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The REAL Fix For the Economy--Savings

From CNN Money.

"The Treasury is borrowing $862 billion in funds that families and governments don't need to use now, and hence are saving. The federal government is then spending part of it quickly and returning the rest, through programs like the "Making Work Pay" tax rebates, to consumers most likely to spend it. The rationale is that all the extra outlays in these two categories will raise GDP far more than if all of that money had flowed to places where savings go, into corporate bonds, stock offerings, CDs, or bank deposits.

But the plan contains a gaping hole. The rub is that savings, just like the dollars government channels into salaries and auto fleets -- and that consumers lavish on restaurants, tourism and computers -- are all spent. They're simply spent on different things, namely corporate investment for research, robots and software. Hence, a dollar transferred from savings to consumption doesn't add to total spending, or to GDP, at all."

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"Let's assume that the government never borrowed that $862 billion and that the money stayed in the hands of American families and foreign governments. Remember, all of that $862 billion is being spent under the stimulus by our government or consumers. If the savers simply kept the money, all of it would remain as savings. So those dollars would flow into the banks in savings accounts and CDs. That money would then be available for the banks to lend, chiefly to large and small businesses."

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"The answer is that banks are in the business of collecting interest, and would indeed lend the extra deposits. "Money never sleeps," says J.D. Foster, an economist at the conservative Heritage Foundation, borrowing a line from the title of the new movie "Wall Street II." How would that money make its way to private investments in a market where demand for capital is extremely weak?

It would happen in two ways. First, the supply of savings would surge, and government borrowing would be far lower. So the pool of funds available for companies would increase, and the competition for those funds would fall. As a result, interest rates would drop even below today's bargain levels. Lower rates would reduce financing costs for companies, making it more attractive to buy everything from forklifts to new systems for logistics.

It's not that America would produce more goods and services. It's simply that a larger slice of the same pie would go to investment, and hence capital equipment. Once again, Obama is simply transferring the same dollars from cars to, say, forklifts."

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"Demand for loans is indeed extremely weak. The businesses "screaming for credit" fall into one of two categories. First, borrowers who are facing severe financial problems due to the recession, and are no longer creditworthy. Second, small companies typically had a single bank that knew their credit, and trusted their leaders. Many of those banks disappeared during the financial crisis. Hence, a number of healthy companies can't persuade one of the remaining banks to establish a fresh relationship, and start lending them money.

But for most companies, the problem isn't the availability of loans at all. It's their reluctance to invest for the future. Right now, most companies are borrowing simply to finance their inventories and replace worn-out equipment. Any plans for expansion are now on hold.

To ignite a strong recovery, the U.S. needs a surge in both consumer spending and private investment. In a good recovery, consumer spending contributes around 2% to GDP growth and investment gives the extra juice by adding another two points or so, bringing the total to 3.5% or 4%. Consumer spending is already near the levels needed for a decent rebound. The problem is investment. Once again, simply reducing government spending and borrowing will not add to GDP right away. It will simply subtract the same amount from consumption, leaving national income the same."

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"A convincing plan to reduce spending would give corporate America a shot of confidence. It would banish fears that taxes will rise sharply and sap earnings. Companies also fret that interest rates will rise dramatically as the government absorbs most of the pool of private savings, forcing manufacturers and retailers to pay dearly for what's left over. Those high rates, in turn, will raise the threshold for what qualifies as a profitable investment. Less borrowing and more savings would do the exact opposite, and open a galaxy of lucrative opportunities.

"If incentives change, growth can pick up in about ten minutes," says John Cochrane, an economist at the Booth School of Business the University of Chicago. The reason is simple: As a leap of faith, companies start to produce more products, confident they'll be able to sell them to consumers who work more hours and companies that keep more of their revenues. The important thing, says Cochrane, is that families and companies feel that the changes aren't a one-time gimmick, but will lead to durable increases in their incomes. "Investment rises first," he says. "Then people work longer hours. Then families have more money to spend, and consumer spending rises along with investment."

This spells out exactly how savings and productivity will save the economy.

Posted by Cute at 5:47 PM

Labels: economy, financial (non-tax), politics