One Man’s Savings Is Another Man’s Debt

COVID-19 was declared a global pandemic by the World Health Organisation on March 11, 2020. Since then, stock markets around the world rallied, to a great extent, fuelled by stimulus packages ranging from conservative to absolute bonkers. Cryptocurrencies reached heights it hadn’t and such is its decentralised nature that Twitter activity of a certain ‘Technoking’ of a certain company was sufficient to send it back to previous levels (Crypto Investments clearly aren’t for the faint-hearted). The # of IPOs in the US more than doubled y-o-y with 494 IPOs raising $174 billion (a 150% increase). Half of the IPOs were backed by SPACs which is short-form for ‘I don’t do anything specific. But you buy me. I buy them. That way you technically own them’. Digital art sold for really large amounts and the buyer does not receive a painting or a print. It remains intangible and is stored on a digital ledger, but it can be bought and sold (highest as of date is ~$70 million for the first 5000 digital artworks of Mike Winkelmann, professionally known as Beeple). Impressive, yet the figures are mind bending.  

During the same time, the collective wealth of the world’s billionaires went from $8 trillion in 2020 to $13.1 trillion in 2021. There are 2,755 billionaires this year, an increase of 660 from 2020.

In 2005, the then Fed Governor, Ben Bernanke spoke about “a global saving glut”, i.e., countries like Venezuela, China, and Korea were increasingly investing their surpluses outside their domestic economies, specifically in US government bonds. His gripe was how it was upsetting US current account deficits. At a fundamental level, this has different effects on the economy including lower interest rates, which spurs domestic borrowing. 

Except, it’s not just surplus economies that are allocating capital to this effect, the savings of the ultra-rich is also having the same effect. The surplus from the economies that he listed fund only a half of the “safe, US-dollar denominated assets”. The other half is funded by the richest Americans. 

A study titled ‘The Saving Glut of the Rich‘ published in February 2021 by Economists Atif Mian, Ludwig Straub, and Amir Sufi (from Princeton, Harvard, and Chicago Booth, respectively) studied how the choices of financial asset allocation of the wealthiest 1% in the US affects the dynamics of government and household debt. That is, how government and household borrowing is funded by the surplus of the rich. 

The authors arrived at this through a process they call ‘unveiling’.

The basic idea is to remove the veil of financial intermediation to see who ultimately holds claims on financial assets such as household and government debt

What the authors found was over two-thirds of the increase in financial assets of the wealthy is allocated towards future claims on US government and household borrowing. 

How the savings flow into government borrowing is relatively straightforward. It gets a little tricky when it comes to the how it flows into household debt.  

It occurs through the equity markets. Over 50% of the stock market value is held by the Top 1%. The investments into these public corporations is spent towards productive investments, resulting in increased economic activity. So far so good. However, these companies do not invest all available capital and transfer some of it (surplus income, technically) to a ‘rainy day’ fund. This consistently occurs alongside a simultaneous reduction in corporate spending, significant of which is lower allocations towards labour and capital expenditure.

In 2014 figures … that was equivalent to $600 billion less going to workers and $600 billion less to plants, property, and equipment—and $1.2 trillion more to profits

This ‘rainy day’ fund comprises of highly liquid, short-term investments or time deposits. The figure is slightly shy of $4 trillion in cash or cash equivalents in 2017, but significantly up from $1.2 trillion in 2010. 

This money is in turn lent out by banks to households in the form of mortgages and consumer loans.

The need to stow away surplus for another day is perfectly understandable from the point of view of public corporations. Given the uncertainty during and after the global financial crisis, only aggravated by the current pandemic, it seems prudent to sit on a war-chest of highly liquid investments.

If the flow of funds is perfectly understandable – that the companies are retaining optionality to see through uncertain times, that the ‘saving glut’ is meeting the credit demand of households, is there a problem at all?

I am afraid there is. This ‘saving glut’ is inadvertently causing an overall economic stasis, and increasing household debt. 

The fundamental purpose of financial markets is to deploy surplus income to enable economic expansion. Economic expansion is an increase in level of economic activity – in the level of goods and services. This could occur through government spending or household spending, including credit-driven expenditures on real-estate and consumer products.

Assessing efficiency of public spending is difficult. A close proximate is measuring improvements in human development and economic indicators. There is a lot of distortion around this, especially in the context of different financial and public health crises and limited to nonexistent buffer to lower interest rates and stimulate economic activity. Government spending is political and partisan when the stimulus packages come with difficult to measure outcomes. We can only reasonably ascertain an approximate degree of influence, and cannot attribute to government intervention.

It could be argued that buying a home is a very real part of the economy. A home is constructed through procurement of physical goods and services. I would very much agree with its utility to the economy at the time of construction. This becomes less the case if we consider asset speculation and inflationary pricing in secondary markets, resulting in transactions that far exceed the inherent value of the asset. Servicing a mortgage has a direct effect on how much a household can spend on other goods and services.

This drop in spending depresses the aggregate demand of the economy, from a lower economic activity. Reduced spending affects revenues and profits of public corporations, which will result in these companies further tightening their purse strings.

Low interest rates during these times mean banks are aggressively selling credit at attractive terms.

This results in a self-serving cycle of unproductive lending and sluggish growth. 

How does one go about rectifying this externality? The authors speak about tax reform for the rich. The current narrative revolves around wealth tax and a progressive taxation regime. These suggestions have its fair share of critics – both in the academic circuit as well as in power centres. Specifically in the case of wealth tax, a few countries in Europe implemented it and was widely prevalent in the 1990s. Most of these countries rescinded it, because it was problematic in design and difficult to implement. The rich relocating to countries with favourable tax regimes did not help the cause either.

The credit demand among households seems like a better place to start.

For one, banks and other financial intermediaries could dial back on the ‘push marketing’ that is currently rife, something that encourages more and more of their customers access credit easily. Access to easy credit is definitely a positive thing, but is outweighed by the problems caused by its end use. Assessing end use for mortgages isn’t a concern, but it is quite difficult to say where some blanket consumer loans and personal loans are used towards. Portions of them could very well end up in speculative asset purchases in the financial markets or alternative asset classes such as cryptocurrencies. Addressing this will additionally involve better financial awareness among households. An intervention with networks of financial advisors will be warranted. 

The other place to intervene seems to be with the pile of cash that companies are sitting on. A practical way to make a dent on this is through shareholder activism and active ownership. The results of the Exxon Board Elections has set a wonderful precedent on climate activism by investors. It offers a promising route to influence corporate action on subjects where regulators are inherently restricted or regulations lack the necessary bite.

And finally, the most important aspect of addressing this ‘saving glut’ is to bring it to the attention of policymakers, public corporations, the top 1% and other key stakeholders to this narrative. It is necessary to flash sufficient light on the repercussions arising out of this and how this is resulting in sluggish economies and an economic stasis. Identifying and educating about a problem is the first step to addressing it.