? Why so timid? I would scrap any form of any asset-based means-testing on Day One, and seeing as the total cost of the welfare system is the best part of £200 billion, we can recover the 'cost' by simply reducing all flat rate benefits by half a per cent (or indexing them up by half a per cent less than inflation), job done. What's not to like?
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So much to the timid. They also discuss the 'mortgage penalty' at length (i.e. the fact that Housing Benefit doesn't cover mortgage interest - which is true; but the present government has invented half a dozen schemes that amount to the same thing - which they cheerfully overlook) and throw in a few irrelevant facts and downright lies in their conclusion (the numbering is mine and is cross referenced to my analysis below):

"... the ultimate aspiration remains home ownership...(1) Given the attention paid to, and historic Government support for, helping first-time buyers secure a foothold on the property ladder (2), it is unfortunate that at the same time it is unwilling to support the lowest earners who are left in poverty as a result (3). Those with low earnings who are trying to get onto, or stay on, the housing ladder are just as in need of support (4) as those in rented accommodation (5). We support reducing the mortgage penalty for low-earning households, not currently eligible for WTC, particularly in the current economic environment.

Objective: reduce the mortgage penalty for low-earning households.

If mortgages continue to be penalised, the Government will increasingly find that low-earners will opt for rented accommodation. This potential surge in the Housing Benefit bill can be avoided through supporting those who want to try to own their own home (6).

OK. Let's look at those irrelevant facts and lies in turn:

(1) Irrelevant. I'm sure a majority would like to drive a new Mercedes, send their kids to private school or go on three holidays a year.

(2) Lie. The government has done its best over the last thirty or forty years to restrict new construction to the bare minimum, in other words, they deliberately want to strictly limit the total number of home owners, and by restricting supply, push up prices for new entrants. Sure, we used to have MIRAS, but all that did was to push up house prices by an equivalent amount.

(3) Irrelevant. If people are "left in poverty as a result", then as a result of what exactly, pray tell? My answer would be "As a result of overestimating their future incomes and their willingness to accelerate consumption by borrowing money". I don't see why any government would feel that it is up to other taxpayers to subsidise them, that creates moral hazard, to say the very least.

(4) Lie. No, they're not "in need of support". I'm completely in favour of having a bit of redistribution that's enough to pay for people's utilities and food and a few quid for the odd trip to the pub or the cinema (of course I'm paying for it, but it's like insurance - if I never lose my job, I'm happy; if I lose my job and get some of my taxes back as welfare, I'm happy) BUT I passionately object to the idea of paying extra so that people can afford to buy/own houses, which, as mentioned is a negative sum game.

(5) Lie. I have already pointed that the CSJ fail to understand the fundamental difference between paying Housing Benefit to private landlords (which is another form of mortgage subsidy, is hugely expensive and should be scrapped forthwith) and some accounting tomfoolery between the DWP and local councils or Housing Associations. The overall cash cost to the taxpayer of keeping people in social housing is negligible (or might even make a small profit).

(6) Lie. There wouldn't be a "surge in the Housing Benefit bill" if we just scrapped Housing Benefit. Sure, everybody has to live somewhere, but seeing as the cash cost of social housing (as badly run as it is) is minimal, why not just use the saving to build loads of new social housing, and run it on commercial lines? As a free marketeer (and Land Value Taxer) I don't really like the idea of letting out state-owned assets at below market rents*, but if they built enough social housing, then by definition market rents would fall anyway, so ultimately, social rents would be market rents, making a sizeable contribution to the Exchequer. What's not to like?

So, as I predicted, the Tories are just as bad as Labour and will do anything to prop up house prices and protect the hallowed home-owner, remembering always that for every low income family who can only keep their homes because of subsidies, there's slightly more than one other family who ends up priced off the ladder (and who has the dubious privilege of being forced to pay for the, er, dubious privilege).

* To avoid hardship cases, those on low incomes could have the rent they pay capped at twenty per cent of their income, i.e. they would live 'rent-free' and pay an extra twenty per cent PAYE on their earnings, which, administratively, is an absolute doddle. I have thought this through, you know.

Financial Times talks sense, talks shit.

Sense:

... banks must also be made safe-to-fail. Credible bankruptcy regimes which force creditors to automatically swap their debt for equity should be introduced... The goal should not be to restrict business, to cap the size of companies or to vindictively cut profit margins. Rather, it should be to prevent growth in the financial sector if it occurs in ways that rely on implicit public guarantees.

All good stuff, it's all long been in the MW manifesto.

Shit:

If households and businesses cannot borrow, they cannot spend or invest, leading to a downward spiral in demand and in prices.

Wot?

There are plenty of people who have never been in debt (e.g. who rent or live with their parents and don't even have a mortgage) who still go to work; create wealth; earn money and then spend it. It might take them a bit longer to acquire larger items (aka "investing"), it's called "saving" but over a lifetime, they will probably "spend" more (and hence encourage more wealth creation by others) than another individual who borrows and spends willy-nilly, because the latter individual will be spending a large chunk of his future income on loan interest.

Similarly, businesses that can leverage up can expand faster than otherwise; but are far more likely to go *pop* and cause far greater damage when they do than a business that grows organically.

"Consumers struggle to save"

"Encouraging people to save" via tax-favoured savings schemes - TESSAs, PEPs, ISAs, Child Trust Fund, Individual Savings Account, Pension funds (and depending which bunch of morons fails to lose the next General Election, either Lifetime Savings Accounts or Savings Gateway) - is one of those mantras that economically illiterate politicians like to trot out when they can't think of anything else interesting to say.

UK banks* love this, of course - people are so bedazzled by the thought of earning interest 'tax free', that instead of doing the sensible thing and paying off their mortgage as fast as they can, they commit some of their disposable income to 'saving'. Banks of course are just middlemen - they pay depositors 5% and charge borrowers 6%. So a 'responsible saver' with a large mortgage and some money in an ISA is in fact paying the bank 6% interest on debts he could have paid off in order to earn 5% on money that he could have used to pay off the mortgage ...

Let's face it, this is all crap.

The economically literate person will pay off debts and/or save (i.e. spend less than they earn) when they are working, and will run up debts and/or use up savings (i.e. spend more than they earn) when they aren't working (i.e. while studying, unemployed, at home with young children or in retirement). The 'cost' of foregoing £1 of spending when you are earning is far less than the 'benefit' of being able to spend that £1 when you aren't. That much seems uncontentious.

Similarly, some people are naturally cautious, and end up dying with £[loads of money], they have saved too much. Others fritter away each pay-cheque within a day or two and spend their last days alone, shivering in a council flat, they didn't save enough. That's just human nature, which no amount of social engineering can change.

There is a balance to be struck here - glossing over the natural desire to leave a few bob to your children or grandchildren, or to have some rainy day money - the ideal savings rate (taking the population as a whole - bearing in mind that people at different stages in their lives will be saving and dissaving at the same time) that would maximise the utility of each individual (and hence to society as a whole - society merely being the sum total of all of us) is thus, to the nearest whole per cent, absolutely nothing, nil, zero, nix, nada, niente, rien**.

* Yes, the Nationwide is a building society not a bank, but their 'research' is what sparked this off.

** The fact that with a growing economy, The People as a whole become wealthier with time is another topic.